Ross Mayfield: System Economics

MySQL Nabs Venture Capital

Wed, 04 Jun 2003 20:14:00 GMT

MySQL AB, the open source database software provider, gained a $20M investment from Benchmark Capital. MySQL is often used as a primary example of how open source can be a component of a real business model. May be a harbringer of things to come, but their case is unique in that the core product is a commodity and they have achieved massive penetration.

Had a chance to meet their CEO, Mårten Mickos, at PC Forum. Terribly nice guy, wish the best for him.

Vonage, Hacks & Arbitrage

Wed, 28 May 2003 16:06:58 GMT

The way Joi and Gen are using Vonage is a new arbitrage method for international long distance. International telephony has always been about arbitrage (risk free profit). Technology driven cost reduction outpacing regulatory regimes that prop up prices. Here's a brief history of international long distance arbitrage and a suggestion for a next stage.

International telephony was originally governed by the ITUs Global Accounting Rate system. A body of national PTTs that would convene and negotiate bilateral settlement rates. For example, the US and German would tally up the traffic imbalance as measured in minutes and agree on a settlement rate. Problem was, country code #1 had significantly greater amount of outbound call volume. With the Public Switched Telephone Network (PSTN), to this day, calls are paid by the originating carrier to transit and teminating carriers. The US negotiated volume discounts that were significant for its outbound calls.

When the PC came around some smart entreprenuers realized an arbitrage condition existed and the technology to take advantage of it was affordable. They invented Call-Back. An individual customer living abroad calls to a PC in the US, enters the country code of the final destination number (the hub country or another) and then hangs up. The individual is called back by the PC while the PC calls the destination country and recieves a dial tone for the destination country. The settlement fee is paid from the hub country (the lower outbound US rate).

Next came Refile, which turned this arbitrage method from a consumer service to a wholesale operation. Competitive carriers in foreign countries (many were cropping up because deregulation was taking place at the same time, first in the US, then the EU and culminating with the Uraguay round WTO accord that liberalized 90 countries) sent calls in aggregate over International Private Lines to the US. A re-file carrier re-originated calls from the US to foreign countries, initially saving in most cases over 500%.

Calling cards allowed re-file carriers to provide consumers a way circumvent originating carriers and get to their re-file hub.

Next came Internet Telephony. Initially it was used for transit on private lines to take advantage of compression. Then some carriers used the public Internet for transit with some sacrifice for quality. Some new businesses like ITXC leveraged redundancy in transit to increase quality.

Consumer Internet Telephony didn't prosper until now because of the variable quality of transit as well as the interface at the ends. Vonage has changed that with some success (just reached the 25,000 subscriber mark). But its primary focus is domestic long distance. It probably doesnt provide the service internationally both because of the quality of transit, complexity of serving diverse markets and potential regulatory backlash in foreign countries.

What's interesting about Joi & Gen's use, and they aren't the only ones, is they are setting up their own arbitrage method -- originating calls abroad, transiting over the Internet and terminating through Vonage's network (mostly over the Internet) and re-file agreements. Vonage's greatest value is a persistent circumvention of local monopoly carriers (where most of the cost of a call resides because of the above driving efficiency in international markets), but its value for international transit is worth consideration.

It will be interesting to see what Vonage hacks arise. There are a few options created by its bridge feature -- If you're on the phone with party A, you can flash, dial #90, dial party B's number, # and hang up. It then calls party B and the call continues between A and B. A hack that allows you to call to your Vonage box from your wireless phone and have it bridge you to an international destination seems tantilizing.

A hardware hack to make the box more portable would be invaluable (I would rather pay for a dedicated DSL connection from a hotel room and then use Vonage to bypass their telephony toll trolling). Particularly with WiFi support.

When arbitrage conditions exist, as with wireless carrier rates compared to terrestrial or hotel customer capture, the market ultimately converges upon it. Vonage has the potential to be a platform. But if regulators try to stem its diffusion another call delivery method will just take its place.

The Matter of IT

Tue, 20 May 2003 06:38:47 GMT

As the technology industry emerges from the bottom, it criticism has been lowered to the nature of being. Information Technology has always been a source of competitive advantage. At the bottom of the business cycle, advantage is basic survival, risk taken only on low hanging fruit. But now, as the leaky pipes have stopped dripping, some wish to relegate the job of IT to that of a plumber.

Friday's article in the NY Times by Steve Lohr asks the question, "Has Technology Lost its Special Status?" Technology as an industry is 10 percent of the economy and 60 percent of business spending. According to John Gantz of IDC, technology spending has increased 2-3 times the rate of economic growth since the 1960s. The question is if the industry will return to its historical growth rates, the driver of valuation multiples. Lohr reports:

That assumption about technology's special role is questioned in a provocative article this month in The Harvard Business Review, titled "IT Doesn't Matter." The article asserts that information technology, or I.T. for short, is inevitably headed in the same direction as the railroads, the telegraph, electricity and the internal combustion engine — becoming, in economic terms, just ordinary factors of production, or "commodity inputs."

"From a strategic standpoint, they became invisible; they no longer mattered," Nicholas G. Carr, editor at large of The Harvard Business Review, wrote in the article. "That is exactly what is happening to information technology today."

