The key to lowering transaction costs

Summary:During a panel discussion about distributed business at SuperNova 2005, Philip Evans of the Boston Consulting Group (BCG) and author of "Blown to Bits: How the New Economics of Information Transforms Strategy," offered up some basic principles for business success, which he defined primarily as lowering transaction costs.

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During a panel discussion about distributed business at SuperNova 2005, Philip Evans of the Boston Consulting Group (BCG) and author of "Blown to Bits: How the New Economics of Information Transforms Strategy," offered up some basic principles for business success, which he defined primarily as lowering transaction costs. He defines transaction cost in two parts: "First, it's the time and effort expended to reach an agreement, and secondly, it's the difference between the value to the parties of the actual agreement reached and the value of an optimal or rational agreement. For example, if I am an insurer and insure your house, you have less incentive to protect your house against burglary or fire. We both lose. If we have an agreement where you promise to make a best effort, you could get cheaper insurance and we are both be better off." 

Evans shared his principles for lowering transactions costs:

Technology needs to be simple and pervasive: For example, Linux is written using e-mail and list servers. Wikis and blogs enable rapid development of dialog and communities. Fundamentally, humans won't use tools that are complex and unwieldy unless the reward is sufficiently attractive, and even then the "transaction" cost is very high. Evans noted that many companies are looking to replace traditional, sophisticated knowledge management systems with wikis.

Common intellectual property: Certain kinds of intellectual property can be shared, such as via the GPL and other open source licensing schemes. Toyota protects its unique automotive technology, but its process knowledge is treated as common property, Evans said. Just as companies have to figure out what business processes to maintain in house and what to outsource, they need to determine how the ecosystem can be enabled by shared knowledge.

Scientific discipline: Focus on trial and error. The key is having a disciplined approach and reporting the results of experimentation so that the lessons can be applied in successive iterations of the project or product.

Granular diffusion of information: For example, use blogs and wikis, not corporate PowerPoint presentations, to enable small, frequent granular communications. Because of the dialog, a rich semantic--the shorthand signature of a rich and productive community--can develop. It encourages transparency, visibility, trust and a higher frequency of transaction, Evans said.

The end result, Evans said, is lowering transactions costs and expanding the rate of innovation. The scaling of the network drives down transaction costs, which in turn drives scaling of the network. It's a virtuous circle, but putting the principles into practice requires major introspection and effort, he said. BCG works with companies by deconstructing the way people work and interact into four networks: a  transaction network that enables productive activity; a trust network that establishes relationships; a communication network of messaging and conversations; and a power network, with organizational structure and accountability. "A disconnect, such as having high trust, but low transaction, means that the organization is lacking in collective motivation," Evans said. 

The concepts are related to an earlier presentation at Supernova given by John Seely Brown from his book penned with John Hagel, "The Only Sustainable Edge: Why Business Strategy Depends on Productive Friction and Dynamic Specialization." I had seen the presentation previously, but I gleaned a few new nuggets. He talked about leveraging the "extreme distinctive expertise in each part of a supplier ecosystem," and  learning architectures--how participants in a supply chain learn from each other going down the value chain in the ecosystem. He describes the phenomenon as "orchestrating learning left, right, and sideways."  

The four networks that Evans described fit well with the Seely Brown/Hagel sustainable edge concepts. In working with extended supply chains, Seely Brown said, "You have to work from an influencing point of view and the leverage assets you don’t control--it requires a change of mindset." The mindset for lowering transaction costs or creating a sustainable edge can be enabled by emerging collaboration technologies and services, but without a cultural change, as expressed in the principle Evans outlined, companies will end up losing their edge and increasing transaction costs...  

Topics: Networking

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