Europe 2009 Transcript: Platforms,

Markets & Bytes - the Economic

Landscape of the 6th Paradigm (Sean
Park)
By Lee S Dryburgh on January 11, 2010 7:28 PM | Permalink | Comments (0) |
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Sean Park was one of the award winners back at the debut eComm Europe last
October. He won the "Most Insightful Speaker" Award. The slides and video are on
his blog. Below is a full transcript. Highlights are mine.
Sean: Good morning everyone. As Lee said, I'm a founding of Nauiokas Park. For
my sins, I was a banker, a trader, for about 15 or 16 years. Maybe to my credit, I
resigned from that industry at the end of 2006. I thought it was remediably
broken. I've since started my new firm which is focused on principal investments
strategic advisory in technology-enabled disruptive business models, financial
services, and markets.
Why am I at eComm? I'm not really sure. I'm very pleased to have been invited. It's
very exciting, but I don't know anything about telecoms, other than as a
customer, both enterprise and consumer. But, I think there are a lot of similarities
between the two businesses, and increasingly so, and that's because they're
digital businesses.

I'm going to talk to you about platforms, markets, and bytes, the economic
landscape of the sixth paradigm, or maybe I should have said the industrial
landscape of the sixth paradigm. I'm going to try to answer these questions in 20
minutes. I'm going to be broad, not deep, so indulge me if I skate over a few
points, and some of these I explore in my blog in more depth. I'm happy to
discuss them afterwards in more depth.

In a world where everything can be expressed in 0's and 1's, the way we define
our economy, the way that industries are structured, are they still relevant? If not,
what new business models or structures are going to emerge, and maybe to focus
on this and to give an example; what's the difference between a bank and a
telecom company?

Before I get into that, I want to give a little bit of background in terms of a
framework of what I'm thinking. What is the sixth paradigm? If you haven't read it,
you should, Carlota Perez is a Venezuelan economist. She wrote a book called
Technological Revolutions of Financial Capital, builds off of Schumpeter, talks
about long economic cycles that, in her thesis, are driven by technological
revolutions.

Since the first one of the modern era, which was the Industrial Revolution, she
posits that there have been five. Each of these revolutions is accompanied by a set
of best practices. The economy, the society, and the institutions need to adapt to
this revolution they change. You get interesting affects in terms of how the
economy diverges from the financial markets and a lot of this, again skating over
it, has to do with the fact that technology tends to move exponentially or
adoption of new technology moves exponentially whereas our social and cultural
institutions move linearly. There is a divergence and it takes us time to get our
heads around the way the world will work in this new paradigm. She calls it a
"techno-economic paradigm".

Here are the five that she's identified: Industrial Revolution, Steam and Railways,
Steel/Electricity, Mass Production, and the last one is the Age of Information and
Telecommunications. My thesis is that we're coming to the end of that fifth
paradigm and we're about to enter the sixth paradigm.

There are a lot of similarities, I think, between this one and the one at the
end of the 19th Century, in terms of what we're seeing. Today, the financial
crisis we lived through might be analogous to the oil crisis marking the end
of the Age of Information and Telecommunications. I'm not going to go into
that too deeply.

What will drive the sixth paradigm? Guessing, because as she points out you can
only really tell in hindsight; it's very hard to identify these as they're happening,
but I'm going to have the hubris of a banker to try to guess that maybe this is it;
cloud computing - cloud computing may be a catch phrase, but ubiquitous
computing storage might be the technology that drives the sixth paradigm,
where you have "everything as a service".

She picks archetypal points - Intel's release of the first microprocessor in 1971
launched the Information Age. It's not that simple; it's a cluster of technologies, a
cluster of people, but if you have to pick one for this, maybe it's Amazon Web
Services 2006/2007 launching EC2 and S3.

