Innovation and Bubbles: The Curious Case of the American Economy

The New York Times series on Apple and its supply chain is eye-opening, much discussed for its lens into the global and American economy through the story of one of our most innovative companies.

Here is what I take from it.

While America continues to set the bar in innovation, the mass of the manufacturing jobs created from that innovation are outside the US due to wage arbitrage and labor “flexibility” as well as skills shortages (although I doubt that skills training and eventual parity would bring the bulk of the jobs back because of the first two factors mentioned).  So ironically, while the heart of a lot of innovation is in America, it only creates so many jobs as compared to the historical non-globalized economy, i.e., the historical manufacturing economy like the auto industry used to employ a lot more Americans in a non-globalized economy.  It is what it is, and I am not sure what the solution is, but sadly from a macro-economic perspective, job creation-lite is a major reason for why we  have become dependent on fueling and sustaining asset bubbles, particularly in housing.  This is true for both jobs and wealth.  In terms of jobs, construction jobs are some of the last decently skilled positions for folks with an average or no education.  In terms of wealth, as wages have stagnated up and down the income ladder, the “wealth” from inflated asset values has also been the fuel for spending, replacing the missing wage growth.

Consequently, from a macro-perspective, large portions of the economy have been relying on the non-innovative parts of the economy for wages and wealth in order to enjoy the fruits of the innovation economy.  That means that part of the solution in the near-term is going to be reinflating the asset bubble.  And unfortunately, that’s not a great long-term solution to this paradox in our economy.

The Lessons of Rogue Supreme Court Advocates, Github, and Frictionless Markets

One of my favorite stories of someone breaking open the doors of a closed guild is that of Tom Goldstein, now a leading Supreme Court advocate.  The full story, worth reading is here, but the very short version is as follows.  The Supreme Court bar is the most elite of elite places, generally not open to those who have not clerked on the Supreme Court.  Goldstein, not a graduate of the most elite schools much less having a Supreme Court clerkship, but blessed with skill and passion, did the uncouth thing of actually finding parties with potential Supreme Court cases, calling them to ask for the work.  This attitude earned the affection of future Chief Justice John Roberts — at the time a leading Supreme Court advocate with the right credentials —  who said something to the effect that if he needed a heart surgeon, he wouldn’t hire one who called him looking for business.

So what does this have to do with using the internet to create more efficient markets. What if you had a market ecosystem that:

1. Empowered artisans to create and establish their reputation such that they can compete with and even outcompete the incumbents and big guys, so that guild-like barriers come down and the number of suppliers in the market is increased;
2. Provided a marketplace where big guys and small guys all compete with each other and customers are empowered with tools to  evaluate the available offerings side-by-side at procurement;
3. Collected and provided metrics and other data to customers on whether a task is high-value, low-value, how much it has cost before, etc, to solve market signal asymmetry;
4. Enabled the sharing of information in a community of customers, including the reuse of off-the-shelf information (like asking a friend for help who has already taken a course) and assistance through recommendations and sharing of best practices for procurement and accountability.

My bet is that the sum of these characteristics — more suppliers, more information on skills and pricing flowing from the supply side to customers, and more customer discussion on matters and suppliers — would revolutionize an existing market.  This is made possible by creating a community where suppliers and customers engage with each other.

First, by utilizing social dynamics through a github model, you increase the number of competitors by encouraging and empowering suppliers, in line with the general societal trend toward a freelance economy, where a lot of talent sits dis-aggregated from large institutions.  The best expertise is no longer just at brand-name organizations and firms.

Second, by empowering talent to demonstrate skills and establish prestige, the marketplace also empowers customers.  Customers can harness the competition in a marketplace attached to the github.  Initially, the old guard of customers — nervous to use newcomers — will continue relying on the establishment service providers.  Still, even the cautious can use the newcomers, bringing them into the competition, for comparison pricing to discipline the rates that they obtain from their establishment providers.  Other customers, more on the cutting edge, will take a shot with the young Turk suppliers.

Eventually, like with disruption innovations generally, the niche — demeaned at first — will become the market, as it is proven that services can be provided better and more cheaply, through a better market mechanism that mediates between and among customers and suppliers, enabling the frictionless spread of information (both market signals (product quality and price) and substantive content).

