It will come as no shock to most readers that I think one of the key opportunities of the next decade or so is to harness the possibilities unlocked by the advances in ICT – most notably the continuing march towards a ubiquitous, high-speed internet – to vastly lower transaction costs and enable robust, distributed marketplaces to emerge in sectors and activities where heretofore the (informational and transactional) costs of organizing such a market would have been prohibitive. While it is certainly an oversimplification, I think such opportunities can be broadly categorized into two groups:
those that make the transactional mechanisms of existing markets more efficient – either incrementally or by a quantum shift to a new market structure – by reducing informational friction and arbitrage and eliminating parasitic intermediaries while at the same time massively improving the productivity of ‘intelligent’ intermediaries; and
those that enable markets to emerge where previously none existed at all (or only in the broadest economic sense, but where transactions were previously ad hoc and opaque), often (but not always) these are markets for services (rather than goods or financial instruments) where the nature of the service is highly heterogeneous and in data terms is “unstructured” rather than “structured”*
Putting my money where my mouth is, I’ve taken the opportunity to invest in two exciting start-ups that fall into this second group: last year in seedcamp ’07 winner MyBuilder.com and just now in (seedcamp ’07 finalist) School of Everything. Both have passionate, energetic and visionary founders that have been able to translate their ideas into robust and well-executed platforms for organizing and ‘trading’ specialist services. As for any pioneering start-up, neither can be sure of success, however the combination of a fundamentally sound idea, in harmony with the inevitable secular change in how economic activity will be organized in a networked world, married to a strong committed team is as good a place as any to start.
I must admit in the case of SoE, part of my motivation to invest was driven by a more emotional and/or intellectual interest in what they have set out to do:
Our current education system was designed in the industrial revolution to prepare people for factory work. The world has changed a lot since then – and the time has come to rethink education from the bottom to the top.
At School of Everything, we believe that learning is personal, and starts not with what you ‘should’ learn but with what you’re interested in. So we’re building a tool to help anyone in the world learn everything, and teach anything, how and when suits them – by putting people in touch with each other, not with institutions.
Not only is education and learning the lifeblood of our modern economy and an important social good, but by creating a marketplace for people to ‘distribute’ and acquire skills and knowledge, SoE is providing another very useful output for harnessing what Clay Shirky has identified as society’s “cognitive surplus.”
Now, the interesting thing about a surplus like that is that society doesn’t know what to do with it at first–hence the gin, hence the sitcoms. Because if people knew what to do with a surplus with reference to the existing social institutions, then it wouldn’t be a surplus, would it? It’s precisely when no one has any idea how to deploy something that people have to start experimenting with it, in order for the surplus to get integrated, and the course of that integration can transform society.
The early phase for taking advantage of this cognitive surplus, the phase I think we’re still in, is all special cases. The physics of participation is much more like the physics of weather than it is like the physics of gravity. We know all the forces that combine to make these kinds of things work: there’s an interesting community over here, there’s an interesting sharing model over there, those people are collaborating on open source software. But despite knowing the inputs, we can’t predict the outputs yet because there’s so much complexity.
The way you explore complex ecosystems is you just try lots and lots and lots of things, and you hope that everybody who fails fails informatively so that you can at least find a skull on a pikestaff near where you’re going. That’s the phase we’re in now.
So if there is something you’ve always wanted to learn, or something you’d love to teach to others, School of Everything is a pretty good place to start. I wonder if anyone is giving courses on how to run a bank…you’d think demand for that might be pretty high these days… Given these tough economic times I suspect that SoE is even more useful, whether it’s to learn a new skill to keep an existing job (or find a new one) or to earn a bit of money and/or social capital by teaching if you’ve suffered the misfortune of losing your job or are working reduced hours.
In any event, I’m very excited to become a small part of this and congratulate Paul and his team on this follow-on funding and wish them great success in building SoE into a wonderful global marketplace for learning.
Regular readers will know that I have a healthy skepticism with respect to the supposed benefits of ever-increasing size in corporations and in particular with respect to financial services firms. Given the preponderant importance of human capital to creating and maintaining a competitive advantage in financial services, the exponential increase in complexity arising from imposing traditional hierarchical organizational paradigms on tens or hundreds of thousands of employees quickly outweighs the benefits of economies of scale in infrastructure and financial capital in today’s hybrid / universal banking and insurance giants.
