The Information and Services Economy a k a

The Information and Services Economy a. k. a. Business Architecture and Services Science IS 210 Profs Bob Glushko & Anno Saxenian UC Berkeley School of Information Fall 2006

What are services? Services: residual category that accounts for over 70% jobs and value added in economy l The Economist: “Services are anything sold in trade that cannot be dropped on your foot. ” l “There are no such things as service industries. There are only industries whose service components are greater or lesser than those of other industries. . . ” Theodore Levitt, 1972 l We’re all in services now, more or less. . . l

What are information-based services? Data and information of any sort can be considered raw materials, inputs l In physical form (book) takes great effort to search, retrieve, store, manipulate, transform l When digitized, information is: l ¡ ¡ ¡ Easily stored and processed – databank, data warehouse, data mining Easily customized, enriched, accumulated, transformed Easily distributed - infinite scalability

Drucker on the knowledge economy Industrial economy: scarce resource is fixed assets (capital, expensive machinery, tools) l Knowledge economy: scarce resource is talent: quality of knowledge & productivity of knowledge l Growing importance of specialists and specialized knowledge (v. generalists) l Shift from knowledge to knowledges: requires workers to work in teams (v. individuals) l

Drucker on the knowledge economy (II) “The essence of management is to make knowledges productive. ” l The 21 st c. organization will have to put as much effort into developing talent as to recruiting it Replace silo-based hierarchies with talent markets ¡ Allow workers to find new challenges & managers to identify talented people for new roles ¡ l Value of talented people goes beyond predefined tasks: building brands, relationships, reputations, and other intangibles (high value)

Industry v. services: a matter of degree

The two worlds or production Back stage l Product excellence and scale Division of Labor ¡ Standardization ¡ l l l Limits Controlled Product Process Zero Defects ¡ Scale economies Front stage l Solutions and customer experience ¡ 1 -off: Moment of truth Seamless interaction & integration Proximity to customers Zero defections Co-production ¡ Scope economies ¡ ¡

Theoretical foundations: the classics l Economics: Organize in firm v. market ¡ Adam Smith ¡ Ronald Coase ¡ Oliver Williamson l Production: How to maximize output ¡ Karl Marx ¡ Henry Ford ¡ Frederick Taylor ¡ Alfred Chandler

Adam Smith & the wealth of nations An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 ¡ The founding work of “modern” economics and political economy ¡ Written on the eve of industrial revolution in Britain l Smith’s main theoretical contributions: ¡ The wealth of nations is a result of increasingly specialized “division of labor” (pin factory) ¡ The “invisible hand” of self-interest/ the market insures that the process continues without role for organized intervention l

Ronald Coase “The nature of the firm” l Coase’s question: Why is there any economic organization? Why is economic activity organized into firms rather than by individual proprietors? ¡ For mainstream economists, prices and markets are exclusive mechanisms for allocating resources and coordinating economic activity ¡ When do organizations/ firms supersede the price mechanism, eliminate market, and allow “entrepreneur” to coordinate economic activity

Ronald Coase ”The nature of the firm” l Firm will expand until costs of organizing an extra transaction within the firm becomes equal to the costs of carrying out the same transaction by means of an exchange on the open market or the costs of organizing in another firm. Why? There are costs associated with using the market 1. Cost of discovering prices (imperfect information) 2. Costs of negotiating and concluding contracts for each transaction

Williamson: transaction cost economics l Williamson identifies key dimensions of individual transactions and maps every transaction to optimal (most efficient) institutional arrangement l Assumptions 1. In the beginning there were (efficient) markets 2. Bounded rationality: human behavior intentionally rational but only limitedly (Simon) 3. Opportunism: “self-interest seeking with guile” (economic agents use strategic behavior to gain self-interest)

Opportunism: the “hold-up problem” Classic version: Klein, Crawford, Alchian (1978) One party makes a relation-specific investment to transact with another (value is lower, or zero, to other uses than transaction between those parties) Impossible to draw a complete contract that will cover all possible issues that might arise in transaction – might affect returns on investment l e. g. Very expensive dies used to shape steel into specific forms needed for sections of body of a particular car model, paid for and owned by supplier Supplier vulnerable to hold-up; the efficient solution is vertical integration

Firm and hierarchy Advantage of firm for Williamson: Hierarchical relationships in which one party has control over both sides of the transaction and power to resolve disputes. A Hobbesian solution to opportunism: Market for Williamson is like Hobbes’s state of nature, and only possible resolution is through internalization of transactions within hierarchical structure Hierarchy: originally, rule by priesthood, heavenly beings; today, rule by single ruler with control over organization, authority passed through a series of subordinate rules, and so on through a pyramid.