Another factor driving the sixth paradigm is what I call "exchange ubiquity". I
didn't really have a good catch phrase for this. Exchanges are now everywhere.
Traditionally when we say exchange we think of financial exchanges. Betfair took
the exchange model and applied it to another business very directly, which is the
business of betting on sports. It goes beyond exchanges. Really, it's marketplaces
and everything. iTunes is a marketplace. It's a marketplace that started for music,
now videos, and tomorrow any digital goods - maybe. Facebook is also a
marketplace. You've got the applications on top. Maybe it's a stretch, but things
like Skype are marketplaces for voice communications.

Underlying marketplaces, and maybe this is where eComm - communications

is at the heart of a digital economy. Alexis Richardson, who is the Principal
behind RabbitMQ, which is an open-source messaging software, said "The
difference between bank messaging and telecom messaging is disappearing."
That's more and more true, every day.

The last one is maybe digitization. This one is fairly self evident but if you look at
when I'm talking about digitization, it's transforming physical goods into digital
goods for the purpose of trading and managing them. A great example is ISINs in
the securities industry. Not so long ago, 30 years ago, the securities business was
a physical business. You had certificates that were biked around the city of
London, biked around, or driven around New York when you wanted to trade
shares or bonds. Today obviously, it's a book entry. Every security is identified by
its QSIP or ISIN.

VoIP, I'm not going to teach you guys anything. Obviously, voice is turning
into a data business. Amazon, Jeff Bezos, his insight was with the ISBN database
he could transform books into a digital good that could be sold and managed.
There is obviously a physical supply chain, but it's right at the end of the
business. The heart of the business is a digital business.

To take this a step further, there is a disclosure; Zoopla is a company we've

invested in. It's a U.K. property portal, but it's a very interesting one. It has a
database of prices on all 27 million U.K. residential properties and an enormous
amount of metadata around it, and using AI, increasing every day. You can
imagine a future not too far away where every property has a Zoopla standard
identification number, and you can trade that property, manage it, insure it,
mortgage it based on that number. If that existed today, or 10 years ago, we
wouldn't have had the extent of the problems we had in the securitization
markets, which were driven by bad data.

How does this translate? I think there are two people that are worth thinking
about when you're thinking about how this affects the new industrial or economic
paradigm, Ronald Coase and his Theory of the Firm; basically transaction costs
drive the optimal size of a firm in any industry. I would posit that transaction
costs are changing and dropping massively, and that's got to have an effect on
the way the companies are structured, and industries are structured. I'm not sure
it has, yet, but it's inevitable.

The second person I think is worth reading and understanding is Herbert Simon,
who is a psychologist of polymath, who really did a lot of research on complex,
adaptive systems. Our economies are clearly complex, adaptive systems and his
thesis was, or what he discovered was that complex, adaptive systems wherever
you found them, in nature, in our economies, in mathematics, tended to be more
evolutionarily fit if they had a property called "nearly-decomposable," a
mathematical property that essentially, without putting up the back of all the
mathematicians here, means that systems that are formed of components and
subcomponents, modular. Again, this is something that intuitively, I think all of us
know, especially in the computer or software industry. You build programs in
nested objects and decompose the complexity of the system.

This leads us to a world of bytes, and to give you a quick example, I'll let you read
this, but I just want to prove the point that almost anything is becoming a
digital good, in the heart of the system. At the edges it might be physical, but
in the heart of the system, it's a digital good.

Here, gas, the industrial company Shell, you think that's not a digital business? I
think it is. Markets, any structures that allow any buyers and sellers to exchange
any type of goods, services, or information. Again, abstract markets further out
and you could start doing that in this digital world. Platforms are absolutely key
in terms of business models and strategies, going forward. This is something
that, again, is second nature to the computing industry, but I think in the digital
world it's going to become more and more relevant for almost industry.

