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The theories of Transaction Cost Economics originated in the paper “The Nature of the Firm” by Ronald Coase who was awarded the Nobel Prize in 1991. Coase wondered “if the price mechanism is the most efficient mechanism for allocating resources in a market economy, why do firms exist?” “why does a firm emerge at all in a specialized exchange economy”, and “why coordination is the work of the price mechanism in one case and of the entrepreneur in another”.
Coase’s answer was that economic agents incurred transaction costs when using the price mechanism. The greater the number, and the complexity, of transactions, the greater the costs involved in transacting. According to Coase, the firm should not be studied in isolation as a production function to be optimized. Instead, the transaction should be made the basic unit of analysis and the firm should be seen as one of several alternative ways of organizing transactions.
Williamson, following in Coase’s footsteps, elaborated on the reasons that transactions were costly. Uncertainty, complexity, informational asymmetry, and opportunism were inherent to transactions, which made it difficult to coordinate highly interdependent production and distribution processes through the market mechanism alone.
According to Williamson, firms emerged primarily to reduce the costs of transactions. Firms merge with other firms to bring more activities within one governance structure
Transaction costs consist of search costs, bargaining costs, contracting costs, risk costs, monitoring costs and enforcement costs. The basic premise of transaction cost analysis is that costs associated with transactions vary with the characteristics of the transaction, and different organizational forms are better suited to economize costs for transactions with different characteristics. Transaction cost economics is about finding the most economic organizational form given the characteristics of a transaction.
So viewed through the lens of transaction cost economics, outsourcing should take place when internal transaction costs for producing a good or a service are higher than the market costs, and should be outsourced to a vendor who has a relative advantage in delivering the service.

From SAP Info:
Wikipedia characterizes “collaboration” as a process defined by the recursive interaction of knowledge between two or more people who are working together toward a common goal. “Outcome” is defined on Google as the result of the performance (or nonperformance) of a function or process.
In the public sector context, collaborative outcomes are common to two or more government agencies and a quantitative or qualitative result experienced by stakeholders from this combination of government activities, achieved by leveraging common solutions, processes and / or technologies. Simply put, collaborative outcomes are a form of inter-agency collaboration or joint working where the agencies involved share responsibility for, and actively collaborate, to manage towards a common outcome.
Why are collaborative outcomes important? They reduce the layers of bureaucracy, foster a constituent-service oriented culture, reduce costs and ultimately drive higher public value.

Collaborative Service Delivery

One of the remarkable characteristics of the top Indian outsourcing companies is that while they capitalize on their clients’ willingness to outsource work to them, they don’t farm out work to others. They do everything themselves. Wipro, for instance, operates its own travel booking company. Now a startup called Anantara Solutions is trying to revolutionize the Indian outsourcing industry by operating as a virtual outsourcing company–which taps partners with specific areas of expertise. If this model takes off, it could pose a serious challenge to the outsourcing status quo, not just in India but worldwide.
Steve Hamm in Business Week.

It seems to me that the future of job advertising will be relevance. Relevant ads sent to relevant people. What is needed is the capacity to deliver narrowly targeted advertising messages in places that have communities or groups created around very specific common interests. This gives us the ability to reach groups of people who are relevant to specific job requirements. Maybe this will mean building a network of blogs, and categorizing them in some way. For example http://www.anshublog.com/ has a small audience built around ERP and SaaS. If you want to hire good talent in this area, you may want to include this blog in your publishing list. Two companies who are teaming together to start doing something like this are JobThread (http://www.jobthread.com) and Arbita (http://www.arbita.net)

What on earth is Web 2.0?

If you google “define: web 2.0”, this is what you get from wikipedia….
“Web 2.0 is a term often applied to a perceived ongoing transition of the World Wide Web from a collection of websites to a full-fledged computing platform serving web applications to end users. Ultimately Web 2.0 services are expected to replace desktop computing applications for many purposes. Awesome. But what does it mean? I for one don’t have the foggiest notion.

McKinsey has something crisper. They describe web 2.0 as a group of technologies, which rely on user collaboration and include Web services, peer-to-peer networking, blogs, podcasts, and online social networks.

