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By Lee S Dryburgh on January 11, 2010 7:28 PM | Permalink | Comments (0) | TrackBacks (0)
Sean Park was one of the award winners back at the debut eComm Europe last October. He won the "Most Insightful Speaker" Award. The slides and video are on his blog. Below is a full transcript. Highlights are mine. Sean: Good morning everyone. As Lee said, I'm a founding of Nauiokas Park. For my sins, I was a banker, a trader, for about 15 or 16 years. Maybe to my credit, I resigned from that industry at the end of 2006. I thought it was remediably broken. I've since started my new ﬁrm which is focused on principal investments strategic advisory in technology-enabled disruptive business models, ﬁnancial services, and markets.
Why am I at eComm? I'm not really sure. I'm very pleased to have been invited. It's very exciting, but I don't know anything about telecoms, other than as a customer, both enterprise and consumer. But, I think there are a lot of similarities between the two businesses, and increasingly so, and that's because they're digital businesses. I'm going to talk to you about platforms, markets, and bytes, the economic landscape of the sixth paradigm, or maybe I should have said the industrial landscape of the sixth paradigm. I'm going to try to answer these questions in 20 minutes. I'm going to be broad, not deep, so indulge me if I skate over a few points, and some of these I explore in my blog in more depth. I'm happy to discuss them afterwards in more depth. In a world where everything can be expressed in 0's and 1's, the way we deﬁne our economy, the way that industries are structured, are they still relevant? If not, what new business models or structures are going to emerge, and maybe to focus on this and to give an example; what's the difference between a bank and a telecom company?
Before I get into that, I want to give a little bit of background in terms of a framework of what I'm thinking. What is the sixth paradigm? If you haven't read it, you should, Carlota Perez is a Venezuelan economist. She wrote a book called Technological Revolutions of Financial Capital, builds off of Schumpeter, talks about long economic cycles that, in her thesis, are driven by technological revolutions. Since the ﬁrst one of the modern era, which was the Industrial Revolution, she posits that there have been ﬁve. Each of these revolutions is accompanied by a set of best practices. The economy, the society, and the institutions need to adapt to this revolution they change. You get interesting affects in terms of how the
economy diverges from the ﬁnancial markets and a lot of this, again skating over it, has to do with the fact that technology tends to move exponentially or adoption of new technology moves exponentially whereas our social and cultural institutions move linearly. There is a divergence and it takes us time to get our heads around the way the world will work in this new paradigm. She calls it a "techno-economic paradigm". Here are the ﬁve that she's identiﬁed: Industrial Revolution, Steam and Railways, Steel/Electricity, Mass Production, and the last one is the Age of Information and Telecommunications. My thesis is that we're coming to the end of that ﬁfth paradigm and we're about to enter the sixth paradigm. There are a lot of similarities, I think, between this one and the one at the end of the 19th Century, in terms of what we're seeing. Today, the ﬁnancial crisis we lived through might be analogous to the oil crisis marking the end of the Age of Information and Telecommunications. I'm not going to go into that too deeply. What will drive the sixth paradigm? Guessing, because as she points out you can only really tell in hindsight; it's very hard to identify these as they're happening, but I'm going to have the hubris of a banker to try to guess that maybe this is it; cloud computing - cloud computing may be a catch phrase, but ubiquitous computing storage might be the technology that drives the sixth paradigm, where you have "everything as a service". She picks archetypal points - Intel's release of the ﬁrst microprocessor in 1971 launched the Information Age. It's not that simple; it's a cluster of technologies, a cluster of people, but if you have to pick one for this, maybe it's Amazon Web Services 2006/2007 launching EC2 and S3. Another factor driving the sixth paradigm is what I call "exchange ubiquity". I didn't really have a good catch phrase for this. Exchanges are now everywhere. Traditionally when we say exchange we think of ﬁnancial exchanges. Betfair took the exchange model and applied it to another business very directly, which is the business of betting on sports. It goes beyond exchanges. Really, it's marketplaces and everything. iTunes is a marketplace. It's a marketplace that started for music, now videos, and tomorrow any digital goods - maybe. Facebook is also a marketplace. You've got the applications on top. Maybe it's a stretch, but things like Skype are marketplaces for voice communications. Underlying marketplaces, and maybe this is where eComm - communications is at the heart of a digital economy. Alexis Richardson, who is the Principal behind RabbitMQ, which is an open-source messaging software, said "The