John Hagel and John Seely Brown believe this is an important article because it very effectively captures the backlash sweeping through executive suites against IT spending...But Carr’s article is also dangerous because it endorses the growing view that IT offers only limited potential for strategic differentiation....and are preparing a rebuttal in the July issue of HBR:

Extracting business value from IT requires innovations in business practices. In many respects, we believe Carr attacks a red herring – few people would argue that IT alone provides any significant business value or strategic advantage.
The economic impact from IT comes from incremental innovations, rather than "big bang" initiatives. A process of rapid incrementalism enhances learning potential and creates opportunities for further innovations.
The strategic impact of IT investment comes from the cumulative effect of sustained initiatives to innovate business practices in the near-term. The strategic differentiation emerges over time, based less on any one specific innovation in business practice and much more on the capability to continuously innovate around the evolving capabilities of IT.

Some tech executives have countered in the NY Times article:

"I.T. is the vehicle by which you turn ideas and content into intellectual property products," Mr. Craig Barrett (of Intel) said. "As a nation and as a company, you either upgrade your I.T. infrastructure or you won't be competitive."

Samuel J. Palmisano, chief executive of I.B.M., made the case for his industry's growing at twice the rate of the economy when he spoke to analysts on Wednesday. "The industry is fundamentally a growth industry because it underpins productivity," he said.

Kevin Werbach speaks of new models in the Post-PC era in his Supernova report:

...The point of the article is not that tech is dying, or that innovation is drying up. It's that enterprise technology is moving into a new phase. Bigger, faster, and more feature-laden are no longer selling points in the same way. Smarter, simpler, more efficient, and more flexible are the new criteria. It's much harder to make powerful system simple than to make them complex....

Zack Lynch points how IT drives growth in other sectors:

For instance, although not a punctuated leap in competitive advantage, social software has the potential to accrue significant value for companies that leverage its potential to accelerate innovation. In some industries, two product cycles can be the difference between corporate life and death.
For example, decreasing innovation cycle times in the pharmaceutical industry by 10% could slash years off product research, development and approval processes. When translated into revenue and market capitalization impacts, intelligent adoption of social software could significantly disrupt the balance of power in this multi-billion dollar industry. Who says IT competitive advantage is dead?

What is unique about IT compared to other revolutions is how it extends the capabilities of people and groups. IT fuels competitive advantage by enhancing productivity. Erik Brynjolfsson of MIT has demonstrated that productivity gains occur not through IT in and of itself, but when it is introduced with new business practice and process.

This is actually a contrarian point for many. Some private equity investors shy away from technologies that require change of behavior, for example, because it adds risk that users will resist change. But in fact, that's the real promise of IT, to extend our capabilities in new ways. Changing behavior is good in a changing world.

Brynjofsson's studies have been in process-intensive areas of organization. Areas where economies of scale can be easily realized. When business process is defined, it is almost immeadiately outdated because environmental conditions change presenting new sets of information. This underscores the need for business practice that realizes economies of scope (agility), but also the limits of process itself.

What remains is knowledge work. Most jobs in the service sector spend the majority of their time undertaking unstructured tasks in social context. And this time is where innovation occurs (Palmisano points to IP creation, but that's just one set of montetizable outcomes).

IT will continue to drive competitive advantage for business because an incremental enhancement of how groups work still yields exponental benefits.

Boyd's Law

Mon, 12 May 2003 21:29:42 GMT

Stowe Boyd highlights a research report he just wrote on Time to Get Real: Challenges for the Real Time Enterprise. Most of the report is on systems that realize economies of speed, but he also offers his own law:

I get the opportunity to dig into the value of real-time communities, explore the rapidly emerging real time enterprise architecture from folks like Microsoft, IBM, and Oracle, and examine the explosion of instant messaging and its impact on business. I explore Reed's law and extend it into the real time context:

"The third law [explored later on as Boyd's Law] is what I call synchronization amplification: As companies seek to increase their individual responsiveness and decrease the impacts of volatility in their markets, they will increase their synchronous communications with partners, but the net effect will be an increase in asynchronous operations of the meta-enterprise. This seeming paradox is simply explained. A real-time enterprise will have more frequent communication with its partners – passing information from application to application, or conducting real-time communication between people. As a result, the latency in information transfer decreases. This means that companies in the meta-enterprise are free to take action on this lower latency information, increasing overall performance across the meta-enterprise."

Boyd's Law is one method of achieving economies of span. When a company effectively integrates vertical production functions, sequencing results in lower transaciton costs. This can happen both at the system economics and firm-level.

Google's Exponential Returns

Wed, 30 Apr 2003 03:18:49 GMT

There is more to Google than useful, simple and powerful products. In the end there will be less Harvard business school cases about its product than its organization. At Etech, first employee Craig Silverstein discussed Google's product development process and the systems that support it. What's different is the use of smaller organizational units (groups of 3 on average) supported by lightweight inter-group communication with a culture of sharing.

The danger of smaller organizational grouping is the potential redundancy or splintering; and the difficulty of realizing economies of scale. The danger and difficulty is overcome through systems, but not the typical enterprise systems that seek to automate processes. The benefit is greater speed and agility (scope).