Until now however, I have been without an elegant and robust metaphor for this thesis. But when I read Michel Bauwens’ essay (thanks to a pointer from Gordon Cook) comparing the current fundamental, secular changes in societal organization driven by the revolution in information and communications technologies, I knew I had found my meme:
…there is also the emergence of a new form of horizontality, no longer local and disconnected and unable to compete with hierarchical forms, but able to scale globally, through the global coordination of a multitude of small teams, outside of a logic of command and control. I think this is the significance of peer to peer (and peer production specifically), and that it points to the concept of Peak Hierarchy.
In my view, we have already reached the point in history, where ‘peer to peer plays’, i.e. interconnected horizontality, outcompetes hierarchical and diagonal plays. The two examples we have are of course Linux and Wikipedia.
In other words, we have reached a point in history, a true turning point, where a new form of social organization, starts to outcompete hierarchy. (But of course, just as early hierarchy was a hybrid with the system out of which it arose, so the new early forms of p2p are hybrid forms within the dominant system)
If this is true, and I of course believe it is, then we have indeed already reached Peak Hierarchy. It should be historically situated at the mid-point between the moment that Linux became the dominant technological force in the internet, and that the Wikipedia was outreading and outproducing the Brittanica. From that moment on, faced with these undeniable examples of success, the scramble for adaptation to distributed forms of organization, to integrating participation in the very heart of hierarchy, has started to make itself felt. There has been a magnetic reversal of the poles. The chaotic attractor has become the peer to peer mode. Hierarchy is still dominant, and will stay so for a determinate amount of time, but social forces are already looking elsewhere, mostly unconsciously, but nevertheless.
This is unprecedented, and is changing the whole course of human history. Of course, it will take time to play out, see how difficult it was to realize the truth of Peak Oil, how adamantly the forces of biospheric destruction fought and are fighting back. But we can also see that it is ultimately a losing battle for them.
Not only does this thesis capture the essence of the issues facing the prevailing global political and economic paradigm but it neatly frames the diminishing returns characteristic of the twilight of a golden age and the accompanying bewilderment of the existing elite who either fail or refuse to understand the tectonic changes inevitably undermining their comfortable sinecures. Shades of the fall of the Roman Empire? Listen to Michel’s take on this:
Not only is the concept of ‘Peak Hierarchy’ an important pillar in our investment thesis, but it also directly colours how we think about building and organizing our own firm over the coming years. We are convinced that this will give us an additional competitive advantage, especially as many of our potential competitors are likely to continue operating more traditionally for many years to come.
So I’m adding it as a category here at the Park Pardigm and expect to read more of my thoughts on its meaning and implications on business and finance going forward.
Metro reports this morning that 6% of adults in the UK – a million people – regularly use their credit cards to make their mortgage payments:
More than 1million people use high-interest credit cards to cover their mortgage or rent payments, debt experts say. Six per cent of householders have turned to plastic to pay for the roof over their heads during the past year, according to housing charity Shelter.
Young people struggling to stay on the property ladder are most likely to use the ‘rob Peter to pay Paul tactics’, despite risking long-term ruin. Many credit card companies charge interest between 15 and 18 per cent – up to three times higher than typical mortgage rates.
Clearly – and I would expect all my readers to understand this – borrowing at 15% to pay off debt contracted at 6 to 8% is financial lunacy. (It’s called negative carry and you have to have a damn good reason to hold a position like that for any length of time.) There may be an argument to do so occasionally for one or two months if you are facing an exceptional and short term liquidity shortfall as the ease and convenience (ie opportunity cost) of using an existing committed line of credit (ie a credit card) offsets the extra interest cost. Indeed this may be the case for some of these people. However for most I suspect it reflects two failures that should be addressable: firstly it reflects a basic lack of financial (mathematical?) literacy among a substantial proportion of the population, secondly it reflects a lack of appropriate basic banking (lending) products, or awareness of those that do exist.
