Monday, January 14, 2013

Evolution begets Genesis begets Evolution

I’ve talked about the genesis of activities (i.e. new things) and how they evolve to more of a commodity but does any relationship exist between the two? The answer is yes.

In the Theory of Hierarchy, Herbert Simon showed how the creation of a system is dependent upon the organisation of its subsystems. As an activity becomes commoditised and provided as ever more standardised components, it not only allows for increasing speed of implementation but also rapid change, diversity and agility of systems that are built upon it.

In other words, it’s faster to build a house with commodity components such as bricks, wooden planks and plastic pipes than it is to start from first principles with a clay pit, a clump of trees and an oil well. 

Bricks, planks and pipes along with other architectural building blocks have led to a faster rate of house building and a wider diversity of housing shapes. This is the same with electronics and every other field you care to look at. Commoditisation to standard components leads to increased agility, diversity and speed of creation for higher order systems that are built with it. 

The same phenomenon occurs in biology i.e. the rapid growth in higher organisms and the diversity of life is a function of the underlying components, standard building blocks that have evolved allowing higher orders of complexity.

This doesn't mean that change stops with the standard components. Take for example, brick making or electricity provision or the manufacture of windows, there is a still significant amount of improvement hidden behind the "standard".

However the "standard" acts as an abstraction layer to this. Just because my electricity supplier has introduced new sources of power generation (wind turbine, geothermal etc) doesn't mean I wake up one morning to find that we're moving from 240V 50Hz to something else.

If that constant operational improvement in electricity generation was not abstracted behind the standard then all the consumer electronics built upon this would need to continuously change - the entire system would either collapse in a mess or at the very least technological progress would be hampered.

It’s no different again with biology. If there weren’t underlying components from DNA to RNA messaging to transcription to translation to even basic cell structures within more complex organisms then you and I would never have appeared in the time frame.

Now as an activity evolves to a more standard, good enough commodity then to a consumer all this improvement is normally hidden behind the interface. Any changes are ultimately reflected in a better price or quality of service but the activity itself for all sense of purpose will remain as is e.g. a standard but cheaper brick or power supply or wooden plank. 

There are exceptions to this but it usually involves significant upheaval due to all the higher order systems that need to change and hence Government involvement is usually required e.g. changing electricity standards, decimalisation and the changing of currency or even simply switching from analogue to digital transmission of TV.

Hence, activities evolve to more of a commodity (i.e. linear) and those that become components act as an interface boundary between the higher order systems that consume them and operational improvement to the activity. Change can happen but it’s costly. I’ve summarised this in figure 19.

Figure 19 : Componentisation, Genesis and Evolution

Obviously not everything becomes a component of something else but IT systems often are and IT is no exception to the effects of commoditisation and componentisation. For example, the cloud represents the evolution of many IT activities from product to utility services (commoditisation) and through provision of good enough, standard components it is causing a rapid rate of development of higher order systems and activities (componentisation). 

This isn’t the only effect, there are others.

Volume Effects
In an earlier section, I mentioned Jin Chen’s Entropy Theory of Value and how as activities evolve to more of a commodity they have declining unit value (assuming no effects such as monopolies). The total value tends to be highest during the transition (i.e. product) phase.

This can often be misconstrued as meaning that when something becomes more of a commodity then total revenue declines. This is not the case because of volume effects.

In the 1850s, William Stanley Jevons observed “England's consumption of coal soared after James Watt introduced his coal-fired steam engine, which greatly improved the efficiency of Thomas Newcomen's earlier design"

In other words by increasing the efficiency and hence reducing the cost for provision of an activity (in this case steam power), a large number of new activities which might have once not been economically feasible became economically feasible. This led to an increase in the consumption of the underlying subsystem i.e. coal.

In general, as an activity becomes more of a commodity it can increase in total volume of units produced through a number of routes, including: -
  1. There existed an unmet demand for the activity in the market that a lower cost enabled e.g. general price elasticity.
  2. As it becomes a standard component it enables the rapid generation of new higher order activities (and industries) that consume the component e.g. transistors giving rise to calculators, computers and a wide variety of electronic devices which all consume transistors.
  3. A lower cost of providing or a more efficient use of a component activity enables new consuming activities to become economically feasible e.g. more efficient steam engines cause more coal consumption.
These volume effects above can also be recursive throughout the value chain e.g. evolution of a higher order system to a standard component of other more higher order systems will also lead to increased consumption of any lower order system. 

For example, in 1947 Raytheon introduced the first commercially available microwave oven (the “Radarange”) at an equivalent price today in excess of $50K. As the microwave became more of a commodity and also integrated into other components (today, microwaves are a common component of modern), this has caused a growth in consumption of underlying subsystems – from electric power to microwave generators.

Alternatively, if we examine the last forty years of computing infrastructure then as it became more standardised and lower cost per unit (measured in price per transistor) rather than seeing a decline in revenue we have seen a growth in volume to offset any efficiency gains. Hence today, even though I can buy a million times more compute resource for a $1,000 than in the 1980s, this does not mean that IT budgets have reduced a million fold in that time. In fact, we’ve just ended up doing more stuff that consumed more compute resources. Hence whilst the differential value of computing infrastructure has declined to almost nothing, the volume of consumption has massively increased and the revenue (i.e. total IT budgets) associated with it remains reasonably constant.