But in such knowledge intensive work you can't automate what is largely practice. Instead, light weight tools like wikis and weblogs support what people need to get things done and in scale the system yields emergent properties.

Google uses product much like a wiki called Sparrow Web to develop community-shared pages. Originally developed by Xerox PARC it offers lightweight editing without knowing HTML. Its less flexible than a wiki, but works well for functions like submitting great product ideas, launch process forms, reporting and weekly snippets to a common knowledge base. Craig said its "suprisingly good for communication."

It also helps that they acquired the leading blogging software company and they are eating their own dog food. When Pyra's first move when they joined the company was to set up Intranet blogging, "they knew they hired the right people." Blogger serves a relatively older tradition of having people contribute snippets of what they worked on during the past week. But now their software, widely adopted, is giving different people their own voice in the system.

Unlike other organizations they have more people freely communicating about what they are up to and sharing what they learn. Allowing teams to be smaller, yet effective as a whole. And because each communication creates linkages, stays with the organization and builds upon the past -- there are exponential returns to sharing.

What happens when these simple tools are combined with Google's search engine is fairly obvious. The best content and experts emerge.

When an organization scales, its systems and organization are a key component of its competitive advantage. Knowledge intensive companies have struggled to find a mix of both for leverage. Google's greatest innovation may prove to be within and seductively simple.

Without formalized information flows imposed by many enterprise systems, Google has been able to let its employees make their own associations. The right systems and organizational openness fosters social capital within the organization -- which decreases risk and is foundation of intellectual capital.

Keep It Simple, Stupid

Tue, 11 Mar 2003 16:28:14 GMT

John McDowall on the unnecessary complexity of groupware and knowledge management tools:

Effective Social Networks on Ross Mayfields blog brings up the point of the complexity of groupware tools - I would add to this the whole field of knowledge management as being guilty of the same sin. There is a self perpetuating myth that there needs to be a complex set of software to manage large amounts of unstructured information. The myth appears to be that this information is hugely valuable and needs sophisticated tools to ensure you can squeeze the last drop of value out of it. One of my professors taught his class a key rule in any engineering project - always do a rough estimate for any calculation/project to get an idea of the size before doing a detailed analysis. This serves several purposes - makes sure you understand the variables in the problem and makes sure you do not misplace any zeros in the detailed analysis. Doing the same in any groupware or knowledge management application is a similarly revealing exercise - take a representative sample of information and reduce it to the key facts - it quickly shows there is not much there and what is there does not benefit from complex tools. So what is all this unstructured data - mainly attempts to create the evidence to prove the few facts that we are all trying to reach agreement on. Perhaps we should be looking for tools to assemble evidence in favor of the few key truths that we all hope exist.

Besides the resulting cost of complex tools, there is an even larger problem -- people don't use them.

World of Ends

Fri, 07 Mar 2003 05:41:48 GMT

Dr. Weinberger and I decided to sum up a whole bunch of stuff in one big site: World of Ends: What the Internet Is and How to stop Mistaking It for Something Else. Dr. W. explains more here.[The Doc Searls Weblog]

The Nutshell

1. The Internet isn't complicated
2. The Internet isn't a thing. It's an agreement.
3. The Internet is stupid.
4. Adding value to the Internet lowers its value.
5. All the Internet's value grows on its edges.
6. Money moves to the suburbs.
7. The end of the world? Nah, the world of ends.
8. The Internet’s three virtues:
a. No one owns it
b. Everyone can use it
c. Anyone can improve it
9. If the Internet is so simple, why have so many been so boneheaded about it?
10. Some mistakes we can stop making already

It all begins with Simplicity, turns out bandwidth is a commodity, and let's be stupid and not screw it up.

Blogspace as a Dissipative System

Fri, 28 Feb 2003 20:27:30 GMT

Just came across A Systems Explanation for the Blogosphere, by Nick from Blogosphere.us that describes blogspace as a self-organizing dissipative system:

Much in the way a temperature gradient existed between the two metal plates in the Bénard Cell example, an information gradient can be said to exist between those individuals who have information and those who want it. Traditionally, the transfer of information between these "people" would have to flow through an information gatekeeper before it could reach the person who wanted it - an analogous process to "conducting" the information from source to receiver. However, as the information gradient between individuals strengthens, that "base" system for transferring information reaches its full potential. If the information gradient continues to strengthen, some sort of dissipative structure has to emerge from the surrounding information environment to more efficiently deal with the differences. The Blogosphere can be thought of as a dissipative system for dealing with a strong information gradient. Instead of being conducted from first hand source to gatekeeper to audience, information in the Blogosphere is capable of traveling directly from the source to the audience - eliminating the limiting factor in the information transfer.

A friend of mine used to say that all of media and politics follows the laws of thermodynamics. This systemic approach is highly complementary to the Ecosystem of Networks model at the Political Network layer and Joi's Emergent Democracy paper. Written clearly, worth a read.

App Server Commoditization

Wed, 26 Feb 2003 15:54:19 GMT

Sun's project Orion will provide an Application Server for free with Solaris. A move that repositions Sun and BEA in conflict.

BEA, the market leader, has already faced similar pricing pressure from IBM. J2EE App Servers are a commodity. Now its a battle of the bundle, with Sun seeking to sell hardware, BEA development frameworks and IBM integration services and datacommodities.