Blogs (short for Web logs) are online journals or diaries hosted on a Web site and often distributed to other sites or readers using RSS (see below).
Collective intelligence refers to any system that attempts to tap the expertise of a group rather than an individual to make decisions. Technologies that contribute to collective intelligence include collaborative publishing and common databases for sharing knowledge.
Mash-ups are aggregations of content from different online sources to create a new service. An example would be a program that pulls apartment listings from one site and displays them on a Google map to show where the apartments are located.
Peer-to-peer networking (sometimes called P2P) is a technique for efficiently sharing files (music, videos, or text) either over the Internet or within a closed set of users. Unlike the traditional method of storing a file on one machine—which can become a bottleneck if many people try to access it at once—P2P distributes files across many machines, often those of the users themselves. Some systems retrieve files by gathering and assembling pieces of them from many machines.
Podcasts are audio or video recordings—a multimedia form of a blog or other content. They are often distributed through an aggregator, such as iTunes.
RSS (Really Simple Syndication) allows people to subscribe to online distributions of news, blogs, podcasts, or other information.
Social networking refers to systems that allow members of a specific site to learn about other members’ skills, talents, knowledge, or preferences. Commercial examples include Facebook and LinkedIn. Some companies use these systems internally to help identify experts.
Web services are software systems that make it easier for different systems to communicate with one another automatically in order to pass information or conduct transactions. For example, a retailer and supplier might use Web services to communicate over the Internet and automatically update each other’s inventory systems.
Wikis, such as Wikipedia, are systems for collaborative publishing. They allow many authors to contribute to an online document or discussion

Andrew McAfee, Associate Professor, Harvard Business School has the following definition:
“Enterprise 2.0 is the use of emergent social software platforms within companies, or between companies and their partners or customers.

From the economist:

economist-hrincentivessurvey.gif

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Building a Community

In his blog “How to change the World” Guy Kawasaki lists 8 points to note in the art of building a community..
1. Create something worth building a community around.
2. Identify and recruit evangelists:
3. Assign at least one person the task of building a community.
4. Give people something concrete to chew on. Communities can’t just sit around composing love letters to your CEO about how great she is. This means your product has to be customizable, extensible, and malleable.
5. Create an “open system”. In other words create a system that is conducive to people adding on and changing products and services. For example an “open system” school would enable parents to teach courses and provide a manual (SDK) for parents to understand how to do so.
6. Welcome criticism from the community. A company cannot control its community.
7. Foster discourse.
8. Publicize the existence of the community.

 

The Indian IT industry has a simple revenue model: People x Rate = Revenue. As models go, its nothing to write home about, but it has served us well over the years. The big problem with the model, however, is that revenue growth is linear with respect to employee count. In other words if you want more revenues employ more people.

For fiscal 2006-07, Infosys did about 13,240 crores in revenues with about 60,000 employees (DQ/IDC survey). About 4% of Infosys overall employee-base is non-Indian. In its consulting business however, 80% of Infosys’ employees are non-Indian. Infosys failed to make its consulting business profitable, and also fell short of its targeted manpower growth. Infosys has a RPE (revenue per employee) of approximately INR 22 lakhs or US$ 55,000. The large Indian IT firms do not have a very good track record as far as their RPE goes, so the jury is still out on whether we will be able to retain profit margins after moving up the value chain. In fact over the last few years, the RPE of the large IT firms has declined:

rpe.jpg

In an article at indiatimes.com Wipro’s Sudip Nandy says that “We can also rejig our onsite employment. For instance, an onsite employee may be engaged only 70 per cent of the time working for a single customer. So, we can employ two onsite employees and make them work on three customers to generate more revenue per employee”. Mastek says: “We have already started taking steps to achieve better revenue per employee. For instance, one of our Mastek’s traffic management IT deals (with city of London) commanded twice as much as the prevailing billing rates. We have to move towards either solutions or product based business models to achieve better revenue per employee.”

