The 3.x Economies

Much of what I write in this space will revolve around the new knowledge economy in which we increasingly find ourselves (no, I’m not talking about the “New Economy” of the 90s ;-). Therefore, I offer these thoughts on the 3.x economies in which we have lived.

The Knowledge Economy

A knowledge economy is fundamentally a new animal because its outputs are increasingly information-intensive services and “products.” Many of these products are infinitely scalable, like CDs, software or Webcasts. Selling additional “copies” of digital (music) is accomplished at virtually zero marginal cost for production and distribution. Of course, a knowledge economy also produces numerous industrial and agrarian goods, but the value of these goods is shifting toward information-intensive services that are related to the goods—away from the underlying goods themselves. Some examples are:

• Automobiles: the financing, insurance and warranty services produce most of the value of the car in the form of profits for carmakers and, arguably, value for the consumer. How many new cars would be purchased without financing?
• Food products: as people in rich economies focus on diet for health and fitness reasons, they increasingly depend on information about the food in terms of value. The “organic food” industry is one example in which people often spend 25 percent more for food products for the information about farming practices rather than the products themselves. Labeling is an increasing issue with packaged foods.
• Transportation: getting industrial products from A to B is close to a commodity service in many cases; however, as real-time manufacturing penetrates all industries, information about the goods being transported is far more valuable than the goods themselves so that factories can plan their production and minimize safety stocks.
• Consumer products: the “brand” may be the quintessential example of information about the product carrying the lion’s share of the value of the product with which it’s bundled. The cost of the perfume often represents less than ten percent of the purchase price, the remainder going to advertising, packaging and sales. The label on the pair of blue jeans is often more important than anything else about them. Witness the current Puma craze; now Puma and Nike have a bona fide battle of the swooshes.

The information technology “industry” has been a focus of attention since the 1990s as computing has permeated business processes. Computers produce information that can be used to change business processes and create new ones. The IT “industry,” which represents software, hardware, network/infrastructure services and related services, is enabling the current focus on information. Computers gather information about each step in a business process, and that information can be extremely valuable in a certain business context (think package tracking). Real-time information about the sale of goods can help consumer products goods companies to adjust their promotional activities and distribution in close to real time. Helping people to understand new product features with Web- and phone-based customer service is pervading all industries.

Information is growing to represent an increasing portion of the differentiation of products and services. Producers use information about the sales of their products to design new products and services, from antiperspirant to cars to contact lenses. Consumers use information to determine what they will buy and how they will use what they buy. Because information about products and services increasingly is the differentiating factor, product life cycles have been shrinking, and this trend is accelerating. Information is needed for producers to understand a new “use context” around a product and to create, test, produce and market a new product with these characteristics. The more information that’s available, the shorter life cycles can be.

By way of definition, “knowledge” is information that is applied to a certain context to inform a human endeavor. At this point, computer-generated information requires the human touch to be organized and applied to a situation in which a person is trying to use it to perform a task. This is labor-intensive. Think of the increasing list of products and services that require customer service or technical support. These information-based services are increasingly necessary to help customers use products and services in the context in which they find themselves. Information itself is like a raw material that must be refined in order to become knowledge that is relevant to a usage context.

The Industrial Economy

In an industrial economy, one must build a factory before one can produce a product. Raw materials are often scarce and hard to get, and their procurement often constrains the company’s choices for the location of the factory. Moreover, the dependence on scarce raw materials puts a strong stamp on the participants in an industrial economy because if one company gets the raw material, that material is unavailable to another company. It’s a zero-sum game.

Extensive sunk costs must be borne to obtain the real estate, get government permits and build the plant, and upfront investment can take years. Capital-intensive equipment is often complex and may take years to learn to operate, which dictates specialized training. When the company has borne the expense of training, it wants to amortize the training investment by keeping workers in the same position (as long as they are productive).

Once a plant is built, the company wants to amortize its sunk costs, so maintaining that physical location is necessary. This creates inflexibility. Creating new products entails working with raw materials that are subject to those materials’ physical and chemical characteristics, so product life cycles are often longer than those in a knowledge economy, where information about a product carries a large part of the differentiating value and can change relatively quickly.

A company in the knowledge economy is in a far different situation. Its inputs and outputs are chiefly information. Location is far less constrained. People can work from almost anywhere they can share information. Based on continuing advances in technology, location is becoming more flexible every day. Creating a space to share knowledge and build knowledge products is subject to the participants’ habits, values and capabilities.

The Agrarian Economy and 3.x

As inflexible as the industrial economy may be, it’s a veritable contortionist compared to the agrarian economy in which people facilitate the earth’s ability to grow food and goods that they can use to build shelter. Agriculture was the basis of the economy for most of the world until the Industrial Revolution, and wealth was often determined by how much land one owned. This was a zero-sum situation as well. People often produced their own food, and commerce played a supporting role. Agrarian economies afforded people even less flexibility: there was little money, travel was very difficult for most people, and finding a “job” was extremely difficult, especially since families were large and expensive to support; therefore roles among economy participants were more static, and people were tied to the land (talk about tight coupling ;-). Acts of God played a far larger role in production due to weather, pests and disease.

In an agrarian economy, the human value-add to production is limited to enriching soil, mitigating pests and irrigation. In an industrial economy, human-added value represents a far greater portion of the total value of the product, and wealth is largely governed by how well management can organize and synchronize activity to operate the plant and related processes efficiently. People control their destiny much more than in an agrarian economy, whose production is constrained by how fast things can grow and yields. Agrarian economies tied people even more tightly to the ground.

The agrarian economy was the first real economy in the modern sense of the world because economic activity was stable, organized and measurable. Prior to agriculture, people were not “producing” their livelihood; they were hunting and gathering food, and shelter was often improvised, as people were nomadic.

It’s a Gas

So what does this all mean? A knowledge economy is much less zero-sum because inputs are information, which is less inherently limited than natural resource inputs. The economy is more dynamic: the more information that gets exchanged among producers and consumers of goods and services, the faster product life cycles change. There is more choice for the knowledge economy’s participants.

To use another metaphor, let’s say that an agrarian economy is a substance in solid state. Things are difficult to move and relatively inflexible. An industrial economy is in liquid state. It is more flexible and changeable than the agrarian economy because its inputs are a degree of abstraction higher: one can built a factory where one wants, and its products began as raw materials that people worked on to create the products. In the agrarian economy, workers “assist” nature to grow food.

Of course, you know by now what’s coming: the knowledge economy is a gas. It’s a level of abstraction higher than the industrial economy because we’re not even working on raw materials any more; information is the key input. We aren’t bound by the physical and chemical properties of the inputs.

There are countries in the world whose economies are agrarian and industrial, and all countries are rapidly coming on-line. Therein lies a significant opportunity: by studying the adoption process, we can discern patterns and predict demand.