difference between bank messaging and telecom messaging is disappearing." That's more and more true, every day. The last one is maybe digitization. This one is fairly self evident but if you look at when I'm talking about digitization, it's transforming physical goods into digital goods for the purpose of trading and managing them. A great example is ISINs in the securities industry. Not so long ago, 30 years ago, the securities business was a physical business. You had certiﬁcates that were biked around the city of London, biked around, or driven around New York when you wanted to trade shares or bonds. Today obviously, it's a book entry. Every security is identiﬁed by its QSIP or ISIN. VoIP, I'm not going to teach you guys anything. Obviously, voice is turning into a data business. Amazon, Jeff Bezos, his insight was with the ISBN database he could transform books into a digital good that could be sold and managed. There is obviously a physical supply chain, but it's right at the end of the business. The heart of the business is a digital business. To take this a step further, there is a disclosure; Zoopla is a company we've invested in. It's a U.K. property portal, but it's a very interesting one. It has a database of prices on all 27 million U.K. residential properties and an enormous amount of metadata around it, and using AI, increasing every day. You can imagine a future not too far away where every property has a Zoopla standard identiﬁcation number, and you can trade that property, manage it, insure it, mortgage it based on that number. If that existed today, or 10 years ago, we wouldn't have had the extent of the problems we had in the securitization markets, which were driven by bad data.
How does this translate? I think there are two people that are worth thinking about when you're thinking about how this affects the new industrial or economic
paradigm, Ronald Coase and his Theory of the Firm; basically transaction costs drive the optimal size of a ﬁrm in any industry. I would posit that transaction costs are changing and dropping massively, and that's got to have an effect on the way the companies are structured, and industries are structured. I'm not sure it has, yet, but it's inevitable. The second person I think is worth reading and understanding is Herbert Simon, who is a psychologist of polymath, who really did a lot of research on complex, adaptive systems. Our economies are clearly complex, adaptive systems and his thesis was, or what he discovered was that complex, adaptive systems wherever you found them, in nature, in our economies, in mathematics, tended to be more evolutionarily ﬁt if they had a property called "nearly-decomposable," a mathematical property that essentially, without putting up the back of all the mathematicians here, means that systems that are formed of components and subcomponents, modular. Again, this is something that intuitively, I think all of us know, especially in the computer or software industry. You build programs in nested objects and decompose the complexity of the system. This leads us to a world of bytes, and to give you a quick example, I'll let you read this, but I just want to prove the point that almost anything is becoming a digital good, in the heart of the system. At the edges it might be physical, but in the heart of the system, it's a digital good. Here, gas, the industrial company Shell, you think that's not a digital business? I think it is. Markets, any structures that allow any buyers and sellers to exchange any type of goods, services, or information. Again, abstract markets further out and you could start doing that in this digital world. Platforms are absolutely key in terms of business models and strategies, going forward. This is something that, again, is second nature to the computing industry, but I think in the digital world it's going to become more and more relevant for almost industry. You've got a new stack for a modern economy. You've got physical platforms, digital platforms, and if you haven't read Invisible Engines, and you want to understand digital platforms and how they work and the economics of them, you have to read this book. On top of those digital platforms, you have APIs, which serve applications and services at the top of the stack.
