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The Daily Sabbatical/Rotman | Jul 3, 2010 | 4644 views

Opening Up the Boundaries of the Firm

For decades, received wisdom has been that the optimal way to organize production is via the firm, internalizing upstream and downstream functions and expanding around the world
Opening Up the Boundaries of the Firm

M

any executives have been eagerly awaiting the return of better business conditions. But in doing so, they may have overlooked a significant source of growth and productivity that is emerging right now: new economic models that are redefining the relationships between firms and consumers.

New economic models, underpinned by an array of technologies, are emerging in which traditional relationships between firms and their consumers are being simultaneously dismantled and redefined. In these new models, individuals are becoming involved in the production and innovation process; they are sharing information and opinions about products and services; and they are combining in different ways to create content in peer-to-peer markets.

At first glance this seems to run counter to our understanding of how markets function. Traditional explanations such as Ronald Coase’s Theory of the Firm emphasized the central role of the firm in production, owing to its efficiency in keeping transaction costs low. Later theories pointed to the benefits of economies of scale and scope. For decades, received wisdom has been that the optimal way to organize production is via the firm, internalizing upstream and downstream functions and expanding around the world.

The firm is and will remain the central entity for production in markets; but firms are now part of a more complex ecosystem of productive activity made possible by an array of information technologies, such as cloud computing, advances in mobile technologies, social computing, remote sensors and advanced analytics. In this ‘ecosystem’, the relationship between firms and consumers has changed, leading to new forms of interaction and the ability to create economic value in six new ways.

1.    Co-production is allowing companies to harness the ideas, tastes and productive powers of customers and individuals across the world. Danish toy maker Lego has launched an online customization platform where its customers can assemble lists of components for their own designs, which are then made available to other customers.

Marketocracy, an investment-management and research firm, crowd sources its mutual fund investment strategy from more than 100,000 model portfolios run by amateur investors. These models of co-production and open innovation offer businesses a two-way gain: the potential to drive R&D productivity levels up while increasing consumer utility by allowing consumers to have greater input in the design and production phases.

2.    New bridges between producers and customers are enabling businesses to access markets in places where geographic or economic distance had previously kept supply and demand apart. Zain, a mobile telecom company based in Kuwait, has partnered with Citibank to offer mobile phone banking services in rural parts of East Africa. New intermediaries are also emerging to facilitate the productive activities of others: InnoCentive, the innovation platform, is one such example (see sidebar). Information technologies are also allowing businesses to cater to a wider variety of tastes and needs – for example, in the sale of music or books – helping them serve the “long tail” of niche markets.


3.    New forms of business-to-business commerce are becoming technologically possible as changes in the capability, reach and cost of IT allow the aggregation of small pockets of demand for business services that were previously uneconomic to serve. Li & Fung, previously a trading company, now offers other companies sophisticated procurement services. Amazon, known for its online retail presence, now provides others with data warehousing and application platform services. Technologies are therefore creating an environment of heightened specialization for B2B commerce. This presents a range of opportunities, particularly for small companies, which can now take advantage of the benefits of scale previously enjoyed only by large businesses.

4.    Consumer-to-consumer content is being unleashed as groups of like-minded individuals use IT to share information about products and services. Historically, it was very time-consuming and expensive for consumers to compare products: information was expensive, difficult to reproduce and often proprietary. In response, large firms created strong brands to signal product quality and utility. However, technologies have changed this, and now, information is increasingly a non-excludable, non-rivalrous (i.e., public) good. On TripAdvisor’s website, for instance, people can discuss the experiences they have had in different restaurants and hotels, shifting the balance of power from the hospitality sector to the traveller. In this way, consumer-to-consumer content has reduced comparison costs and empowered the ‘virtual crowd’ – since it is now a key indicator of consumer utility.

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