You've got a new stack for a modern economy. You've got physical platforms,
digital platforms, and if you haven't read Invisible Engines, and you want to
understand digital platforms and how they work and the economics of them, you
have to read this book. On top of those digital platforms, you have APIs, which
serve applications and services at the top of the stack.
The traditional industry of corporate structure was very much a vertical structure.
If you look at Tyrannosaurus Telecom and Bank Brontosaurus, these are
vertical entities. J.P. Morgan, British Telecom, KPN, they have everything from
top to bottom and they're organized on the principles, I think, of the fourth
paradigm, which was Sloan's Mass Production hierarchies and where
transaction costs were very high. It's not that these business models are
intrinsically wrong, they were very well adapted to the 20th Century. I think
they're very ill adapted to the 21st Century, and I think some of the things
we've seen happen over the last decade, first in the telecoms industry in the
late '90s and the financial industry more recently, are manifestations of this
misalignment of the structure of these industries against the fundamental
economic structural underpinnings.

I think the new optimal industry corporate structure will be much more of a
horizontal structure. You can have various different components in the stack
within the same organization, I think, but the way of thinking about it needs to be
much more horizontal. You have physical platforms again, and this is something I
always laugh about; I'm not in telecoms but whenever I read articles about the
latest, greatest new thing a big Telco's doing, it's to avoid becoming a dumb
pipe.

What the hell is wrong with being a dumb pipe? Being a dump pipe can be a
great business model. In fact, what's more important; the problem with the
vertical stack is the capital structure is horrendous to align properly to an
organization that is organized vertically. Dumb pipes, you finance them with debt;
they're cash flow driven businesses. There are a lot of businesses in the world that
would be considered dumb pipes. If you look at the satellite business, they don't
sell services. They sell satellite access. These businesses are performing very well.
You just need to align your objectives with your capital structure with the way that
you're structured. You have real economies of scale here. This is a dimension
where size does matter and you can use it to good effect.

Next up, the stack - the problem with these stack analogies is you have bottom,
middle, and top. Everybody thinks that minds are tuned to think top is better. I'm
agnostic. They're just different things in the stack. Digital platform, it's a
substraight - you create a substraight for an ecosystem of services. Selling
trust, I think, is one of the ultimate things you're doing. It's necessary that you
have the technical capability to build something useful, but it's not sufficient to be
successful. I think to be successful, you need to effectively sell trust that it
will work and that people can rely on it. In doing so, you create markets.

Here again, you also have economies of scale, different economies of scale, but
economies of scale nonetheless and probably more pointedly, this is where
Metcalfe's Law of Networks, especially for multisided markets comes into effect. I
love quote from ReadWriteWeb, "Well built developer platforms are the future
of every industry," and I think they got that spot on.

Digital platforms, with APIs allow people to build services and applications at the
edge and this is where innovation should happen. This is where you need rapid
adaptation. This is the Cambrian explosion. This is where any big company will
structurally fail if they try to play in this edge.

I speak from experience. I tried to do this. My last employer, Dresner Klein, which
is part of Alliance which is a huge financial conglomerate, I guess my "aha"
moment was understanding it wasn't because any particular manager or group of
management was dumb or didn't get it, or was wrong. Structurally, these big
firms, actually the better run they are the harder it is for them to innovate at
the edges because innovation is looked at as a virus and the corporate
antibodies, the well-oiled machine does everything it can to stop that from
happening.

Here you have dis-economies of scale. Dis-economies due to complexity, so

bigger here is not better. It's worse. It's not even neutral. Low capital intensity -
take an extreme example, the startup world, you're financing it with options
through equity. You don't have debt finance. If you look at businesses where you
have a mix of the two, and there are a lot of them in the financial business
because you've got risk capital; Imagine the telecoms business, as well, risk
capital at the bottom which is almost the equivalent of a physical platform, which
might be debt financed or the expectations in terms of returns are limited but
relatively certain. At the top you've got very deep, out of the money options,
highly volatile, low capital intensity. You try to marry those in the same
instrument, the same capital structure and nobody is happy.

Coming back to this example of Shell, in that example; who is the bank, who is
the Telco, where is value created? It's not as obvious as it first seems. This is a
friend of mine, Richard Water who works for IHS. He said, "Isn't it just all FX?" It's
gas molecules, FX transaction to electrons, FX transaction to Sterling if the
electricity is sold in the U.K., FX transaction to Dollars; back to Shell, paying for
the gas. It's all a digital transaction and just modifying the same thing across
the value chain.