Commoditization of activities to component subsystems of other activities can led to rapid increases in volume which can offset any decline in revenue per unit despite the actual component activity having little or no differential value.

To illustrate the point, let’s look at something relatively new - the iPad. The average consumer has no or little knowledge of the vast number of components that make up an iPad. Any differential value is associated with the device itself whereas the components are all, more or less, invisible.  Even the most ardent Apple watcher would be hard pressed to describe the 39 screws (of various standard types) in the iPad 2, nor which of those 39 are common with the iPad mini or alternative tablets such as the Samsung Galaxy Tab 10.1. 

There are however multiple manufacturers of these screws and the rapid increase in the volume of tablets whilst resulting in price pressures on component costs has increased the volume of components and associated revenues both directly and though secondary markets such as

There might not be a lot of differential value in small screws but there’s quite a bit of volume and revenue. Hence commoditization results in declining value associated with an activity but if it becomes a component of other higher order systems then volume effects can counter this. 

One final impact that the declining differential value caused by commoditisation has, involves the flight of capital known as creative destruction.

Creative Destruction
Capital tends to chase higher perceived value i.e. higher margin activities that are associated with future value. Hence looking at our change of characteristics from chaotic to linear (see figure 20), then it is those new activities that are moving into the transitional phase. 

Figure 20 – Perceived Value and Evolution

For example, as electricity became provided as a utility (having previously be provided as products such as the original Siemens Generators of the 1860s), the perceived value drifted towards the higher order systems i.e. those things that consumed electricity from televisions to fridges. I’ve combined figures 19 and 20 together in figure 21 to illustrate this point.

Figure 21 – Evolution, Componentisation and Perceived Value.

Equally today, in the world of computing the focus is not on provision of computing infrastructure but instead those new, higher order systems that consume it e.g. Instagram, Netflix, Big Data etc.

This flight of capital, from once industries that were perceived as “value” generating to new higher order systems that are now perceived as “value” generating is known as creative destruction . The commoditization of one set of industries to standard components (destruction of past value) enables these new industries to flourish (creation of future value). In some cases, the destruction is actual and direct, sometimes indirect. To survive this change companies have to adapt.

For example, the commoditization of electricity production from generators to modern A/C based utility services started with Tesla and Westinghouse in 1886. Componentization effects enabled the rapid growth in creation of higher order systems such as electric lighting, radio, television, consumer electronics and even computing. 

These higher order systems became the focus of future wealth generation and capital flowed into these industries whether TV manufacturers or TV broadcasters (Creation).  Electricity itself was viewed as a commodity. Past industries such as the manufacturers of electricity generators were directly affected by a loss of market as existing customers switched to utility provision (Destruction). 

However, being a component of these new higher order activities, the consumption of electricity increased rapidly as those activities themselves evolved e.g. as TV’s evolved from a novelty to commonplace then more and more electricity was consumed (Volume Effects). The manufacturers of generators had to redefine themselves either as components for utility providers or as utility providers themselves or as “backup” systems for customers with concerns over the new suppliers or they had to focus on niche areas (Adaptation)

Other past industries were indirectly affected, often suffering more damage than those who could see the change coming. These included gas lamp lighting companies who were disrupted by the diffusion of electric lighting or music halls that were impacted by television and radio.

Similar patterns to this can found throughout history. For example, more recently the commoditization of the means of mass communication brought about by the Internet has: -

Enabled rapid generation of higher order systems from search engines to social network sites (componentization) with associated companies that were seen as the new sources of value (Creation).

Caused direct disruption of companies that had built products that previously filled such roles from local newspapers to media to catalogues (Destruction). These companies have been forced to adapt to the visibly changing environment.

Caused indirect disruption of companies due to replacement of their services by higher order systems or reduced barriers to entry. For example, electronic retail, booksellers, grocery and holiday booking agents. Many of these companies would not have seen the changes coming as they were indirect.

There has been a rapid increase in the volume of data communicated (volume effects).

I’ve summarized all the effects we have talked about in this section into figure 22 using the previous example of electricity provision.

Figure 22 – Componentisation, Creative Destruction and Direct, & Indirect Change.

By now, the reader should understand that organisations consist of value chains that are comprised of multiple components all of which are evolving due to user and supply competition.  As the components evolve their characteristics change and they can enable new higher order activities to rapidly appear either extending the value chain or creating new value chains. This changes an industry dynamic through the destruction of past sources of value and flows of capital into new value generating areas that then in due course, due to competition, evolve.

Commoditisation begets the genesis of new higher order activities that then commoditise begetting the genesis of even higher order activities than then commoditise. Standard nuts and bolts beget generators beget electricity beget computing beget big data. 

Evolution begets Genesis begets Evolution. 

This cycle of change is a constant result of evolution, which itself is a constant result of user and supply competition i.e. if you don’t like change then simply get everyone to stop competing. The same goes with biology. Business, as with life, is a cycle of change.

Whilst I have talked principally about activities, the above applies to practices and data. Alas, despite its inevitability, people and organisations often act as though they don’t like change even when it is clearly visible that it’s going to happen. Which is why in the next section I'm going to look at inertia.


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