The traditional industry of corporate structure was very much a vertical structure. If you look at Tyrannosaurus Telecom and Bank Brontosaurus, these are vertical entities. J.P. Morgan, British Telecom, KPN, they have everything from top to bottom and they're organized on the principles, I think, of the fourth paradigm, which was Sloan's Mass Production hierarchies and where transaction costs were very high. It's not that these business models are intrinsically wrong, they were very well adapted to the 20th Century. I think they're very ill adapted to the 21st Century, and I think some of the things we've seen happen over the last decade, ﬁrst in the telecoms industry in the late '90s and the ﬁnancial industry more recently, are manifestations of this misalignment of the structure of these industries against the fundamental economic structural underpinnings. I think the new optimal industry corporate structure will be much more of a horizontal structure. You can have various different components in the stack within the same organization, I think, but the way of thinking about it needs to be much more horizontal. You have physical platforms again, and this is something I always laugh about; I'm not in telecoms but whenever I read articles about the latest, greatest new thing a big Telco's doing, it's to avoid becoming a dumb pipe. What the hell is wrong with being a dumb pipe? Being a dump pipe can be a great business model. In fact, what's more important; the problem with the vertical stack is the capital structure is horrendous to align properly to an
organization that is organized vertically. Dumb pipes, you ﬁnance them with debt; they're cash ﬂow driven businesses. There are a lot of businesses in the world that would be considered dumb pipes. If you look at the satellite business, they don't sell services. They sell satellite access. These businesses are performing very well. You just need to align your objectives with your capital structure with the way that you're structured. You have real economies of scale here. This is a dimension where size does matter and you can use it to good effect. Next up, the stack - the problem with these stack analogies is you have bottom, middle, and top. Everybody thinks that minds are tuned to think top is better. I'm agnostic. They're just different things in the stack. Digital platform, it's a substraight - you create a substraight for an ecosystem of services. Selling trust, I think, is one of the ultimate things you're doing. It's necessary that you have the technical capability to build something useful, but it's not sufficient to be successful. I think to be successful, you need to effectively sell trust that it will work and that people can rely on it. In doing so, you create markets. Here again, you also have economies of scale, different economies of scale, but economies of scale nonetheless and probably more pointedly, this is where Metcalfe's Law of Networks, especially for multisided markets comes into effect. I love quote from ReadWriteWeb, "Well built developer platforms are the future of every industry," and I think they got that spot on. Digital platforms, with APIs allow people to build services and applications at the edge and this is where innovation should happen. This is where you need rapid adaptation. This is the Cambrian explosion. This is where any big company will structurally fail if they try to play in this edge. I speak from experience. I tried to do this. My last employer, Dresner Klein, which is part of Alliance which is a huge ﬁnancial conglomerate, I guess my "aha" moment was understanding it wasn't because any particular manager or group of management was dumb or didn't get it, or was wrong. Structurally, these big ﬁrms, actually the better run they are the harder it is for them to innovate at the edges because innovation is looked at as a virus and the corporate antibodies, the well-oiled machine does everything it can to stop that from happening. Here you have dis-economies of scale. Dis-economies due to complexity, so bigger here is not better. It's worse. It's not even neutral. Low capital intensity take an extreme example, the startup world, you're ﬁnancing it with options through equity. You don't have debt ﬁnance. If you look at businesses where you have a mix of the two, and there are a lot of them in the ﬁnancial business because you've got risk capital; Imagine the telecoms business, as well, risk
