What's So New About the New Economy? -- Brian Silverman -- Rotman School -- Lifelong Learning, June 7, 2002, 11:20 a.m.

What's So New about the New Economy? Waves of Innovation and Their Effect on Strategy, Organization and Competitive Advantage

Brian Silverman, Rotman School

These participant's notes were created in real-time during the meeting, based on the speaker's presentation(s) and comments from the audience. These should not be viewed as official transcripts of the meeting, but only as an interpretation by a single individual. Lapses, grammatical errors, and typing mistakes may not have been corrected. Questions about content should be directed to the originator. These notes have been contributed by David Ing (daviding@systemicbusiness.org) at the IBM Advanced Business Institute ( http://www.ibm.com/abi ).

Introduction by Sridhar Moorthy

• Associate professor of strategy
• Back from HBS
• Ph.D. from Berkeley, then assistant professor at U. of Toronto.
• Wanted to go to Boston, taught at HBS for 3 years
• Undergrad degree from Harvard in economics, MBA from MIT
• At Berkeley, studied under Oliver Williamson
• Has won a lot of teaching awards.

3 apologies:

• American.
  • Flew back last night, and was detained at the border.
  • Otherwise would have had more slides.
• Selfish: could present something fairly thought-out, or could present something still percolate, and elicit.
  • Today, presenting things that are being formed.
• One slide missing from the handouts.
  • Definition of transaction costs.

Transaction costs: costs of exchange, frictions in the marketplace

• Doing a task, want to exchange with people who are doing a different task.
• Could have different incentives.
• Don't necessarily care about the other person.
• Firms formed because of transaction costs, sometimes because it's easier to do than inside the market.
• Suppose a river, with a widget factory, but big city is downstream.
  • Widget factory would like a rail spur built from the factory to the city.
  • If you're the railroad, could sign upfront.
  • Huge fixed cost, but small marginal cost.
  • But then if the factory decides that he will only pay cheap, ongoing, then need to write a contract.
• Price depends on:
  • Economic incentives
  • Reputation, based on trust and "hostage"
  • Are there safeguards in a court of law?
    • Depends on efficacy of enforcement, which depends on law, and transparency of information.

Transaction costs can influence other ways

• e.g. textile producer weaves, then have distribution.
  • Putting out system: drop off some threads to a woman and child at home.
  • Contracts with people in the big city.
  • All marginal costs
  • If a dispute, easy to find a new labourer.
• Innovation: capital-intensive production
  • But who's going to buy the equipment?
    • Worker won't want to put it out.
  • Producer will tend to buy the equipment, and turn the labourer into an employee.
  • Since high fixed cost, the producer wants to keep it utilized.
  • Then may get change in forward chain, into distribution.
  • Thus, transaction costs can influence industry structure.

Never quite persuaded by irrational exuberance, nor pessimism.

Idea was: new opportunities, "blown to bits", old rules don't work anymore.

• Professor at Carnegie Mellon changed title from Professor of Strategy to Professor New Economy (and may change back).
• Centered on dot-com.
• e.g. http://www.pulver.com/million/ lists who the new millionaires are.

Then dot-com bust

• Synonymous with startups?
• Internet site: Why the New Economy Failed?
  • Because the old economy kicked its butt
  • http://www.liquidgeneration.com

Silverman view: The new economy isn't new

• Can see a lot of phenomena around new technologies
• e.g. railroads.
• Other subtle, but enduring effects.
• When the think systematically about how a new technology impacts the economy, should think about how it changes the range of feasible strategies?
  • Changes in costs in production, distribution, and transaction costs?
• New economy isn't new, but they're the first to reduce the transaction costs in a net way.
• Previous ways made scale more important in production, and scale and scope in distribution.

Roadmap for today:

• History of the North American economy (U.S.)
• Will draw on
  • Kondratieff, long waves
  • Schumpeter
  • Chandler

Kondratieff, 250 years of history

• Long waves of 50 years
• Boom and bust
• Marxist economists
• End result: end of capitalist.
  • Still on web, Trotskyist say another 10 year.

Schumpeter: named as the most radical economist of the century.

• No point to studying equilibrium, waste of time.
• Studied innovation.
• What drives innovation is bunches of innovation that enables business to do things in whole new ways.
  • water power --> textiles and iron
  • steam power --> steam, rail, telegraph
  • electricity
  • electronics
  • microprocessor
• In the last 50 years, questions:
  • Do waves exist? Do they affect booms and busts
• Unasked Silverman questions:
  • What are the implications of long wave technologies.