Filter Failure

Fri, 17 Jan 2003 22:01:45 GMT

Will new filters save us from spam?. MIT Spam Conference eyes filters to destroy spam business model [InfoWorld: Top News]

In tests Yerazunis performed, MailFilter was 99.915 percent accurate in identifying spam. "I'm only 99.84 percent accurate at identifying spam, so this is much more accurate than I am," Yerazunis quipped.

I am happy for the filter freaks, but its mostly an academic exercise.

Filters are not a solution because they result in false positives, solution techniques are open, spammers adapt, and volume grows. Legal solutions generally wont work because of juristiction, aside from putting bounty hunters on the task. Its fundamentally an economic problem that requires an economic solution -- raising the cost of sending email, but having cost vary according to trust networks. One day we might actually be able to accept these costs.

UPDATE: Video from the conference available. [via BoingBoing]

Datacommodity Service

Thu, 09 Jan 2003 18:19:37 GMT

IBM rolls out on-demand computing service aimed at supercomputers. [InfoWorld: Top News]

Selling processing as a utility service (one of the Datacommodities) from a grid computing architecture is finally commercialized. IBM's first customer, Petroleum Geo-Services, expects to save $1.5 Billion for a three-month-long seismic imaging project based in the Gulf of Mexico.

"Customers in some sectors want access to large-scale computing power in short bursts," said Dave Turek, vice president of IBM Linux clusters and grid solutions. "We think this supercomputing offering can change how business is done."

Aggregating peaks and valleys into a plain is a great business. Especially when customers will pay a premium for serving bursts while not having to incur capital expenses at the peak. This will be one hell of a spot market one day.

Lack of Scarcity?

Fri, 20 Dec 2002 16:53:16 GMT

Eric Norlin is working on a thought piece that suggests that abundance on the Internet in its totality drives goods towards the public domain and makes it hard to make money. This piece with which Doc agrees that Identity could deal with the "scarcity problem" as quoted in the previous post.

Eric, in his 3rd point, comments in his draft: [this point needs work: specifically, *how* it is that a lack of scarcity drives something toward the public domain.] David Weinberger comments in his post: That seems intuitively right. But the question is: what on the Net is in such abundance that it drives goods thusly? It's not the abundance of goods but the abundance of access to goods: you don't need a lot of capital to create and/or distribute digital stuff. (BTW, in such an environment, what is the remaining virtue of capitalism?)

I am a believer in Says Law, back from your Econ 101 classes, in which the market flocks to extreme abundance or scarcity. Says Law provides a natural equilibrium for all markets. If something is abundant and cheap, it is consumed until it is in equilibrium or even tips to scarcity. But let me try to help Eric with his draft.

The Internet in totality has three significant emergent properties:

Low transaction costs: this accelerates Says Law
Inherent optionality: The Net is the most option rich medium, primarily because of its openness (free options create more free options). Every layer in the OSI networking model creates options for use by the above layers. As David Reed says in That Sneaky Exponential, "The value of potential connectivity is the value of the set of optional transactions that are afforded by the system or network." When assets have economies of scope properties (high optionality) in a low transaction cost environment it further accelerates Says Law.
Commoditization: All goods trend towards commoditization. On the Net, the scale and span of the network and diversity of interests allow otherwise fragmented markets to be pooled, further accelerating the process of commoditization. All commodities prices also trend toward zero, as markets become more efficient in how they commonly define goods and contracts as well as develop mechanisms to transact them.
Rapid Obsolecense: The openness of the Net fosters innovation. That, combined with the above, results in shorter lifecyles and rapid depreciation.

For information goods, including software, the above implies a turbulent search for equilibrium that eventually tips to the public domain. For infrastructure, the above implies a volatile physical commodity market in backwardation (future prices are lower than spot prices).

David Isenberg

Wed, 11 Dec 2002 02:16:23 GMT

Note: David doesnt use the word commodity, I stuck it in below

Kevin: In my dreams I would come up with a simple idea like Davids that is so powerful and everyone gets.

Im shocked to have never gotten below layer 7 in the discussion today and have people still call it infrastructure. That's not infrastructure. Infrastructure is important and uncertain.

Today's news:

Massive failure by PTTs and ILECs, getting worse, and I can't wait.
Distance is dead, except where its being held back by regulation and monopoly
Yahoo BB hapan giving away modems, 12Mbps/ ~0.5 upstream 12000Yen/mo=~$15USD, started in April, took to September to get first 1M customers. 5M ADSL subs in an 80M person countries. 120k Fiber to the home (FTTH) customers. Growth. Cost of customer acquisition make him cringe

The Future (not evenly distributed yet)