capital at the bottom which is almost the equivalent of a physical platform, which might be debt ﬁnanced or the expectations in terms of returns are limited but relatively certain. At the top you've got very deep, out of the money options, highly volatile, low capital intensity. You try to marry those in the same instrument, the same capital structure and nobody is happy. Coming back to this example of Shell, in that example; who is the bank, who is the Telco, where is value created? It's not as obvious as it ﬁrst seems. This is a friend of mine, Richard Water who works for IHS. He said, "Isn't it just all FX?" It's gas molecules, FX transaction to electrons, FX transaction to Sterling if the electricity is sold in the U.K., FX transaction to Dollars; back to Shell, paying for the gas. It's all a digital transaction and just modifying the same thing across the value chain. Already, banks and telecoms are more similar than they look, and a lot of digital businesses are. If you look at the process stack of these two industries, and you could probably expand it, you've got enormous similarities. In the front office, again this is probably least intuitive, but if you're managing massive trading ﬂows, they're digital now, the problems that you face are very similar to the problems that telecoms operators face in transacting and managing massive ﬂows of data over their networks. The other factor is customer account service: online payments, security, customer statements, customer support, and the trust around that. These are maybe more obvious, but again, it's the same thing. If we're not there, or if that's not the right business model, then what is? I think the companies that will emerge over the next two decades in the sixth paradigm, that will become the giants of the sixth paradigm, are companies that are Messaging and Co., Trust Inc., Identity Ltd., where they're integrated along the horizontals. That will allow us to have an ecosystem of banking as a service. Disclosure, this is a company we've invested in, FX Capital Group, RabbitFX. They offer FX physical brokerage, so if you need to buy Euros, if you live in the U.K., or vice versa, they offer one thing, one very small thing, very simply, very well, and they only exist because they have an enormous infrastructure e-platform, digital platform underneath them - the banking system, the payment system, the trading system that allows them to do that. Another example is a fantastic example and really is a convergence of telecoms and banking. It's Frontline SMS, some of you might have heard of them. They just launched Frontline SMS Credit. They're focused on developing markets but they
could operate anywhere, I think. This is a company I'm not involved in but I'd like to get involved in. They actually run as a not-for-proﬁt, but they have built a platform that allows you to do messaging, building off of the global mobile network, via a computer, to do mass messaging and manage that. With the credit adaptation, their tagline is fantastic "It's a bank on a laptop" and that's what they'll be able to offer. On the telecom side of the equation, voice is a service. We have that already, companies like Ribbit and others, so what I'm saying is not that companies won't be organized or have elements of all of this stack, but if they do have all of this, if it is a very large company, they need to be thinking about it in this way. Then perhaps, maybe get involved in some of the stack at the very top level, as a proof of concept or shop window, and also where it's obvious they have brand value. Telecoms company and voice, banking and some of the payment services they need to have open architectures and learn from the computer industry; where are the AWSs of banking, of telecoms? Where are these platforms? Why isn't J.P. Morgan opening up its platform and saying, "You guys innovate on top of it," instead of trying to do all of it in house? Where is the AppStore for ﬁnance? You look at companies like Amazon, Apple, Facebook, Microsoft, all enormously successful, and much of their success if predicated on the fact that they build these platforms that allow other people to innovate and work on top of them. My conclusion is that in our industries of ﬁnance and telecoms, we need to shake up the stack and we need to think of this new industrial landscape. We need to start thinking in a context of a sixth paradigm, not a ﬁfth paradigm; 21st Century businesses, not 20th Century. Thank you. Chair: That 20 minutes should be expanded into a book. It's quite clear that all the topics covered there each would be a chapter. I'd be really excited to see if a book gets made out of it. I think a book should be made out of it. I really enjoyed that. Questions from the audience? We have Jim here. You may need to stand up so we can see you. Audience: I notice an emphasis, everyone wants to talk about the bits, and Negroponte used to think we have to talk about both bits and atoms. The atom side of what you just discussed, I've worked with hardware distribution models. Again, it's the same sort of thing. The distributor is running on top of a layer of ﬁnancing to move goods from one person to the other. I'm really seeing and I'm getting into that area again. My question is; have you looked at these in terms of that sort of thing too, in terms of distributing hardware and hard goods?