Already, banks and telecoms are more similar than they look, and a lot of
digital businesses are. If you look at the process stack of these two industries,
and you could probably expand it, you've got enormous similarities. In the front
office, again this is probably least intuitive, but if you're managing massive
trading flows, they're digital now, the problems that you face are very similar to
the problems that telecoms operators face in transacting and managing massive
flows of data over their networks.

The other factor is customer account service: online payments, security, customer
statements, customer support, and the trust around that. These are maybe more
obvious, but again, it's the same thing.

If we're not there, or if that's not the right business model, then what is? I think
the companies that will emerge over the next two decades in the sixth
paradigm, that will become the giants of the sixth paradigm, are companies
that are Messaging and Co., Trust Inc., Identity Ltd., where they're integrated
along the horizontals. That will allow us to have an ecosystem of banking as
a service.

Disclosure, this is a company we've invested in, FX Capital Group, RabbitFX. They
offer FX physical brokerage, so if you need to buy Euros, if you live in the U.K., or
vice versa, they offer one thing, one very small thing, very simply, very well, and
they only exist because they have an enormous infrastructure e-platform, digital
platform underneath them - the banking system, the payment system, the trading
system that allows them to do that.

Another example is a fantastic example and really is a convergence of telecoms

and banking. It's Frontline SMS, some of you might have heard of them. They just
launched Frontline SMS Credit. They're focused on developing markets but they
could operate anywhere, I think. This is a company I'm not involved in but I'd like
to get involved in. They actually run as a not-for-profit, but they have built a
platform that allows you to do messaging, building off of the global mobile
network, via a computer, to do mass messaging and manage that. With the credit
adaptation, their tagline is fantastic "It's a bank on a laptop" and that's what they'll
be able to offer.

On the telecom side of the equation, voice is a service. We have that already,
companies like Ribbit and others, so what I'm saying is not that companies won't
be organized or have elements of all of this stack, but if they do have all of this, if
it is a very large company, they need to be thinking about it in this way. Then
perhaps, maybe get involved in some of the stack at the very top level, as a proof
of concept or shop window, and also where it's obvious they have brand value.

Telecoms company and voice, banking and some of the payment services -
they need to have open architectures and learn from the computer industry;
where are the AWSs of banking, of telecoms? Where are these platforms? Why
isn't J.P. Morgan opening up its platform and saying, "You guys innovate on top of
it," instead of trying to do all of it in house? Where is the AppStore for finance?

You look at companies like Amazon, Apple, Facebook, Microsoft, all enormously
successful, and much of their success if predicated on the fact that they build
these platforms that allow other people to innovate and work on top of them.

My conclusion is that in our industries of finance and telecoms, we need to

shake up the stack and we need to think of this new industrial landscape. We
need to start thinking in a context of a sixth paradigm, not a fifth paradigm;
21st Century businesses, not 20th Century. Thank you.

Chair: That 20 minutes should be expanded into a book. It's quite clear that all
the topics covered there each would be a chapter. I'd be really excited to see if a
book gets made out of it. I think a book should be made out of it. I really enjoyed
that. Questions from the audience? We have Jim here. You may need to stand up
so we can see you.

Audience: I notice an emphasis, everyone wants to talk about the bits, and
Negroponte used to think we have to talk about both bits and atoms. The atom
side of what you just discussed, I've worked with hardware distribution models.
Again, it's the same sort of thing. The distributor is running on top of a layer of
financing to move goods from one person to the other. I'm really seeing and I'm
getting into that area again. My question is; have you looked at these in terms of
that sort of thing too, in terms of distributing hardware and hard goods?
Sean: I think the poster child there is probably again Amazon. Amazon couldn't
exist or their business wouldn't exist without a very excellent logistics and
distribution arm. Part of Bezos's genius was A) raising a billion and a half dollars
from a convertable bond before the dot com bust happened and B) spending that
money building the physical infrastructure he needed to properly run his
business.

