Why the success, now, of companies like Uber, AirBnB, Triptrotting*, RelayRides, HipSwap**, et al.?
In an increasing number of cases, new, what I call, "crowd-scaled" business models are being used by new entrants to challenge incumbents that had previously built large, successful (in some cases, global, billion dollar) businesses. Just a few examples:
- AirBnB, Triptrotting, Couchsurfing <-> Hilton, Sheraton, Marriott et al.
- Uber, Relay Rides, <-> Bauer Limousines, Boston Coach, et al., as well as other larger and smaller, local/regional companies that own the cars, the IT infrastructure, etc.
- Startups, such as DogVacay, HipSwap exploring other markets using this "crowd-scaled" model (joke around Silicon Valley: "There will soon be an 'AirBnB' for every human activity.")
The kernel of the, if not the entire, answer lies in the work of Ronald Coase (more below).
Entrepreneurs (whether Conrad Hilton or today's founder in a garage) must decide whether it makes sense to hire employees instead of contracting out for some particular task (referred to by some as the difference between the "command" economy vs. the "contract" economy). Efficient solutions to the problems which any firm faces, whether Hilton or AirBnB, of coordination and management depend, at least in large part, on the difficulties of getting large numbers of individuals to act in specified, coordinated ways -- whether they need to be "bossed" or can be "motivated" by economic interests.
Historically, "command" structures (true, obviously, of "economies" as well as "firms") have been more efficient, but only up to a limit. Eventually, growth is limited by greater complexity, overhead costs and increasing propensity for centralized management to make mistakes in resource allocation.
This key insight was originally made by the British economist, Ronald Coase in his 1937 article "The Nature of the Firm" (for which, along with work stemming from another seminal article, "The Problem of Social Cost", he received the 1991 Nobel Economics Prize). There is a good Wikipedia Article here (from which some of the analysis in this post is borrowed), but there is also a mountain of material by, and on, Coase easily available elsewhere, on- and offline.
Coase argues that the optimal size of a firm (as measured by how many contractual relations are "internal" to the firm and how many "external"), is determined by finding the most cost-efficient balance between the competing tendencies of such "internal" and "external" costs. In general, larger firms will have advantages, but the decreasing returns indicated above will eventually kick in, preventing the firm from growing indefinitely.
From the referenced Wikipedia article: "Other things being equal, a firm will tend to be larger:
- the less the costs of organizing and the slower these costs rise with an increase in the transactions organized.
- the less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes with an increase in the transactions organized.
- the greater the lowering (or the less the rise) in the supply price of factors of production to firms of larger size.
The first two costs will increase with the spatial distribution of the transactions organized and the dissimilarity of the transactions. This explains why firms tend to either be in different geographic locations or to perform different functions."
Again, from Wikipedia: "Additionally, technology changes that mitigate the cost of organizing transactions across space will cause firms to be larger—the advent of the telephone and cheap air travel, for example, would be expected to increase the size of firms." This, of course, is also true of other, more modern communications technologies: the web, email, IM, texting, Skype, wiki's, etc.("Modern Communications Techologies").
But, while such technologies allow "command" structures to scale better, technology also has an interesting, cross-cutting impact, and this is what underlies the growth in "crowd-scaled" businesses.
Until the confluence (and it is the confluence, not any of the technologies in isolation) of (1) social networks (including, importantly, easy-to-use customer rating and feedback mechanisms), (2) Modern Communications Technologies, (3) powerful smartphones, (4) easily accessible and affordable (often free) smartphone apps and (5) large groups of people comfortable using these technologies (the "Big 5 Factors"), one needed to rely on a "command" structure (not that economic incentives aren't also important in "command" structures) to build a large "firm" (e.g., Hilton). The fact that some Modern Communications Technologies have expanded the scale at which "command" structures could be efficient, may have hidden the important fact that the confluence of the Big 5 Factors also allows large-scale "contract" business structures to emerge, scale and operate -- and, very importantly, with a more capital-efficient business model than "command" structures.
Today, as entrepreneurs explore the "crowd-scaled" business model, we're seeing the first green shoots of "firms" that can grow in a capital-efficient manner to a significant scale using "contract" structures rather than "command" structures. It's going to be interesting to see how this develops in other markets.
______________________________________
* Through Idealab's New Ventures Group, I'm an investor in Triptrotting.
** I am a personal investor in, and actively-involved advisor to, HipSwap.
Comments