The Github Template to Reduce Information Asymmetries

If you are a programmer, chances are that you love github.   Github is the enormously impressive host of millions of code repositories (almost 4 million at the time of this post).  It describes its mission as “[making] it easier to collaborate with others and share your projects with the universe” and “lowering the barriers of collaboration by building powerful features into our products that make it easier to contribute.”  By offering public repositories for free and charging for private repositories, it incents keeping code public, allowing the sharing and building on code.

In all its incentives to be as open and collaborative as possible, the “github” model is another framework for an engaged network of customers and suppliers which reduces information asymmetries.  The natural question to ask is how to extend this github model to create this open, collaborative dynamic in areas other than programming.

This is a useful model in the situation described in my recent post — professions that rely on models that evolve over time, where other members of the community can benefit by having access to those models, for reuse or adaptation, and where the contributor gains in multiple ways by sharing.  A github infrastructure brings the power of open-source collaboration to areas that can benefit from such collaboration.  Such a system should have the following characteristics among others:

• It should be modular down to a single unit, think a certain type of financial model or contract provision, and also be able to group units together so that the depositor can have a collection that can exist as a group, perhaps because the models interplay with each other, constituting a set, designed to achieve a particular objective, e.g., antitrust models by Joe Antitrust, Esq. for use in internet acquisitions as opposed to Sue Competition’s models useful in a natural resources industry; financing documents that are VC firm friendly or startup friendly; etc.

• One should be able to make it public to the world or private to a subset of the world, but public should be the default.

• Users should be able to take documents and “fork” off to make derivatives, so different users may take the same underlying state-of-the-art model and branch off in different directions due to use, preference, disagreement, etc. and changes should be tracked so an user can trace the evolution and forks.

• There should be metrics to identify the most popular models, so these are easily identifiable to users.  Popularity can be defined in many ways, including times downloaded, viewed, forked, utilized in significant deals, etc.

• These metrics should have the potential to convey prestige so that there is an incentive to contribute, as a means of, for example, breaking into a field that uses other relics of prestige to keep folks out.  So, to continue the antitrust example below, Joe Antitrust could establish credibility in a field dominated by lawyers at big firms, while Sue Competition, a relatively junior person at a big firm, could use her contributions as a way to establish her name instead of having to wait until her hair is gray.

Github models would be useful to contributors and borrowers, distinctions that would quickly blend, as all are participating in one creative conversation.  By reducing the asymmetries in information that support inefficient markets, prices in professions that were able to achieve robust utilization of this model should be able to drive down cost.

Facebook S1

Reportedly, the Facebook S1 is coming out next week.  We will have instant coverage and breakdown of the business model as we did for GroupOn, Zynga, and others.  There are also a bunch of historical posts on this blog related to Facebook valuation, which you can find in the Social category to the right.  This should be one of the most informative views into the business models underlying today’s Internet, and as such, is important even to those who do not plan to buy Facebook stock.

The iPad and Amazon Methods of Transforming Customer Behavior

One of the toughest challenges of disruptive innovation is changing customer behavior.  An entrepreneur might have a better way to accomplish something; yet he can scream at the top of their lungs, unheard, because user behavior is too entrenched.

Sometimes, one successfully takes on the antiquated user experience head on, tackling it mano a mono.  This requires something revolutionary whose  design is so intuitive that it “instantly” changes things.  Think the iPad, as an example, instantly establishing the tablet as a category, cannibalizing the laptop.

More often, user experience is harder to change head on.  Even hearing or seeing that your approach could be better, the mainstream user resists, consistent with Clay Christensen’s observation that the disruptive invention first looks like a toy, harmless to incumbent competitors, unappealing for mainstream customer use because it might have less features or power in its current state, but with a small niche use or customer base that finds it a better value proposition than the current user approach.  The new product then improves on the fast lane, while also establishing and proving itself, toppling the walls of entrenchment, such that over time it surpasses the incumbent way of doing things, taking users and leapfrogging incumbent competitors.  Think Amazon here.  It started as a seller of books and music, getting customers used to the strange notion of buying goods unseen, paying online, and waiting for delivery, appearing at first harmless to anyone other than books and music sellers, and certainly not to the Walmarts and Targets of the world.  In a decade and a half, Amazon now rules the retail world, with the former regents playing catch-up.  Customers now have changed their user behavior so much that Amazon sells everything A-Z, including things one would have never thought would have been bought online, delivering at times seemingly in a blink of the eye after pressing the “Buy” button.

