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.