VON in Atlanta, small company, Global IP Sound. Shrink wrapped bundled with a Compaq Pocket PC with vanilla 802.11 with telephony that sounded better than PSTN. WITH NO TELCO IN THE LOOP.
When the net is better than POTS, the cash cow goes away
SIP (Session Initiation Protocol): what HTTP did for documents, SIP will do for communications
POTS: Sure you can do Internet on it, you can do it with smoke signals too
Simple networks provide connections, not services. Providing commodity connectivity. Services are enabled by smart edge devices.
Gilder's Law outpacing Moores Law, Depreciation iinversely nverse, Engineering effort scales according to nobody's law.
End-to-End principle, 25-30 years old, similar to stupid network -- if you can do something at the ends or at the middle, do it at the ends to preserve your options, use of the network will be different in the future.
Internetworking shifts control from network owner to end user
Telephony yet another application, Bob Cannon and Bob Pepper at FCC
Winning apps not created by telcos, most haven't been discovered yet (SIP and presence management!!)
Old biz model
- Voice-monthly income
- network subsidized
- physical subsid
Stupid model
- apps are services -- a vibrant market
- network is protocol -- a commons
- physical a not subsidized -- he says the big question is the business model? -- the commodity business
Who owns and runs the network?
- Telephone company? Difficult transition to the horizontal model
- Cable company? Difficult to give up old video entertainment model
- Municipalties? 125 experimenting
- Utilities?
- New kinds of company?
- Customers?
Politics of End-to-End...big list of ideals vs. the Dark Side
GOLIATH LOST

Q&A

I posed the utility model question and he says Im right, but there are alternatives (he is right too)
Server should be at the edge of the network

The Gravity of Decentralization

Fri, 06 Dec 2002 18:57:25 GMT

Designing business architectures (models & systems) is an increasing challenge. Centralized business architectures are a legacy of the industrial era. But the recent downturn has revealed new decentralized systems that promise to enable new business models and evolve the old. We are just beginning to explore the practice of decentralization and the new gravity it creates.

This post explores key benefits of cost and risk reduction:

Capital Expense: Smart Build vs. Dumb Build
Operating Expense: Centralized Complexity vs. Decentralized Service
Market Risk: Centralized Liquidity vs. Decentralized Standardization
Operational Risk: Centralized Security vs. Decentralized Defense

Identifying these benefits should help understanding how to achieve balance between centralized and decentralized gravitational forces.

Capital Expense: Smart build vs. dumb build

Centralized infrastructures (bandwidth, storage & processing) require significant up-front capital investment, justified by "smart build." They rely on "smart" forecasting of capacity requirements to determine what to build in advance of immediate delivery (spot markets). But in absence of forward markets (like futures, only over the counter) to lock in future prices and quantities, and only rudimentary vehicles to pre-sell capacity -- determining requisite supply is done without market data. In addition, IP traffic, which drives investment in capacity to support it, is notoriously bursty and diverse. Sheer complexity and absence of market data make forecasting and planning an art rather than science.

Also, centralized infrastructures rely heavily on economies of scale in both system economics and business models. The upgrade path isn't granular, at best its at the line card level for routers and servers. In the economics of bandwidth builds rights of way and spectrum licenses are the largest costs. This cost is also the largest speculation of future capacity, both in the lag time until monetized and the volume of capacity it represents. Spectrum speculation also relies on the pricing of an intangible asset, driven by market participants compelled to bid to maintain competitive in a market they already sunk significant costs in. Spectrum speculation recently resulted in $150 billion of spend – before the investment of another $150 billion in tangible asset infrastructure; larger than the addressable market.

The second largest cost, digging the trench are the largest costs, compels telecoms to lay as many fiber strands in the trench as they can. Remaining dark. Supply and demand cannot be balanced, and excess capacity inventory is a service requirement. The result is continual glut or failure to meet customer demands. This is fine when capital markets appreciate excess capacity inventory, but otherwise its punishing model.

Dumb builds of decentralized infrastructure do not rely on central planning/forecasting. Capital risks and burdens are pushed to the customer: forecasting individual requirements, upgrade/migration paths and up-front investment. Intangible assets that only serve the purpose of creating barriers to entry for competitors, such as spectrum speculation, can be avoided costs through models such as Open Spectrum.

In addition, decentralized infrastructures can be more granular. Manufacturing of equipment for these infrastructures remains centralized, but there is less risk in the model. Forecasting a diverse network's requirements is several orders of magnitude greater in complexity than forecasting customer units. Manufacturing systems are also built to take advantage of economies of scale, scope and speed. Capital markets understand the mature model of manufacturing capacity & inventory to more adequately assess inherent risks.

Operating Expense: Centralized Complexity vs. Decentralized Self-Service

Centralized business architectures cannot scale when it comes to providing service. Centrally planned automation of functions and processes become rapidly obsolete in a turbulent environment. Inevitably to maintain service, people are thrown at the problem. And people don’t scale. Large centralized IT administration, network administration, customer support centers result in large Sales, General & Administration costs (e.g. 25% of revenues in the telecom industry). What’s worse, service is significantly impersonal and these jobs strain the limits of satisfaction, creating a dysfunctional cycle of quality degradation.

Decentralized business architectures empower customers to serve themselves and provide communities of support. Obviously this results in less cost and enables scale. But the power of self-service, whether for purchasing, provisioning or support cannot be overstated. Provided self-service is simple, providing otherwise internal information to the customer as well as control instills trust and satisfaction.

Market Risk: Centralized Liquidity vs. Decentralized Standardization

As we learned in developing the first B2B marketplaces, liquid emerging markets take time to develop. Marketplaces and market makers must bear significant risks to establish a market. Despite the benefits by design, providing centralized alternatives to the entropy of existing relationships is an inorganic development. Before centralized markets take hold, competing standard alternatives arise in decentralized fashion. Over the counter markets of buyers and sellers with existing relationships transact directly at first.