The problem with these solutions is that they do not address the crux of the problem, which is that our IT business model is predicated on headcount. People x Rate = Revenue. To address RPE at the strategic level, companies need to predicate their business models on productivity. Then they need to hire the most talented people, train extensively and pay better. To see how this works, look at a company in one of the most commoditized business we have: the retail industry

The Container Store, a privately held retailer headquartered in Texas, USA has been named one of the top places to work in the U.S. for five consecutive years ending 2006. It has a simple formula: one great employee replaces three good; pay them twice as much ($18 per hour vs. the standard $9 a typical retailed pays) while having a lower total wage cost; and provide each employee with 160 hours of training.

In essence, less higher paid smart people rather than a bunch of low paid coolies! And if you’re finding it tough recruiting employees, consider that The Container Store had 4000 people apply for the 40 positions they needed when they opened a retail store in New York City in 2006.

For The Container Store all the principles reinforce each other. By building their business model from the very start to focus on getting three times the productivity from sales associates, they can afford to pay them much higher than the industry average. The extensive training, in turn, helps to drive the productivity necessary to make the economics work. And the higher wages help to attract a better initial employee and retain the highly productive employees they create through their educational programs.

 

 

There is a popular theory that the internet, and information technology in general will substantially lower the transaction costs of selling hard to find products and services and increase the collective share of niche markets, information and viewpoints. Chris Anderson in his wildly popular book, “The Long Tail” calls these niche products and services the long tail of markets.

He claims that internet driven distribution will be able to cater to minority tastes, and individuals will be offered greater choice, and will be able select items that they may never even have known existed. He argues that by destroying the current model where popularity is currently determined by the lowest common denominator, a long tail model may lead to improvement in a society’s level of culture.

This seems to be true for business. Some of the most successful Internet businesses like eBay (auctions), Amazon (retail) and Netflix (video rental) have delivered stunningly successful businesses by leveraging the Long Tail as part of their business models.

However, the same may not be true for culture. The counter view in fact is more frightening, and may well be more correct.

Cass Sunstein, a Law professor at the University of Chicago in his book, Republic.com has argued that the internet causes us to become more extremist and close-minded by exposing us to very selected and biased array of viewpoints. He describes a world where “you need not come across topics and views that you have not sought out. Without any difficulty, you are able to see exactly what you want to see, no more and no less.”

Christine Rosen, author of “Preaching Eugenics” says that we have moved into a world of “egocasting”—a world where we exercise an unparalleled degree of control over what we watch and what we hear. We can consciously avoid ideas, sounds, and images that we don’t agree with or don’t enjoy.

Our technologies—especially the Internet—are encouraging group polarization: “As the customization of our communications universe increases, society is in danger of fragmenting, shared communities in danger of dissolving.”

When you combine these philosophies with Huntington’s theory in The Clash of Civilizations, it paints a frightening picture. Huntington says that the great divisions among humankind and the dominating source of conflict will be cultural and that the fault lines of civilizations are the battle lines of the future.

By encouraging the polarization of groups, the internet may well be fueling the growth of terrorism. The fact of the matter is that this is something we are seeing today all around us. Along with the growth of the internet, we have seen a growing cultural assertiveness, which is seeing the rise of fundamentalism and terrorism. And this is largely a middle class phenomenon. – the group which has been exposed to the internet the most. From 9/11 to the UK bombers, the terrorists were all middle class educated people.

To counter this, Sunstien says that “People should be exposed to materials that they would not have chosen in advance,” he notes. “Unplanned, unanticipated encounters are central to democracy itself.”

 

Talent Communities

The talent shortage, customer demand for complex solutions and the size limits of Indian IT services firms will increase transaction costs to the point where the most efficient business model will be an organization that uses talent networks to deliver IT services. This was echoed in John Hagel’s call to action in his speech at Nasscom 2007. Although social networking has captured the imagination of web 2.0 businesses, collaborative delivery using communities is not very well understood, and we have yet to see a mainstream model that can successfully monetize it. Subsequent posts will describe a business that starts with a web 2.0 Job Portal and works outwards from there to a model that lets networks of small companies collaborate and deliver complex services to customers.
Ultimately the big opportunity lies in creating a disruptive services delivery mode by becoming a leader in the creation of talent communities, in using these communities to reduce transaction costs as well as production costs and in commercializing the resultant value network.