Chapter 1,2,3

Chapter 1 – What are firms for?

To begin to answer this question, Adam Smith, the 'father of modern economics', demonstrated this with the well known account of his pin-making firm which was able to make so many pins from the division of labour. He believed that firms could be efficient by producing goods cheaply which allows them to make a profit. Again, with the assembly line which made Henry Ford so famous, the principles were the same. They succeeded and profited by minimising costs in order to allow the current market price of the goods to be moved by the invisible under the theory of the general equilibrium. Therefore, whatever goods is produced, the price is determined by the market not the producer. Firms in Adam Smith's mind were places where costs can be minimised, and processes things efficiently with the division of labour by reducing manufacturing-cost, this makes them profit machines.

This was different to Ronald Coase, who looked at the limitations of a firm in “The Nature of the Firm” and “The Problem of Social Cost” (1960). Coase questioned why firms emerged and when they are needed. Coase examined the costs that arose when obtaining services from other individuals through subcontracting. Within subcontracting, there are communication, information, bargaining, trade secrets and transport costs which need to be considered i.e. transaction costs. Coase pointed out simply that firms are needed when the cost of subcontracting a good or a service is much larger than producing the same good or service internally. (Yanis 2012) As in the example of Sturges vs Bridgman (1879) case, both parties were unable to enforce the other party action. The solution to a case like this should be the one with the lowest transaction cost, i.e. the doctor to move his shed away from the noisy neighbour, soundproof it, or to use ear plugs. The doctor internalises the problem.

Another influential philosopher, Karl Marx agreed that firms should be efficient, but argued that prices would crash to the level of per unit costs under Smith's theory and result in crushed profits. Instead, Marx's theory was that for profit, firms paid for 'labour' at a fixed market-determined price which is then overcome by the costs with the fruit of labour. (Yanis 2012) The fruition could be in various forms such as time, energy, ideas, which has its own value. However it is only the financial cash profit that is often seen, as for most owners, this is the purpose for starting the business in the first place. How valuable is it to have cleaners in a hotel? Hoteliers will mostly consider cleaners to be of upmost importance, as their clients are highly sensitive to hygiene and cleanliness. Complaints would tarnish their reputation and future trade. However, the warehouse floor in a timber construction company would probably never consider hiring someone specifically to clean. Identifying what is valuable within the business and strategically allocating valuable resources can also be considered as the role of a firm.

In conclusion, progression in civilisation brought about market societies where labour becomes a market commodity to be sold: “I will work for one hour for £10”. Money is the invention after many years of bartering and clearly, you want to trade as little value of something in exchange for something else of much greater value. This is the role of a firm. So what do you do with your scarce resources to be efficient; either through division of labour, or through subcontracting? A firm must operate as a whole and use the availability of innovations, where possible, to reduce marginal cost, and ultimately create value.

Chapter 2 – The world today

Allocation of Resources

“Every social order, including that of ants and bees, must allocate its scarce resources between different productive activities and processes, as well as establish patterns of distribution among individuals and groups of output collectively produced.” (Yanis' Valve economics p.1)

Just as Adam Smith's theory of general equilibrium uses some mechanism to regulate market societies; it is implied that firms should also be the same. There is always a price signal that controls processes and activities in response to tend towards the equilibrium. This price mechanism helps to dictate the price and any imbalances which can attract attention. It's the incentive of money that attracts more resources to be used in the hope of getting a bigger profit, known famously as Adam Smith's 'invisible hand'. In other words, without any interference, this is the free market capitalist system where the allocation of resources is dictated by the goal of profit-making. But interestingly, firms have surprisingly been keeping to a different system; a hierarchical one where resources are not dictated freely by the price mechanism. Often, market-societies, or capitalism are synonymous with firms and corporations. But still, firms can be seen as market-free zones. Firms operate within the market, but they themselves are run as an individual, where stakeholders have the say for the allocation of resources. Mike Abrash recalls how Gabe Newell, the founder of Valve explained his realisation of this:

“Gabe tells it this way. When he was at Microsoft in the early 90’s, he commissioned a survey of what was actually installed on users’ PCs. The second most widely installed software was Windows.

Number one was Id’s Doom.

The idea that a 10-person company of 20-somethings in Mesquite, Texas, could get its software on more computers than the largest software company in the world told him that something fundamental had changed about the nature of productivity. When he looked into the history of the organization, he found that hierarchical management had been invented for military purposes, where it was perfectly suited to getting 1,000 men to march over a hill to get shot at. When the Industrial Revolution came along, hierarchical management was again a good fit, since the objective was to treat each person as a component, doing exactly the same thing over and over.”(Michael Abrash. April 2012)

It was at this point that Gabe Newell had realised something had changed. He had realised that hierarchical management is no longer efficient, and repetition was no longer valuable. Think about it, once something new and exciting has been released, there is a surge of demand and the market becomes over-saturated. This is not new; there have been innovations throughout history which has since become standard processes, goods, services that we do not even think about. Division of labour gave birth to mass production, satellites to telephones, internet to social networking. Technology is a gateway which is opening new markets; but clearly not everyone is able to exploit the potentials. People like Thomas Edison, Alexander Graham Bell, Alexander Fleming and Steve Jobs are well known to be 'famous inventors' when that really is not the case. There are so many cases where ideas have been 'stolen' and the true origins of some things are difficult to locate. Who would you associate the famous 'Moonwalk dance' to? In fact, it was first ever seen in video of Bill Bailey in 1955. However, it was only made famous by Michael Jackson in 1983 during Motown 25. Gabe Newell understood this and understood that innovation alone will not add value. The initial creative act has potential, but needs to be delivered correctly to exploit its enormous value. What Gabe Newell had to do was to be able to continuously be innovative in an industry that is growing fast and present it to the market correctly.