The role of decentralization in market development is the creation of standards for transactions as a bridge to centralized mature marketplaces. Creating standardized definitions of price, quantity, quality and contracts for goods accelerates over the counter liquidity and creates pockets of price transparency. As the market unfolds, conversations drive convergence of standards and invites participants organically.

Physical liquidity grows and demands risk management in the form of forward and futures markets. These markets demand centralization for both price transparency and liquidity to prevent manipulation The point of describing how market emerge in decentralized form and then transition to centralization – but this process is important to understand in the tech industry as it transitions to datacommodity industry through the adoption of utility models.

Operational Risk: Centralized Security vs. Decentralized Defense

Similar to the challenge of scaling service is scaling security. The diversity of threats and complexity of managing them makes large scale centralized security untenable. Like fighting the adaptive threats of Spam through designing new filters, centrally designed security solutions fail to keep up with environmental changes. Further, security requires expertise and there is a limited pool of human capital to provide it. As companies scale their openness to the environment to take advantage of Internet infrastructure, so to scale the demands to secure. The problem is if the costs to insure security run in parallel and even past the value of what they protect, innovation and infrastructure will be hampered by the security overhead.

Countering the trend of security overhead are emerging autonomic security solutions, for example those of Sana Security. Inspired by the design of the immunity systems in our own bodies, they provide a complex adaptive system that adapts to dynamic threats.

While security systems designers scramble to meet this escalating challenge, many would do well to reassess their fundamental design approach. The unfortunate fact is that the prevailing method of security systems design contains at least one fatal flaw: It assumes that system designers can adequately anticipate and create appropriate responses for every type of security breach possible within the system.

From an article by founder Steven Hofmeyr…

It's only human to think that we've anticipated all of the ways the systems we design can be compromised. After all, if we designed the system, then we must know it inside and out, right? The truth is that that vast majority of engineers and analysts cannot possibly predict the wide variety of viruses, worms and hacker attacks that could cripple their systems in the space of a few minutes…

To counter hackers' ability to stay one jump ahead of system designers, security managers are beginning to move beyond firewalls and IDSs [intrusion detection systems] to incorporate a set of technologies known as adaptive detection and response (ADR) systems. These systems deploy highly sophisticated monitoring agents to track operations at targeted file and operating system levels (similar to the way that the human body monitors its own layers of systems). Unlike IDSs, which look for known system and network threats, ADRs first build a complete profile of normal system operations, then continually monitor for any change in the underlying patterns of the system or network.

Now decentralized architectures cannot be applied everywhere, but the decentralized autonomic approach to security certainly has a prominent role in reducing risk and enabling scale.

Balancing Business Architectures

As the tech industry undertakes its fundamental shift to utility service, the gravity of decentralization is breaking down centralized industrial era structures. The Frontiers of System Economics are being explored. System architectures previously focused on economies of scale and speed increasingly shifts to realize scope and span. Business models undertake a similar shift.

The cost reduction benefits of decentralized architectures, as pointed out by Kevin Werbach are too prominent bottom-line benefits to be ignored. So too are the benefits of risk reduction. The challenge in truly understanding the right balance between centralized and decentralized business architectures is that we are just beginning to explore the top-line benefits of decentralization. The top-line benefits of centralized forms of scalable enhancement of existing revenue and generating new lines of revenue are well known. But the top-line benefits of decentralization will have to be the topic of a future post.

Fri, 15 Nov 2002 18:22:59 GMT

Sun springs for software maker. The company says it will acquire Terraspring to further its N1 initiative to provide businesses with increasingly autonomous computer systems. [CNET News.com]

Profiting in a Datacommodity Industry: I

Fri, 01 Nov 2002 19:45:24 GMT

While I am working on a whitepaper on the larger subject, a comment on my post of IBM's announcement [also see their whitepaper: Living in an On Demand World] prompts me to elaborate:

Recently prominent IT companies (IBM, Sun, HP, Microsoft) have announced developments in utility computing, grid computing, virtualized data centers and web services. The importance of these new models cannot be overstated – they are enabling a new phase of networked computing for efficient management of Datacommodities.

Storage, Processing and Bandwidth will trend towards commoditization while Software and Services will trend away from it. The technical standardization of Mbs, MIPS, Mbps, & MHz demanded by customers to reduce their technology risk and for vendors to realize production economies create the characteristics of physical commodities. Storage, Processing and Bandwidth can be considered Datacommodities. The turbulence of the business environment and consumer tastes, on the other hand, requires constant change. Software trends towards commoditization as well, specifically towards standard protocols and components. But the custom assembly of these components, adapting systems to this environmental change is the domain of software and services, a trend away from commoditization.

The Tech Industry has always resisted commoditization, by creating new overlays, bundles and marketing tactics. But a fundamental change has occurred that compels a new strategy of embracing commoditization. A critical mass of Datacommodities have been standardized as fungible physical commodities and made accessible through communications infrastructure and standard protocols. Since this mass exists, there is no going back. This also comes at a time where customers have greater power over vendors to unbundled solutions than before. And new network, data center and web services management systems that virtualize underlying commodity components allow them to aggregate bundles according to their requirements at any given time. With component commodities accessible and bundling shifted to customers, this customer-driven commoditization is a reality the industry must face.

