Data Network Effects in Enterprise – A Converse Coase Theory

Here are two comments that I wrote soon after attending the Fred Wilson talk on network enterprises.  These explain the commonality between data network effects and the recurring theme on this blog of intermediating talent through networks rather than enterprises:

Like the original post, this talk was EPIC. Not only learned a lot, but left me with a lot to chew on.

What I took away is that the key to network efforts is getting users to contribute “data” to the network to create something better for the user that is also defensible for the platform owner.

In consumer, it was about getting users to share “data” that they didn’t know they wanted to share. Facebook (posts, photos, etc.); 4Sq (location); Twitter (micro-thoughts).

In enterprise, it is complicated by the dominant default assumption, that “data” should stay within the four walls of the enterprise.

Finding ways to overcome that can yield so much market surplus, because it is in many ways, such a self-evidently wrong assumption.

I have been thinking about it as the converse of Coase — while the creation of the firm solved inefficiencies associated with transaction costs, it created inefficiencies related to “data” flow across enterprises. Networks in enterprise are the way to correct some of those inefficiencies.

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But in reaction to your talk, one thought that I had was that the notion of data network effects is the other side of Coase’s Theory of the Firm.

An overlooked potential corollary of his theory that a firm-based economy is a response to contractual transaction costs is that there is also an overlooked cost to efficiency in predicating an economy on the firm.  A firm’s first instinct is to keep things within its four walls, so knowledge flow is inhibited across the economy.

By finding ways to devolve enterprises into networks as an extreme case or force enterprises onto networks as the more common case, you fight that deadweight loss in our economy by transferring knowledge across firms across the economy.  Sort of like the pre-calc teachers finally sharing lesson plans with each other via edmodo or patients potentially sharing data among themselves bypassing drug companies and governments.  In the non-network world, this is what a lot of professional firms like McKinsey do — take knowledge and spread it around.

So perhaps, part of the network effects thesis in enterprise is freeing knowledge by using networks to group people in ways that are in addition to or in replacement of the firm.

The Opportunity in the Gap Between Mobile Hardware and Software

From my first computer, a TI99/4A to the PC clones we upgraded to every couple of years, the PC has tracked my life; getting more and more powerful, useful, and desired as I have gotten older.

This year, worldwide PC sales will dip significantly on a year over year basis.

In the last 3 decades, to the extent that this dip has happened before, it has been due to a weak economy.  This time, it’s more fundamental — people are ready and comfortable in giving up their personal computers due to smartphones and tablets.  And as happened with wired telephony, many poorer citizens of the world will simply leapfrog over the personal computer going straight from no computing power to a portable device.  The industry cannot count on growth, and it is a big reason why Dell, HP, and other big PC makers have hit a pothole.

This is a significant turning point, obviously.  The PC is losing its space on our desks and in our briefcases.

Often, opportunities lie in the gap between one part of the market and another complementary part.  One of these opportunities lies in the gorge that has opened between the hardware and some common software functions.  Specifically, despite the power and convenience of portable devices for email and the Internet, there is a big gap between changes in people’s preference and their ability to competently and confidently execute certain basic functions of the PC on portable devices, in particular, the typical office suite of word processing,  spreadsheets, and presentations.  To put some meat on it, I come up with my best ideas while waltzing around town on my phone, but if I have to turn it into a formal presentation, I still frustratingly need to sit and wait for my computer to boot up.

That is just one example of the gap between the preferred hardware and the lagging user experience, but it’s a big one.  As I have blogged before, I am still surprised that so little effort and progress is being made on this problem, when history (Microsoft, for example) illustrates how much durable market power is available to the companies that work and solve this problem even half-way competently.

The Middle Seat

As I noted a month ago, quoting Warren Buffett, airlines are a horrible business.  On the other hand, the business of selling airplanes to airlines is tremendous.

The same backwards logic applies to another business ancillary to airlines, the global distribution systems or GDSs.  The world’s carriers pay $7 billion to the GDSs, while the collective profits of all global airlines are only $3 billion.  On this blog where a topic of constant interest is the creation of electronic marketplaces, GDSs are an important case-study of a particularly successful example.  The Economist has put together a nice history of GDSs.  An excerpt:

At the dawn of the internet age, airlines assumed that the middlemen who came between them and their passengers were headed for extinction. Travellers would eventually buy tickets either from the airlines’ own websites or from price-comparison engines which hooked up directly to the airlines’ computers over the web. So why pay commissions to agents? And why continue to own reservation systems, especially since regulators had stopped them from fiddling with travel agents’ GDS screens to place their own flights at the top? So Lufthansa, Air France and Iberia sold most of their shares in Amadeus (the largest GDS); American Airlines sold Sabre; British Airways and KLM sold out of Galileo; and so on.

However, the loss of direct commission from airlines made travel agents more beholden to the GDSs, which not only slip them a share of fees but also provide their back-office computing. Many online travel agencies have come to resemble physical ones, signing up with a GDS which provides a reservations system and other computing power while handing them a commission (ultimately paid by the airlines) on every booking. Despite airlines’ efforts to make travellers bypass agents and come to their own websites, less than half of flights are booked this way.

Go Small

I’ve noted previously how, in enterprise and government (non-consumer) applications, the customer may have to implant the innovation into its supply ecosystem.  Nothing talks louder than money, and for IT customers, this means the CIO budget.  On that score, the WSJ reports that CIOs increasingly have the flexibility to move their IT spend from the IBMs and HP behemoths to the Silicon Valley upstarts, due to more responsiveness, more flexible pricing models, cloud computing, and general dissatisfaction with the titans.

This is also creating a number of exit options for these startups, as the behemoths try to buy their way to being more nimble.  As the WSJ notes:

Old-line tech vendors have taken notice. Microsoft in July paid $1.2 billion for Yammer Inc., which makes social-networking tools for businesses. IBM, Oracle and SAP have all spent billions for younger online software makers. And H-P executives talk about reinventing the company by expanding into three hot businesses that aren’t among its main ones today.