It’s worth remembering that while the iPad and the Amazon experiences are both valid, the Amazon route is more common — mobile phones, Skype, digital music, open-source operating systems and software, Twitter, and on and on.  Just because you cannot win all your potential customer base at the start, or some part of your potential customer base does not immediately see the value, is not the death knell of an idea, as long as you have a niche to start with and a plan to get your product better.  Indeed, while there may be no other option other than the second route, it also carries the additional advantage of staying under the radar of the current incumbents.

Spreading Expertise Through Garage Sales

Valuable engaged networks of users can also be composed of suppliers.  In many professions and careers, there is much upfront investment spent in putting together models and plans.  Lawyers, consultants, bankers have precedents, teachers and professors have lesson plans, and coaches have playbooks.

Creating these precedent files, teaching plans, and playbooks tend to be more solitary than social.  In a networked world, this presents a tremendous opportunity.

Like other types of information, this information is meant to be shared, with extraordinary benefits to all participants in these ecosystems.  Consumers can mix and match better precedents and plans, improving the overall quality of such material in the marketplace.  Sellers can monetize their investment and expertise.  The net effect is to raise the overall quality of such material in the marketplace, to more quickly spread innovations, and to achieve time savings.

Teacherspayteachers is successfully doing this with lesson plans and other teaching tools.  This article has a nice writeup of its history and performance.  As the article concludes:

The most heartwarming part of the entire business is how it benefits everyone involved. Teachers are able to make some extra money, other teachers are given access to top-rated lesson plans, and students get the educational benefits from the best lessons available.

Information Asymmetry And Networks of Engaged Users

One of the fundamental assumptions of neoclassical economics is that market participants, such as suppliers and consumers, have all relevant information related to the transaction.  Economists have won Nobel Prizes for incorporating into economic theory the perhaps obvious fact that this is almost never a characteristic of markets in the real world.  The information that flows in markets, including the asymmetry of information between different consumers, different producers, and most importantly, between producers and consumers, is critical to the functioning and outcomes of markets.

The Internet, of course, can dramatically change an information asymmetry.  It’s fascinating to think of information asymmetry in the context of existing markets with massive revenues.  Take the professions for example.  Many professions — think law and medicine — are in large part about delivering information to consumers at extraordinary cost.  (Of course, licensing requirements mean that there are things — prescribing or appearing in court — that only guild members can perform.)

Information asymmetries play out in both the availability of the product itself as well as market signals.  In terms of product, personalized information often really means delivering standard information to multiple parties with the same issue or problem.  In terms of market signals, there are also asymmetries about market performance dynamics — such as price, value of the work, time required by the provider, quality and skill, appropriate expertise, other participants, etc.

While suppliers like to think that their high rates are about expertise and the product delivered, high prices may be more about the asymmetry between suppliers and consumers in having access to market signals.  Nonetheless, both product and market signals are an area of potential disruption of existing, fat markets.  Think of consumers banding together to share information, that is off-the-shelf, for free or low-cost, or to compare notes on how much something should cost or where a high-priced expert is truly required.  An independent repository and delivery system for information emerges as a player in the market, not necessarily replacing the existing suppliers but changing the market dynamics between consumers and suppliers.

Indeed, an internet where everyone is online, in theory should allow the frictionless spread of information, pushing down the cost, improving the quality, and accelerating innovation of information-based markets.  However, there is a practical reality.  The frictionless spread of information depends on — in a world of limited attention and time — being able to get users to use the Internet to participate in the creating and the delivery of the efficiency-creating information.  And that comes down to creating a compelling user experience.  This lesson is demonstrated through the consumer internet: the application has to make the user want to constantly “check in” on FourSquare or “post” on Twitter and Facebook, and participate in the spread of information.  Finding the user experience to produce a large and committed user base is the toughest part of disrupting an existing market.