Although it seems counter-intuitive, there is the potential for even greater profit in the Tech Industry than before, but it requires change. Providers of technologies that are trending towards commoditization need to adapt their business models to that of lean infrastructure providers while providing new value added services such as risk management. Providers of software and services need to adapt to leverage underlying commodities while changing how they serve their customers.

IBM's Commodity Managment Model

Thu, 31 Oct 2002 18:17:28 GMT

There is some real substance behind IBM's new campaign. Palmisano outlines IBM's $10 billion initiative [InfoWorld: Top News] See the presentation.

This marketing genius can viewed from a few functional perspectives:

1. MarCom: Great teaser campaign ("Humor translates as confidence, and that works well with I.B.M. these days," the Ad Man said) that works well in today's pessimistic environment. Even better positioning of "on-demand computing" as a natural evolution of computing to satisfy business requirements in a turbulent world.

IBM’s Definition of an On-demand Business: An enterprise whose business processes

– integrated end-to-end across the company and with key partners, suppliers and customers –

can respond with speed to any customer demand, market opportunity or external threat.

2. Product Marketing: realizing an integrated commodity management model

3. Product Management: standards-based integration (for span), virtual management (for scope), utility aggregation (for scale) with spot purchasing (for speed).

IBM has presented a compelling case for how their vertically integrated model will function in the commodity tech industry. They have embraced inevitable, what I think is the sea change after the bubble:

Storage, Processing and Bandwidth will trend towards commoditization while software and services will trend away from it. More on that tomorrow, this is getting fun.

Spanning Business Models

Fri, 25 Oct 2002 18:00:04 GMT

One of the best strategy articles on firm-level economies of speed, scale and scope was "Unbundling the Corporation," by John Hagel & Marc Singer. The thrust of the article was that decreased transaction costs created by IT furthered the need for firms to specialize in their core competencies. They suggested three general areas of specialization:

Innovation-focused companies that realize economies of speed (Apple)
Infrastructure-focused companies that realize economies of scale (Level 3)
Customer service-focused companies that realize economies of scope (Schwab)

However, companies like Cisco or Ebay do not fit neatly into the above categories. What was missing was consideration of economies of span. Economies of span are realized by efficient sequencing of stages of production. Traditionally, this is accomplished through vertical integration. But IT today enables virtual integration techniques through outsourcing, supply chain management and electronic marketplaces. Essentially virtual vertical integration can be accomplished through efficient use of technology assets and innovative underlying contracts. So lets add a fourth area of specialization:

4. Network-focused companies that realize economies of span

Cisco is a company known for innovation, but most of their innovation is not in internal R&D, but through innovative M&A. Their emphasis on outsourcing, their adoption of direct self service models and use of M&A (continued unabated during the down turn through new models like spin-ins) allows them to realize economies of span without vertical integration.

Ebay's marketplace model standardies market design, underlying contracts, credit and payment for buyers and sellers. Based upon this standard approach, they decentralize almost all commerce activties (most notably inventory and shipping) and tools into the hands of buyers and sellers. Aside from the technical architecture of the day, its an example of a decentralized business model at work (make you wonder about the scale economies they could realize with decentralized architecture). Ebay is the best example of how a network focused company can realize economies of span.

Its natural that an Ebay or Cisco would also optimize their systems to realize economies of span. Business models must be aligned with underlying business systems. Focusing on the economies of speed, scale, scope and span provides one framework for determining specialization of business models and technology assets for competitive advantage.

The Possibility Frontiers of System Economics

Wed, 23 Oct 2002 16:37:15 GMT

Systems can be optimized to realize economies of speed, scale, scope or span. Combinations of these economies can provide strategic differentiation from the technology asset base. The System Economics Radar provides a framework to explore how combinations of the four economies yield four production possibility frontiers:

The Productivity Frontier is defined by a system optimized to realize economies of speed and scale. That is, a system that achieves increasing marginal returns through reduced transaction costs in throughput and scale. Optimizing a system to extend this frontier yields the highest level of productivity for a given function over time. An example technology asset class optimized for the productivity frontier is manufacturing execution software.

The Innovation Frontier is defined by a system optimized to realize economies of span and speed. That is, a system that achieves increasing marginal returns through reduced transaction costs in sequence and throughput. Optimizing a system to extend this frontier yields greater network effects. An example technology asset class optimized for the innovation frontier is supply chain management software.

The Agility Frontier is defined by a system optimized to realize economies of scope and span. That is, a system that achieves increasing marginal returns through reduced transaction costs in repurposing and sequencing. Optimizing a system to extend this frontier yields greater options for asset configuration. An example technology asset class optimized for the Agility Frontier is Web Services architectures.

The Diversity Frontier is defined by a system optimized to realize economies of scale and scope. That is, a system that achieves increasing marginal returns through reduced transaction costs in scaling and repurposing. Optimizing a system to extend this frontier yields scaled productivity for a variety of functions. An example technology asset class optimized for the Diversity Froniter is customer relationship management software.