Sean: I think the poster child there is probably again Amazon. Amazon couldn't exist or their business wouldn't exist without a very excellent logistics and distribution arm. Part of Bezos's genius was A) raising a billion and a half dollars from a convertable bond before the dot com bust happened and B) spending that money building the physical infrastructure he needed to properly run his business. In this vision of the future, the point is not that the physical world will disappear, but the management thereof can become an abstraction, which liqueﬁes it enormously. Both the management and a point you raised that I really didn't touch on, the ﬁnancing, and one of the reasons I left banking was I became increasingly frustrated at the way that ﬁnance was delivered. The way that banking and ﬁnance is delivered hasn't changed in 400 years, since Monte di Pietà in Italy in the Renaissance. It's the same thing, just bigger, faster, better. I'm sure that now with the tools that we have, it can be much more modular, ﬂexible, adapted - this idea of abstracting from a pool of risk capital to the way it's engineered and placed. The great example is a company we're invested in called WeatherBill that does weather insurance. The way we build the company is the underwriting is done by a weather fund in Bermuda. We've abstracted - all we do is price and originate the risk within WeatherBill. Again, the reasons the banks don't like that is that when you do that, there is an element of transparency and the more you do that, there is more and more transparency because the stack can only work if there is transparency. Banks love the fact that there is this big black box and there is opacity. They try to, and are often very successful in taking oligopolistic rents from that lack of transparency. I think inevitably, the tide is moving that way and you'll get this abstraction of the economy into various different layers that's made possible because of this digital technology. Conceptually, you probably could have thought of this 200 years ago, but actually translating it into something that pragmatically works, at a cost that is not prohibitive is only something that's happened in the last few years, and it's continuing to happen. Audience: Do you think that such platform companies should operate publicly toward the end customers, or should they hide between [00:24:42.06 ?] aggregating platform services vertically, and proposing niche services towards parts of the classical customers for big [00:24:53.10?] Sean: I think it's the latter. I think it's a mix. For instance, take the example of either a telecom or a bank, and it was a point that I tried to make at the end; not
that they should completely retreat from that edge, and I actually think that could be dangerous. You want to have, whether it's a shop window or certain areas where your brand or expertise really does add value at that part, and even the last thing and probably the most important over the long term is just to keep yourself honest, eat your own dog food, to have applications or services that are consuming your own platform. It's an early warning system of does it work or not. I think the risk is, and humans work as pendulums, maybe the pendulum will shift too far the other way. When I speak to people, I probably emphasize more this idea of really separating those two businesses, because most of the people I speak to or most contexts is they're so deeply embedded. I'm trying to over exaggerate that separation. The short answer is I think it's a mix, but the way that management thinks about it is absolutely important. It's not trivial, the fact that if they're looking at the business in that way, even if they're doing every element along the value chain, it's very important for the way that they're going to structure their offering. Audience: Your proposition of "everything is a service" seems predicated on people neither wanting to own things or that providing them services is always the most efficient, when practically speaking you're going to have issues of network capacity, or availability for example. How do you blend the "everything is a service" vision with the more pragmatic desire or requirement of people to own physical devices, applications, and so on. Sean: That's a good question. First of all, if Carlota Perez is right and then in terms of her thesis of how the economy evolves, and then if I'm right in terms of this is the start of maybe a new paradigm, I think what you just raised is a perfect example of the divergence in technology in our social and cultural intuitions and frameworks that we work in. I think for the next few years, there is going to be an increasing disconnect between those two, and at some point, maybe 10 or 15 years from now, it might actually boil into something that's quite traumatic for the economy, as the technology pushes our economies into that direction of everything is a service, and our cultural prejudices mean that we're not adapted to live in that kind of a world. Forty years from now, those will realign. I think the reason these cycles happen maybe this way is partly generational. The cycles have to do with human lifespans, to some extent, because people who grow up in a certain paradigm get comfortable with that. They actually reach positions of power very late in that paradigm, probably, and that's where you
get this tension. But, the new generation coming through, so anyone who is born today or my children for instance, probably won't have the same context in terms of how they consume goods, services, and how they relate to the world around them. I think naturally, that adaptation will happen only with time, and in the short term, you'll get the classic tensions between where the technology is pushing us and us digging in our heels, not wanting to go there. Chair: Thank you very much. Sean: Thank you.
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