So, in order for the theory to play out, a very practical product needs to be created that has a large and committed user base.  Once you have the user base, you can mold it to create better working markets — the savings from which are the source of monetization for the idea.  This is my interpretation of Union Square Ventures’ succinct investment thesis —  “a large network of engaged users that has the potential to disrupt a big market [outside the existing system].”  This other post, and particularly, the comments have great discussions of how this thesis could play out in two large, static markets — health care and education.

The Good, the Bad, and the Opportunities

One source of dissonance in the modern world is the paradox of life where, on one hand, technology is accessible to us at unimaginable price/power ratios in the form of iPhones, iPads, and TVs, but other things, often more basic, like education, housing, and health care, are getting more and more expensive, and consequently, less accessible.  This is at the core of a lot of our personal, political, and societal tensions today.  Larry Summers makes a keen observation in the FT this week:

The nature of the transformation is highlighted by the 50-fold change in the relative price of a television set of a constant quality and a day in a hospital over the last generation.  While it is often observed that wages for median workers have stagnated, this obscures an important aspect of what is occurring. Measured via items  such as appliances or clothing or telephone service where productivity growth has been rapid, wages have actually risen rapidly over the last generation.  The problem is that they have stagnated or fallen measured relative to the price of housing, health care, food and energy or education.

This dissonance is also a source of rich potential.  Solutions to magnify the productivity growth in these lagging areas — the basics and essential services — are rich wells of entrepreneurial opportunity.  Look for areas that have incurred above-average inflation and disrupt them!

Discovery Streams to Curated Sets

So, I’ve been thinking about what is “it” with Pinterest?  What’s the underlying insight to take away and extend?

As humans, we collect.  One way to create is to collect and display and organize other works in our own way, in ways both common and elite.  Think baseball cards, stamps, art, toys, wine etc.  Think museums, galleries, Trader Joe’s.  There is a creativity in the choices made for inclusion and exclusion.  In other words, one way we express ourselves is by collecting and curating.

Pinterest — and the concept of curated sets — fits into the Internet’s mega-theme of providing better self-expression tools.  I have blogged about how the trajectory of the Internet can be plotted as a map of better enabling the expression of its users and encouraging creativity and content production.  See here.  Curated sets provide another method, template and format for creating and sharing in a way that could be quick, easy,  meaningful, and satisfying.

This interesting post on the Elad Blog makes an important point on the power of a curated set.  The curated set is fundamentally different in moving away from the stream of Twitter and Facebook.

However, all of the social services continued to serve content as a time ordered stream.  Moving from a stream to a structured collectible set of content was the next innovation in social media….

Pinterest (launch 2010) was one of the first sites to take push button content generation (via bookmarklets and “re-pinning”) and structure it into sets of curated content called “boards”.  This allowed users to collect content from across the web, as well as from other users on the site.  In some sense it took what a site like Tumblr had been doing but transformed blog-like streams into structured, curated collections users could share.  Importantly, it was easy for new users to consume these sets of content visually as structured sets, and to share these sets with others.

It’s interesting to think how the stream has become so dominant today.  There is a place for the set as well.  The set brings more of a sense of unity and permanence.  The set allows the author to create and the user to consume a set of content that has unity around a theme, around the curator’s taste, distinct from the “stream” of disparate content based on the actions of one’s friends on Facebook or who they are following on Twitter.  There is also less of a transitory (blink and you will miss it, or alternatively, don’t look and it will take a long time to catch up) quality to the content with the curated set.  It doesn’t disappear downstream.  I bet this use case opens a number of interesting opportunities for business models across a variety of areas.

Context and Presentation

Sometimes, especially when data is concerned, we immediately think complication – algorithms, data science, and equations.  There is a place for that, but we can outsmart ourselves.  Often, simplicity wins the marketplace.  A good reminder about data plays on bryce.vc this week:

Here’s the thing. Data, big, medium or small, has no value in and of itself. The value of data is unlocked through context and presentation.

Context and presentation, and not only the data itself, make the difference.  Without it, the data is likely not to be seen as useful to the user, even if it could be, and without being useful and causing a change in behavior, the opportunity to create value is missed.