In this vision of the future, the point is not that the physical world will
disappear, but the management thereof can become an abstraction, which
liquefies it enormously. Both the management and a point you raised that I really
didn't touch on, the financing, and one of the reasons I left banking was I became
increasingly frustrated at the way that finance was delivered.

The way that banking and finance is delivered hasn't changed in 400 years, since
Monte di Pietà in Italy in the Renaissance. It's the same thing, just bigger, faster,
better. I'm sure that now with the tools that we have, it can be much more
modular, flexible, adapted - this idea of abstracting from a pool of risk capital to
the way it's engineered and placed.

The great example is a company we're invested in called WeatherBill that does
weather insurance. The way we build the company is the underwriting is done by
a weather fund in Bermuda. We've abstracted - all we do is price and originate the
risk within WeatherBill. Again, the reasons the banks don't like that is that when
you do that, there is an element of transparency and the more you do that, there
is more and more transparency because the stack can only work if there is
transparency. Banks love the fact that there is this big black box and there is
opacity. They try to, and are often very successful in taking oligopolistic rents
from that lack of transparency.

I think inevitably, the tide is moving that way and you'll get this abstraction
of the economy into various different layers that's made possible because of
this digital technology. Conceptually, you probably could have thought of
this 200 years ago, but actually translating it into something that
pragmatically works, at a cost that is not prohibitive is only something that's
happened in the last few years, and it's continuing to happen.

Audience: Do you think that such platform companies should operate publicly
toward the end customers, or should they hide between [00:24:42.06 ?]
aggregating platform services vertically, and proposing niche services towards
parts of the classical customers for big [00:24:53.10?]

Sean: I think it's the latter. I think it's a mix. For instance, take the example of
either a telecom or a bank, and it was a point that I tried to make at the end; not
that they should completely retreat from that edge, and I actually think that
could be dangerous. You want to have, whether it's a shop window or certain
areas where your brand or expertise really does add value at that part, and
even the last thing and probably the most important over the long term is
just to keep yourself honest, eat your own dog food, to have applications or
services that are consuming your own platform. It's an early warning system
of does it work or not.

I think the risk is, and humans work as pendulums, maybe the pendulum will shift
too far the other way. When I speak to people, I probably emphasize more this
idea of really separating those two businesses, because most of the people I
speak to or most contexts is they're so deeply embedded. I'm trying to over
exaggerate that separation.

The short answer is I think it's a mix, but the way that management thinks about
it is absolutely important. It's not trivial, the fact that if they're looking at the
business in that way, even if they're doing every element along the value chain,
it's very important for the way that they're going to structure their offering.

Audience: Your proposition of "everything is a service" seems predicated on

people neither wanting to own things or that providing them services is always
the most efficient, when practically speaking you're going to have issues of
network capacity, or availability for example. How do you blend the "everything is
a service" vision with the more pragmatic desire or requirement of people to own
physical devices, applications, and so on.

Sean: That's a good question. First of all, if Carlota Perez is right and then in
terms of her thesis of how the economy evolves, and then if I'm right in terms of
this is the start of maybe a new paradigm, I think what you just raised is a
perfect example of the divergence in technology in our social and cultural
intuitions and frameworks that we work in.

I think for the next few years, there is going to be an increasing disconnect
between those two, and at some point, maybe 10 or 15 years from now, it
might actually boil into something that's quite traumatic for the economy, as
the technology pushes our economies into that direction of everything is a
service, and our cultural prejudices mean that we're not adapted to live in
that kind of a world. Forty years from now, those will realign.

I think the reason these cycles happen maybe this way is partly generational. The
cycles have to do with human lifespans, to some extent, because people who
grow up in a certain paradigm get comfortable with that. They actually reach
positions of power very late in that paradigm, probably, and that's where you
get this tension. But, the new generation coming through, so anyone who is
born today or my children for instance, probably won't have the same
context in terms of how they consume goods, services, and how they relate
to the world around them.

I think naturally, that adaptation will happen only with time, and in the short term,
you'll get the classic tensions between where the technology is pushing us and us
digging in our heels, not wanting to go there.

Chair: Thank you very much.

Sean: Thank you.