Karl Marx on Capitalism l Karl Marx Capital: A Critique of Political Economy, Volume 1: The Process of Capitalist Production 1867 In capitalism, labor power is a commodity that can be bought and sold. l Below this surface of free exchange, value is created through “exploitation” of labor by capitalist. l Capitalist production: large numbers of laborers working together to manufacture commodities l Social nature of large scale production (cooperation) reveals the “collective power of the masses” & requires concentration of the means of production l

Marx on the division of labor l l Manufacture is prevalent characteristic of capitalist production process Two-fold rise of manufacture from differentiated crafts production: 1. 2. l Loss of general handicraft skills via separation and application to production of single commodity Specialized division of labor isolates detailed operations, further reduces breadth of skills In capitalist manufacture, the detail laborer converts body into specialized implement; no longer produces (or able to produce) a complete end product

Karl Marx and Adam Smith Marx studied Smith, was clearly influenced by him l Marx’s distinction: l ¡ ¡ Division of labor in society: means of production dispersed among multiple independent competing producers, anarchy versus Division of labor in manufacturing (the workshop): means of production controlled by capitalist authority/despotism Division of labor in society exists in many economic systems, division of labor in manufacture exists only in capitalism. l Labor as appendage of capitalist’s workshop l

Frederick Taylor: scientific management l l Ordinary management: “initiative and incentive” Scientific management: task management Scientific management 1. Develop science to replace old rules-of-thumb 2. Scientifically select, train, teach, develop worker 3. Insure all work is done according to scientific principles 4. Division of labor between management and workmen: each does what they are best fitted to

Scientific management l Management’s role: planning ahead according to the “laws of science” ¡ ¡ l Defining the tasks involved in a job, subdivision of labor Establishing many rules, laws, formulae to replace judgment of workers (“one best way” via time and motion studies) Tasks must be systematically recorded and indexed Requires thousands of pages of scientific data just for an ordinary machine shop Workers: execution of tasks defined by management ¡ The “science” amounts to so much that the man who is suited to handle pig iron cannot possibly understand it, nor even work in accordance with the laws of this science, withouth the help of those who are over him”

Henry Ford on mass production (1926) Mass production not about amassing men and machinery: failure of pure financial emphasis in manufacturing becomes evident with labor revolt, social strife l Critique of early 20 th c. “efficiency movement” with its time and motion studies: need a wholly new method l ¡ l e. g. Don’t just rationalize pig iron loading by making worker load 47 1/2 tons a day (rather than 12 11/2 tons) for $1. 85 rather than $1. 15/day) , but make it unnecessary for workman to carry 106, 400 lbs for $1. 85/day Goal is productive organization that delivers in continuous quantities a useful commodity of standard material, workmanship and design at minimum cost

The principles of mass production The keyword to mass production in shop is simplicity; three plain principles: 1. Planned orderly and continuous progression of commodity through the shop; 2. Delivery of work instead of leaving it to workman’s initiative to find it; 3. Analysis of operations into their constituent parts. Importance of consistent quality: small spring leaf must be identical strength, finish and curve with millions of others designed to fulfill the same purpose. Requires automatic machinery, the most accurate measuring devices, controls, etc.

The effects of mass production (Ford) 1. 2. 3. 4. 5. 6. Increase in industrial control and engineering Products of highest standard of quality ever attained in output of great quantities. Creation of a wide variety of single-purpose machines that reproduce skill of hand Elimination of hard work in the form of wasteful and laborious burden-bearing. Growing need for skilled artisans and creative genius in mass production. Rising wages for workers, higher living standards

Chandler and the “visible hand” Thesis: From 1950 s to 1920 s, the formative years of modern capitalism, the US saw the emergence of a new business institution and a business class. ¡ Growth of the “modern business enterprise” ¡ Emergence of new class of salaried managers l Rise of managerial capitalism; the visible hand of management replaces the invisible hand of the market l By mid 20 th c. emergence of a relatively small number of large mass producing, large mass retailing, and large mass transporting enterprises in which the salaried managers coordinated production and distribtuion and allocation in major sectors of the American economy

Chandler’s modern business enterprise By WWII modern business enterprise was the most powerful institution in the American economy, its managers the most influential group of economic decision-makers. l Definition of modern business enterprise: l ¡ ¡ l Many operating units, each with distinct administrative office; multi-product, multi-location enterprise Units are hierarchically ordered and monitored and coordinated by full-time middle and top salaried managers Traditional American business firm was a single-unit, single product, single location enterprise, with individual or small number of owners/ managers, governed by market and price mechanisms.

