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Markets for the Digital Generation

Over the past few months, I’ve received a number of comments and criticisms of AmazonBay (see here and here for example.) Two in particular are frequent and valid enough to merit a response, and can more or less be paraphrased as follows:

(1) What’s the deal with the focus on gigantism??? Why would every thing merge into Megacorp???
(2) Why the obsession with sports (markets)???

And another which I would classify as artistic:

(3) What’s with the ‘Darth Vader’ -esque tone???

So let me try and shed some light.

The first point is something that struck me as well almost from the first time I saw the completed film. It was in fact an unintended derivative of the story I was trying to tell and in that sense I guess was more of a conceit that (in a chronological story structure I chose, inspired by Googlezon) allowed me (using real firms representing existing business sectors and models) more easily to force viewers to look at the way markets are organized from a different perspective. To step outside ‘received wisdom’ so to speak. Especially for viewers currently involved in banking and financial services who - like in any walk of life - can too easily fall into the trap of not questioning the status quo. So yes I would agree with the critics view that merger upon merger as described in the film is not really plausible, interesting or original.

Actually - and this is something I hadn’t really thought about when I wrote AmazonBay - the question of giant versus small (corporations) in itself is an interesting question in the context of how the corporate landscape will evolve in 21st century market economies. What will be the optimal size of a firm in 2015? 2025? Can we use Coase’s “The Nature of the Firm” as an analytic starting point?

Coase argues that the size of a firm (as measured by how many contractual relations are “internal” to the firm and how many “external”) is a result of finding an optimal balance between the competing tendencies of the costs outlined above. In general, making the firm larger will initially be advantageous, but the decreasing returns indicated above will eventually kick in, preventing the firm from growing indefinitely.

Other things being equal, therefore, a firm will tend to be larger:

the less the costs of organizing and the slower these costs rise with an increase in the transactions organized.

the less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes with an increase in the transactions organized.

the greater the lowering (or the less the rise) in the supply price of factors of production to firms of larger size.

How will these factors play out in a world with ubiquitous connectivity, massive and distributed access to computing power, social networks and knowledge-based production and consumption? Does it mean a world where companies like Google or Citigroup with their financial and computational firepower become ever larger? Or do they fall victim eventually to dis-economies of scale where organizational complexity overwhelms their primary advantages? If so does technology nonetheless push back the frontier at which these constraints arise? (ie the ‘optimal bigger is better is bigger than today but not infinite.) Or on the other hand will our new technologies render the (large) firm irrelevent by allowing frictionless, dynamic and continuous allocation and reallocation of resources and agents outside the traditional corporate structure? (I actually tried to raise this possibility - however obtusely - in the film in the episode concerning the IBM buyout and how it was transacted.) I don’t know. I guess I could take the lame route and say it will be some combination of the two, but that obviously isn’t very insightful! Perhaps it is more useful to think in terms of ‘infrastructure’ tending towards the very large while ‘commerce’ and ‘fashion’ will tend towards a smaller and more fluid future (as framed by Stewart Brand):

The second point I have addressed previously. Clearly the relative importance (of sports markets) is overstated in AmazonBay but there are two serious points I was trying to make. Firstly, sport will - in my opinion - come to be considered a viable alternative investment market. Indeed it already is. As far as I can tell, Betfair alone will probably match over £2 billion of bets (transactions) on the World Cup football tournament. (To put this into perspective, this would be similar in terms of average daily turnover to the smaller European stock exchanges. In terms of number of trades it would be on a par with or exceed the largest global exchanges.) And alongside traditional ‘punters’ having some fun and/or trying to make some money the traditional way, a new breed of professional sports traders are driving volumes and liquidity on this and other betting exchanges using sophisticated algorithms and active risk management. I’m sorry you can keep your semantics, a rose by any other name… It’s a market. It has a substantial economic impact (directly and indirectly.) It is uncorrelated and diversifying to other asset classes and I’d sure rather have my pension fund manager investing in a smart sports hedge fund than yet another convertible arb fund chasing the same over-fished, highly-correlated (with other ‘traditional’ financial assets) markets. Secondly, and much more importantly I used sports as a metaphor for new (in the sense that people don’t currently think of these outcomes as tradable/investable markets) and important markets. Ok, ok, fair enough I should have made this more explicit. I should have mixed it up a bit: weather, politics, the number of mobile phones sold in Africa… the point is that in an AmazonBay world many many more markets will become viable as traded, liquid markets.

Finally, for all you film critics out there, now I know what it feels like to be an artiste (!) Hey, I’m not Speilberg. Hell I’m not even Randall M. Badat. Yes I was inspired by Googlezon. But also Blade Runner. (Has the Digital Generation even heard of Blade Runner???) I thought it would be an effective way of engaging the people I most wanted to reach - 40 to 50 something leaders of financial services firms, including my own - as (a) it is in their cultural programming (Blade Runner, 2001, etc.) to see the future through this comic book dark prism and (b) I wanted to create a sense of foreboding to frame the message in the context of ‘wake up’ or the future may look scary. If I had Ferris Bueller’s economics teacher narrate it, no one would have paid attention:

In 1930, the Republican-controlled House of Representatives, in an effort to alleviate the effects of the… Anyone? Anyone?… the Great Depression, passed the… Anyone? Anyone? The tariff bill? The Hawley-Smoot Tariff Act? Which, anyone? Raised or lowered?… raised tariffs, in an effort to collect more revenue for the federal government. Did it work? Anyone? Anyone know the effects? It did not work, and the United States sank deeper into the Great Depression. Today we have a similar debate over this. Anyone know what this is? Class? Anyone? Anyone? Anyone seen this before? The Laffer Curve. Anyone know what this says? It says that at this point on the revenue curve, you will get exactly the same amount of revenue as at this point. This is very controversial. Does anyone know what Vice President Bush called this in 1980? Anyone? Something-d-o-o economics. “Voodoo” economics.

So to conclude, I fall back on the words of the great Yogi Berra:

“Prediction is very hard, especially when it’s about the future.”

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