“The Hungarian journalist who invented the Biro pen - Laszlo Biro - sold the patent for his invention in 1950, just before the pens dropped in price and became mass market items used in schools. The Bic Cristal - based on his idea - has since sold more than 100 billion units, and sells more than 14 million a day.” (Rob Waugh, Aug 2013)

The Digital Age

The Digital Age can be characterized by technology that has increased the speed and breadth of information within society. The availability of internet has increased to a vast 2.4 billion people worldwide which is 34.3% of the world population. (http://www.internetworldstats.com/stats.htm) The progression of technology utilising the expansion of the internet has made the world smaller. Digital content has become the bread and butter of today's life; it has become incredibly easy to send and receive information. Working in one country doesn't have the same limitations today as it did 15 years ago, the majority of the internet was on dial-up and restricted to large desktop computers. Today, smart phones allows you to send and receive gigabytes of data, all of which can include movies, music, work files/documents, photos etc. Digital content has become a necessity of today, just as writing and sending letters was over 20 years ago. But now, with the increased connectivity of the world the global market has expanded, but with it, problems begin to emerge.

Boundaries that have been set for many years are breaking. Workers within production and service industries have to compete with individuals from developing countries. Contrasting, 'mind workers' are now not from restrained to their locations. There is a trend where exchanges are separating the physical world from the digital world. Just as the inadequacy of computer interactions were foreseen giving rise to the touch screen technology, new markets are being opened to which only a few prosper from. (Nicholas Negroponte, 1995)

Company	Equity - US$ million	Employees	Equity Per Employee
Valve	2,500	400	6.3
Google	72,000	44,777	1.6
Activison Blizzard	11500	7000	1.6
Apple	118,000	80,000	1.5
Mojang	52	36	1.4
Microsoft	79,000	97,000	0.8
Rovio	202	650	0.3
Nike	10,000	44,000	0.2
Sony	28,000	146,300	0.2
Dell	11,000	108,800	0.1
Ford	16,000	171,000	0.1

Table 1: Company equity statistics (Wikipedia 2014)

Looking at Table 1, how have a handful of people been able to create value in the same regions that top companies are making? How can a company like Rovio, Mojang and Valve compare to companies like Apple and Microsoft who have been around for two or three decades longer? The answer lies within how Valve have managed to identify that in today's Digital Age with the hierarchical management bottleneck innovation through people at the top. Valve is designed as a company that would attract the sort of people that is capable of 'taking the initial creative step'.

Chapter 3 – Identifying value

Think about it. What do you do when you have a question and have nobody to ask? Most people would 'Google' it; you need to use a tool to find what you are looking for. The internet's humble beginnings began with the indexing of vast amount of data and search engines have been the driving force behind its success. Google has become so common that its use has become an adjective in the English language, just as 'Hoover' and 'Phillips' pertain to vacuuming and screwdrivers. The problem today is that there is too much information. Just as there were hundreds of inventors discovering and exploring ways to create the telephone, or the lightbulb in the 1800s, we now have millions trying to be innovative. For a firm to be successful in the world today, they must adapt to on-going new trends arising world-wide, indicating they are adapting to the new era. But how can this be performed in such a fast-paced society?

“You need people who are adaptable because the thing that makes you the best in the world in one generation of games is going to be totally useless in the next. So specialization in gaming is sort of the enemy of the future. We had to think about if we’re going to be in a business that’s changing that quickly, how do we avoid institutionalizing one set of production methods in such a way that we can’t adapt to what’s going to be coming next.” (Gabe Newell 2014)

Gabe Newell, who had worked for Microsoft for thirteen years, entered the entertainment industry because that was where he felt he could make a contribution. He was already financially set for life, yet instead he ventured to satisfy his creativity. Doom showed to Gabe that games are popular, digital, and are progressing with the new era. What's more, Doom is still being played today in the form of First Person Shooters (FPS). Doom was simply an intangible good that can be made highly cost effectively and distributed quickly with the rise of the Digital Age. Tetris, Bomber-man, Angry Birds, Farmville, Twitter, Facebook and many other programs could be replicated once you realise their success. But there would be almost no value in doing so; Gabe understood that the most valuable assets in a gaming company are the creative people. By giving freedom and not restricting the creative potentials of employees, this became the key goal at Valve.

Gabe could have started his own brand of computers, software and consultancy or even worked at Apple. So why did Valve, as a company decided to make games? The answer is not clear, but it seems that in the Digital Age, there is with little doubt that they were almost certainly going to produce digital content. As we already established, there is no value in repetition, so entering into any kind of manufacturing processes would not be innovative. From here there is only one way to go: experiences. Whatever the hardware, there needs to be content to be experienced and the most unrestrained possible genre would be within gaming. This is the difference to older companies such as Ford, Dell, Sony and Nike. These are industries which have a lower level of efficiency in today's information era. There is less value in hardware, just as Apple has managed to create pleasurable experiences through their products. Apple has done this most significantly with their phones, introducing touchscreen and an intuitive operating system. Similarly, Valve has contributed to the gaming industry with their release of Half-Life.

They first released Half-Life in 1998 using a very heavily modded version the Quake engine used for Doom. This was a massive success which won over 50 Game of the Year awards. By November, 2004 eight million copies had been sold. But does this equate to massive profit? The success of games has always been disproportionate to its profit. The reason for this is that even the most successful games have always been hampered by piracy. For example, Crysis, considered one of the best selling games of all time had also been leading the charts in piracy. Cevet Yerli, the CEO of Crytec, believed that the game would have sold four to five times more if released on console, where piracy was much less prevalent. This was the problem Valve faced.