A cynic would say that it is easier for a lender to price (and thus provide) ‘credit card’ debt and so this is what is offered. It is true that credit card risks – being very granular, and widely distributed, and having a relatively long history (through various economic cycles) – are more easily modeled using statistical techniques. Indeed this is why you haven’t seen distress in the market for credit-card backed securities as opposed to mortgage-backed securities: they tend to behave as modeled and so the stress tests used to structure these securities tend to reasonably accurately represent real life losses under economic stress. Indeed, the high interest rates reflect the probability of high expected losses. Looked at from a portfolio point of view, credit card receivables are less ‘lumpy’ and losses more normally correlated and distributed than most other kinds of lending. Of course one of the reasons that mortgage loans cost less and are typically seen as ‘safe’ (or at least safer) assets is that they are secured on real property (and in the case of a primary residence, seen as the first in the queue for repayment as people are loathe to lose their homes.) The problem with this (as is being brought home in spades by events in the US) is that the lender faces two residual risks – one the value of the underlying real property can change (go down) and the transaction costs involved in ‘realizing’ (ie foreclosing: taking ownership and liquidating the property to repay a delinquent loan) are typically very high (it depends on the legal regime and labor costs but these can often be as much as 20-30% of the value of the property, especially for lower value homes.)
So what can be done? Schools, but also financial institutions, need to do a better job of educating their citizens/customers. You need a driver’s licence to drive a car. Perhaps you should have a borrower’s licence to take out a loan? Ok perhaps not – I’d much rather see a market solution, and I suspect there must be a long term commercial benefit to financial institutions who take this responsibility seriously (and not just as a box-ticking exercise under regulatory duress.) Perhaps new innovative start-ups like Kublax will start making a difference in this area.
Next, financial institutions need to pro-actively offer better overall financial solutions to their customers. For most high-street banks however there may be a inherent conflict of interest in promoting more intelligent solutions to credit cards. (Don’t misunderstand me, credit cards are a fantastic product when used appropriately – ie for 20-40 day ‘working capital’ rolling credit, but they should always be paid off in full, or at worst used for very short term cashflow smoothing as per above.) Ideas like the various ‘One’ accounts, which automatically offset deposits with mortgage debts should be extended to consolidate all assets and liabilities. An idea I’ve been thinking about for several years is to create a company that would help individuals manage their personal balance sheet in a professional way. I suspect that the vast majority of people don’t really know what a balance sheet is, and amongst those that do, few think of their own finances in this way, other than perhaps momentarily when applying for a mortgage or writing a will. Perhaps I am naive but I believe the concept of a balance sheet – stripped of jargon and intellectual snobbery – is one that the vast majority of people could grasp if presented in a friendly and clear manner.
Finally, if banks won’t help their customers contract more appropriate debt, I hope more people will make recourse to markets like Zopa for unsecured financing. Aside from getting better rates, participating in a market like Zopa forces people to spend a little time thinking about their balance sheet and how credit markets work (even if they probably wouldn’t articulate in this way.) Zopa is user friendly and welcoming in a way that banks – despite I’ll admit some efforts to improve their public perception – just aren’t.
Of course none of this will help anyone who is bound and determined to spend more than they earn (or more accurately will earn), but I suspect that many of those struggling with managing their finances would welcome a helping hand in having a better understanding of their financial situation and the options available to them.
Great post the other day on ‘You’ve been noticed’ highlighting how the traditional (centralized) banking paradigm is facing a real alternative for the first time in the modern era (notwithstanding the historical success of credit unions, especially in rural locales; of course these depended on a wholly Web 2.0 concept – community!)
How long before the price of this debt is reduced due to better “Social Ranking”, ie on Rapleaf, or eBay? I think we may be seeing the world of Micro-lending re-engineering the world of traditional lending. Instead of just “Bad Debt”, perhaps people will respond to “Bad Rep”, and pay on time? I mean who wants to look bad in the eyes of friends and colleagues?
Banking has used technology to great effect in terms of making their processes more robust and massively more efficient over the past 2 or 3 decades. Some of these gains have trickled down to the customer, but most have been absorbed by the management and the shareholders. And I’m not just talking in terms of pricing or margins. Indeed much more important in my view is the heretofore missed opportunity to pass on a truely tailored, friendly and understandable customer experience notwithstanding the fact that the technology (and business models) to do so already exist. However it is not hard to understand why such reticence (on the part of the incumbents) exists: they are making money hand over fist (ie if it ain’t broke, don’t fix it), barriers to entry are very high (but perhaps not just quite as high as they think), they have huge financial and psychological investments in the giant mass-production factories they have built (not easy admitting obsolescence) and all the usual human and behavioral impediments to change in large organisations.
