What a networked society means for businesses

As connecting to everyone becomes easier, big companies will get bigger, even as they’re confronted by a proliferation of small, specialized firms

network
Pixabay (Creative Commons BY or BY-SA)

Does the growth of networks that make it easy for everyone to connect to everyone else encourage greater concentration of business enterprises (i.e., the big get bigger) or greater fragmentation (the proliferation of many small, specialized firms)? The answer to this question, it turns out, is “yes.”

On one hand, ubiquitous broadband networks are enabling organizations to grow by expanding the scope of their operations — sourcing inputs from everywhere, collaborating with partners anywhere, and selling goods or services globally. On the other hand, the evolution of computing and communications technologies is dramatically lowering the barriers to entry for new competitors, leading to disruption in almost every business sector.

But which way is the wind blowing? What determines whether more networking favors more concentration or more fragmentation? Way back in 1987, at the dawn of the networked age, three scholars — Tom Malone, Joanne Yates and Robert Benjamin — published a study that explored this question. 

In their study, titled “Electronic Markets and Electronic Hierarchies,” the authors identified two different ways of “organizing economic activity”: markets that coordinate the flow of goods or services through the process of negotiation among a disparate group of buyers and sellers, and hierarchies that manage the flow of goods and services within an established structure (such as a single firm). And they also described two different elements that determine the final cost of goods or services: production costs that are required to actually create a product or service and coordination costs that are involved with acquiring inputs and distributing the outputs of production.

Production costs are typically lower in markets where different sellers compete for a buyer’s business, and higher in hierarchies where competition is absent. At the same time, coordination costs are generally higher in markets, because of the greater effort required to gather information from multiple potential suppliers, and lower in hierarchies, where less negotiation is needed.

Relative Costs for Markets and Hierarchies

Organizational FormProduction CostsCoordination Costs
Markets Low High
Hierarchies High Low

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