Scope & Span: Web Services, Loose Coupling & Functional Commoditization

Tue, 22 Oct 2002 18:21:58 GMT

The trend towards component-based software and web services is an evolution of software to realize economies of Scope and Span.

App Servers have embraced J2EE (and MS embraced its .NET) and development frameworks have evolved to support component-based software development. XML standards provide further functional defintions of component commodities. Components can be functionally repurposed with minimal transaction costs, realizing economies of Scope and significant risk reduction

Web Services goes beyond scope by leveraging XML standard interfaces and common Internet protocols to realize span in distributed architectures. With standard definitions and interfaces, essentially becoming commoditized, components can be efficiently sequenced with low transaction costs to realize Economies fo Span.

The value of this model is the functional commoditization. Functional, in that the technology can be repurposed at a low transaction cost. Commoditization, in that it has a standard definition and interface. Add a contract and business processes to the underlying functionality and commodity and you have a service. Functional commoditization is another way to describe Loose Coupling.

We are a long way from the vision of portfolio management of distributed software components. Unlike managing a portfolio of financial securities, technology assets posess systemic characteristics. A portfolio of technology assets realizes diversification benefits from both being diverse and the properties of Scope technologies. The combinatorial value of Span technologies realizes network effects within the portfolio.

Today's evolution in software architecture towards Service Oriented Architectures marks a shift from more static systems that emphasized Speed and Scale towards dynamic systems that realize Scope and Span. The shift is made possible by the adoption of standards, but is driven by change requirements of competitive turbulence.

Valuation Considerations of System Economics

Tue, 22 Oct 2002 16:28:32 GMT

Continuing the thread on System Economics, today I will explore the vaulation considerations for technology assets that exhibit different economies (Speed, Scale, Scope & Span)

Economies of Speed, Scale and Span produce increasing marginal returns that can be linearly projected. Take the example of a backbone provider that is considering the purchase of DWDM optical transport system for a single strand of fiber. Different systems will offer different capacities per fiber strand, realizing different throughputs, or Economies of Speed. Different systems will offer different scalability characteristics, realizing a per line card upgrade path for Economies of Scale. Optical to Optical switching platforms can route traffic without sacrificing throughput to realize economies of sequence, or Span. An example of a system that exhibits diseconomies of Span is below. Provided that vendors do not offer free optionality, either in contract or technology, potential returns can be measured with linear discounted cash flow techniques such as ROI.

The only exception to the above is when vendors offer contracts or technology upgrade paths that inherently include free options. For example, a system that provides Economies of Scale from a vendor that requires a minimal initial investment for the base platform relative to the cost of future upgrades makes the upgrade path non-linear. Buyers could purchase the base platform with no intention of upgrading capacity with the exception of an unlikely and signficant change in traffic requirements.

Economies of Scope, however, produce increasing marginal returns that are non-linear. Tunable lasers, for example, are a technology asset that can be repurposed as factors of production, realizing Economies of Scope. Unlike a standard line card in a DWDM system which is built to be red, green or another specific wavelength, a tunable lazer can change wavelengths. This enhanced modularity reduces investment risk and makes it a better choice for spares or systems with a high likelyhood of architectual change.

What makes Economies of Scope non-linear is the options they create. Tunable lazers are purchased almost as insurance. If a system is populated with Tunable lazers it decreases the requirement for capital expenditures in spares and decreases operating risk of being able to fulfill services. Repurposable assets should be valued using techniques that account for different options in use. A Real Options methodology would be more suitable for measuring the value of a technology asset that realizes Economies of Scope.

System Economics: Economies of Speed, Scale, Scope and Span

Mon, 21 Oct 2002 16:24:36 GMT

This week I introduce a new framework for revealing analyzing the business value of systems that I use in my consulting practice.

Within System Economics, technology assets within a system exhibit transaction costs as factors of production. Transaction cost theory has been primarily applied firm-level analysis to reveal areas of specialization, the optimal size of the firm, and the role of technology in decreasing transaction costs that create firm boundries. At the system-level, transaction cost analysis of components and architecture provides a robust framework for system optimization and alignment with business objectives.

A technology asset portfolio determines the competitive capabilities of a company. The objective of a business system is to support economic gains, primarily through enhancing productivity.

Economic gains to productivity, as measured by per unit increases in efficiency, can be attributed to economies of speed, economies of scale, economies of scope and/or economies of span:

Economies of speed are achieved by using an asset to produce outputs at a higher rate of throughput. Through a decrease in the time required to produce an output, per-unit costs decline. Digital signal processors and parallel computing are examples of technology assets that realize economies of speed.

Economies of scale are achieved by using an asset to produce more of a single output. Through the increase in volume of products or services of that single output, per-unit costs decline, and more customers will be attracted. Centralized storage and high-capacity optical transmission systems are examples of technology assets that realize economies of scale.

Economies of scope are achieved by using an asset to produce different types of outputs. Through the increase in the number of outputs produced using the same asset, per-unit costs decline. Modular platforms are examples of technology assets that realize economies of scope.

Economies of span are achieved by efficient coordination, or sequenced use, of assets. Through the decreased transaction costs between stages of production, per-unit costs decline. Control and logistics systems are examples of technology assets that realize economies of span.

This week I will expand upon the above System Economics framework and apply it to specific trends such as Web Services.