Companies like Zopa and Prosper are certainly interesting and deserve to be applauded, but somehow I think they are only scratching the surface. Furthermore it becomes quickly obviously that the regulatory framework is woefully ill-adapted to allow this new paradigm to flourish. (Of course as Ms Perez so eloquently stated in her masterpiece, this is unfortunately par for the course:
…in the first decades of installation of the new industries and infrastructures, there is an increasing mismatch between the techno-economic and the socio-institutional spheres…
It is indeed intuitive when looked at from this perspective, that the (social) inertia of the existing – and previously successful – paradigm acts as the main obstacle to the diffusion of the new paradigm.)
One example (and there are far, far to many to enumerate here) is the strictly national framework imposed. To participate on Zopa, one must be a UK resident. On Prosper, a US resisdent. Whereas in many instances, trans-national communities would form much more interesting and robust markets. And wouldn’t facilitating a natural flow of capital from developed to emerging economies, leapfrogging underdeveloped financial systems to create access to millions (much as skipping fixed-line infrastructure and moving straight to mobile telephony has revolutionized access to communication for much of the developing world) be a fantastic opportunity? I’m not saying it is impossible; but the mindset and starting point of most regulatory regimes is more adapted to a 19th-century world of independent nation states than today’s reality of a massively complex global tapestry of interconnected communities.
Malcolm Matson observes that a new business paradigm – c2b, consumer to business – is in the acendancy:
This classification of the world into “service/content providers” and “service/content users” lies at the very heart of the obsolete and flawed Cable-TV and telecoms business models. It is what gives rise to their desperate attempt to differentiate ‘bits’ from ‘bits’. Ultimately this is fruitless and doomed effort to make water run uphill, for the liberating impact of these technologies is unstoppable – as end users enjoy the impact of Moore’s Law on the ever more powerful array of “digital creative tools” and as OPLANs begin to emerge around the world, then we will see an explosion of C2B activity – not just at the internet level but locally, within neighbourhoods, cities and communities. The mind can only glimpse through a glass darkly what positive social and economic impact this may have – positive for all of us and quite the opposite for some vested interests that thought their ‘right to life’ was immutable. Bring it on …
Rebecca Blood calls it the dawning of the “age of participatory culture” and the end of the industrial age.
What does a c2b paradigm mean for other industries. Telecoms and media seem to be the focus but if this idea is real (and I think it is) it will certainly have profound implications (and create real opportunities) for other industries, including financial services.
So what might the implications be for financial services? Is it (just) the emergence of peer-to-peer business models? (zopa, intrade, etc.) Is it back to the future with mutual banking or insurance models? Or is there more? I suspect there is, although I’m not so sure that the c2b model in financial services is as intuitively as obvious as it might be in say media and entertainment. It’s certainly something I’ll be thinking about and I’d welcome any views or ideas on this front.
I haven’t written about these new person to person banking exchanges before, but a recent article in the Economist is as good an excuse as any.
Zopa in the UK and the new Prosper Marketplace in the US are variations on the eBay/Betfair person-to-person business model focussed on lending and borrowing. Zopa likens their business to microfinance only using the internet to create the networks of lenders and syndication of risk needed to make this a viable and attractive proposition. Interestingly on Zopa, you can only lend (I imagine borrow as well but haven’t read the terms) if you are not a “a credit broker or lend money to other persons in the course of any business. “ I can imagine where this idea came from but over time I wonder why an exchange would want to limit or restrict the types of participants on them. Indeed, institutional players can be key liquidity providers with the long tail of individuals setting the marginal price. Betfair is a lot more robust as a marketplace for instance for having a heterogeneous base of users.
Prosper Marketplace has added an additional angle which is to allow customers to form groups of affiliated borrowers that can (in theory) harness their collective trust / reliability to achieve lower borrowing rates – similar to the idea of the traditional credit union or the more modern social network (a la Friendster or LinkedIn.)
It will be interesting to see how these networks develop, but weaved into the tissue of the connected web, it is possible to imagine a day when such exchanges become ubiquitous and the preferred method of dynamically managing credit for millions or billions of users – retail and wholesale – around the world. Clearly there are many many obstacles to overcome but imagine the day when a hedge fund can trade on Betfair using leverage provided by Zopa using PayPal as a payments system…all dynamically managed in real time.