Silverman view:

• Each pervasive change affects all companies that can use the tool
• It's a mistake to focus just on the new companies
  • Should also look at other companies

Beating the dead horse slide

• Wave --> change in cost --> change in industry structure.
  • Can we do the change in alliances, or firm structure -- change in transaction costs

Comment: What about the crash of 1929?

• Kondratieff people would say it's exaggerated wave.
• Chandler would say: resources are exhausting themselves.
  • Sufficient irrational exuberance below.
• In 1870, the depression was just as bad.

Railroads:

• First job in consulting was on transportation industry.
• Alfred D. Chandler: first study on railroads.
  • Had priviledged access to Dupont archives when he was young.
• 1977: The Visible Hand, about the rise of professional management
  • Big administrative enterprise with hierarchy could have been done, but it needed to be more efficient than market coordination.
  • This required new technologies that made it more efficient to produce in one place.

Railroads 1790 - 1840

• Production was typically artisans, with 3 or 4 apprentices
  • Might be able to "put out" to families with extra children
  • Some early labour-saving machinery, powered by people or mules, water or wind -- limits to production
• 1830s McLane report on production
  • Most companies less than 10 people, virtually all less than 50 workers

Railroads: Innovations of steam-powered locomotives, robust rails and telegraphs (to tell you a train is coming, stop!)

• Were initially complement to canals
• Put canals out of business: NY to Chicago 3 week by canal --> 3 days by rail.
• Huge excitement on the "new economy" of railroads.
  • Huge jump between 1860 and 1870.
• Railroads in 1850s capitalized around $10M, where as only 40 factories capitalized at $250K
• Formed the NYSE
  • Stock crash

From book: Eugene White, Crises and panics (1990)

• Opportunities for profit, but hard to evaluate future earnings.

Look at a different part of railroads

• Managerial challenges in coordination than previously -- compared to army and fur traders
  • e.g. Erie Railroad, 200 locomotives, 3,000 freight cars, but only one track.
• Telegraph becomes important
• Each railroad was going about 50 miles
  • Seems to maximize scale economies
  • But difficult for multiple companies to get coordination
• Railroads starting acquiring neighbouring companies
• Then, divisional structure, each for 50 miles of track
• First time, divisional structure.

Chandler: railroad moves more products, but users also get benefits.

• Production: Can sell to an expanded market.
  • e.g. beer expansion
  • Large plants
• Distribution: can carry more things
  • Latent economies of scale and scope
• 1864: $72M, 2000 employees, rise of large wholesalers

Impact on transaction costs?

• Reduction of transaction costs?
• Look more and more like capital intensiveness?

Comment: Economies of speed?

Silverman story:

• Scale economies in production
• Scale economies in distribution
• Transaction costs slight reduction
• Railroad technology pervades.

Conjecture:

• First three waves increase scale economies in production and distribution, and increased transaction costs.
• In the electronics age, agnostic
  • Still highly centralized information systems, continues to favour centralized management.
• In the new economy wave, would argue that transaction costs go down.
  • Not a lot on production economies
  • Mostly will reduce transaction costs.
  • Information codifiable, transmittable.

Comment: need an major investment in infrastructure in waves, or will they create dividends that have to wait for? Do we need to invest, and then invest again?

• Technology is what it is.
• All organizational innovations haven't been explored yet, but are in the age of being perfected. People are grappling with it.
• The need to wait for the next wave of technology.

Comment: Transaction costs, and the number of transactions, as the costs go down and the network increases.

• Transaction cost reduction doesn't mean that life gets easier, or that the cost of business goes down.
• Interesting work on joint ventures, versus property rights in the country

Comment: Technology and price/benefits?

• 1840 - 1910: Cost of carrying something on the railway fell 90%.
• Moving to mass customization is different from transaction costs.

[Skip over slides to last slide]

Implications for managers:

• Need to think about re-tooling firms.
• Assert: different sets of skills
  • How do manage someone without authority?
• Need different organizational systems.
• Can learn from past technology waves.

Implications for business schools

• Need to retool business school
• Distance learning?

Good news: fall of the dot-coms is not the fall of the new economy

• We live in interesting times.