What changed? 1. 2. 3. Macroeconomic instability International competition intensifies Accelerating pace of technological change Undermines stability required for LT investment and corporate planning: costs fluctuate, consumers unpredictable, new competitors

Network forms of organization Networks: organization typified by reciprocal patterns of communication and exchange, interdependent v. Market: spontaneous coordination of self-interested individuals and firms via prices, invisible hand Hierarchy: administrative coordination with visible hand of management, authority, internal transactions Not points along a continuum, but a distinct and viable organizational model with historic antecedents

Fractal link design: a cognitive map SUPPLIER supplier SUPPLIER customer CUSTOMER customer SUPPLIER Nishiguchi and Beaudet, 1998

A new dominant logic for marketing l Marketing in the goods economy: financial optimization and the 4 P’s ¡ ¡ l Product Price Placement Promotion Marketing in the services economy: communication across organizational boundaries ¡ ¡ An ongoing social and economic process Knowledge is fundamental source of competitive advantage Inherently customer-oriented and relational Goods as distribution/delivery mechanisms for services

The core competence of the corporation l “Competitiveness in long run derives from ability to build, at lower cost and faster than competitors, the core competencies that spawn unanticipated products. ” l Core competences are collective learning in the organization—particularly how to coordinate diverse production skills & integrate multiple technology streams Sony’s miniaturization capabilities Citicorp’s operating system for 24/7 operation l Core competence is communication, involvement, and deep commitment to working across organizational boundaries: need to blend deeply specialized and different types of expertise

Complexity and the economy Complexity economics as non-equilibrium theory (vs. standard economics seeks static patterns in behavioral equilibrium) with nonlinearities and positive feedbacks: multiple equilibria, increasing returns, importance of small events. Complex systems with multiple elements adapting or reacting to patterns created by the elements; l In natural sciences: elements (cells in immune system, ions in a spin glass) co-create; systems evolve l Application to economics: human agents become the elements in the systems (bankers, consumers, firms, investors) but they do have strategic intent, behavior l

Six degrees: science of a connected age l Why does a large complex connected systems behave differently than a dissociated collection of components? ¡ ¡ ¡ Small disease outbreak => epidemic Crickets chirping => synchronization Single genes => genetic traits l How does individual behavior aggregate to collective behavior? Parts don’t sum up in a simple fashion, but interact to generate “bewildering” emergent behavior l The “science of networks” recognizes that “what happens and how it happens depends upon the network” which itself has evolved historically.

Paradigms of the economy l Schumpeter’s creative destruction Entrepreneurs and technological change as main drivers of growth ¡ Incentive to innovate: short term monopoly rents, enforced created by copyrights and patents ¡ Continuous innovation creates losers in a “continuous gale of creative destruction” ¡ Network effects (increasing returns) amplify costs Challenge of continuous displacement of older firms, products, regions, workers, and inherent inequality ¡ l

Services innovation Two kinds of services innovation: 1. Improve services productivity 2. Develop new service models Service productivity lags behind manufacturing productivity In 2003 (Indexed to 100 in 1997) manufacturing productivity: 219 grocery retail, wholesale, merchandise stores: 141 commercial banking: 102

Creation nets l “Networks of creation” in which hundreds or thousands of participants from diverse institutions collaborate to create new knowledge, learn from one another, and appropriate and build on one another’s work—under guidance of a network organizer. Rather than protecting and hoarding knowledge, offer to others to gain access to broader knowledge flows. ¡ Opportunity to jointly create new knowledge and deliver innovations to market by collaborating closely with diverse people/institutions ¡ Not joint ventures or arms-length technology licensing, but long-term, interactive relationships with networks of suppliers, customers, specialists, even amateurs ¡

What comes next? Transformations: Wisdom Experiences: Knowledge Services: Information Goods: Data Commodities: Noise