The Russian Doll Model of Economic Growth

31 Flares Twitter 19 Google+ 6 Facebook 3 LinkedIn 3 Email -- 31 Flares ×

After working through two posts on the theme of socioeconomic evolution it became clear that the 2×2 matrix had reached the limits of its explanatory power.  Today we will try to open up some new avenues by playing with concentric circles.

This post will just scratch the surface by addressing two questions:

  1. Why do companies evolve in the opposite direction as the economy as a whole?
  2. What distinguishes the growth of an attention economy venture from that of a transactional economy venture?

Where We’ve Been

Before we get going let’s quickly recap where we have been.  We have posited that socioeconomic coordination has developed in distinct layers, each layer emerging out of the foundations created by previous layers…

Hunter gatherer tribes relied on one-to-one relationships and cultural norms to facilitate cooperation within small groups.

With the advent of agriculture, tribes became stationary and their carrying capacity increased.  Larger populations and more investments in long-term resources demanded new forms of organization.  Political hierarchies emerged to provide the needed stability.  These political institutions initially took the form of simple feudal arrangements and gradually developed towards more elaborate structure.

As political economies grew they eventually reached scales at which the costs of the bureaucratic infrastructure (in terms of both inefficiency and/or inequality) exceeded the benefits of additional stability.  It was at these frontiers (geographical and ideological) that markets emerged.  The most prominent markets were spawned by state bureaucracies in support of political aims, but some also emerged at the edges outside state influence (i.e. black markets).

Markets grew and eventually far exceeded the scale of the bureaucracies that spawned them.  But markets also have their limits.  Those limits are not necessarily geographic in nature, but rather are related to flexibility and complexity.  The transactional model has proved highly effective at facilitating many forms of commerce but has proved too rigid for newer forms of collaboration.

It is at those edges that attention economies have emerged.  Like each preceding paradigm, much of the attention economy has been built via market oriented activity, but it is quickly taking on a life of its own.

The Social Technology Stack

Those four layers produce a picture of the overall economic space as follows:

This is the social technology stack – four domains of socioeconomic technology built one on top of another.  Each addresses a distinct scale and scope of economic activity.  Each emerged out of the limitations of the preceding paradigm.

Unfortunately the visualization cannot be drawn to scale or it would be impossible to discern.  In reality each paradigm is several orders of magnitude larger than the one preceding it.  To a very rough approximation, relationship economies top out at 150 people, political hierarchies at 150 thousand, and transactional economies at 150 million.  [We could debate these thresholds endlessly but for our purposes such precision is unnecessary.  Moreover, the thresholds are not fixed.  New technology extends the functional ranges in both directions, blurring prior boundaries.]

The area of the attention economy is drawn smaller than that of the transactional economy due to its current stage of development.  While attention economies already reach larger scales than transactional markets (represented by the outer radius of the yellow ring), the depth (value-add) of that activity still lags the depth of transactional commerce (represented by the width of the yellow ring relative to the green ring).

This russian doll model intuitively conveys that each layer is necessarily underpinned by preceding layers…

  • Political hierarchies are fragile when their relational foundations are weak.
  • Markets are corrupted when not supported by healthy political institutions.
  • Attention economies would remain shallow without preexisting markets to motivate deep investment.

The Development Paths of New Ventures

For this part of the analysis it will be helpful to make a distinction between innovative ventures and competitive ventures.

  • Innovative venture will be used to describe new ventures that enter the market via pie-expanding innovation.  Initially they have few direct competitors and therefore are not competing for share of a preexisting market.
  • Competitive venture will be used to describe new ventures that enter preexisting markets and compete directly with incumbents for market share.

The distinction is qualitative.  Competitive ventures will need to offer some incremental innovation in order to gain market share.  Successful innovative ventures will indirectly compete with incumbents, even if only via disruption.

Innovative and Competitive are only the two extremes of a continuum.  I will illustrate the all-or-nothing cases for the sake of clarity.  The same approach could easily be used to illustrate various shades of grey.

Innovative Ventures

First let’s look at the development path of innovative ventures.

Innovative ventures will tend to be found at the edges of the russian-doll chart.  While this comports with our intuitive notions that innovation tends to occur at edges (geographical and metaphorical), we could also intuit the same from the structure of our working model.

Recall that each of the rings corresponds to a particular economic paradigm in a 2×2 plane.  Each paradigm will initially develop in fits and starts until it gain enough momentum to become self sustaining.  Growth will then accelerate until the socioeconomic technology inherent to that paradigm begins to produce diminishing returns.  This is the familiar sigmoidal growth curve applied to countless technological cycles.

Because innovative ventures are defined as pie-expanding they will opportunistically position themselves relative to the most promising environments for growth.  In the russian-doll model that is the outer rings.

Therefore we can plot the growth of an innovative venture using an analogous set of concentric rings centered on the outer edge of the previous chart:

 

The three rings represent three stages of growth.  Each arc extending beyond the boundaries of the attention economy represents new economic growth.  As the bubble expands so too does the overall economic pie.  Those arcs are shaded yellow to indicate that they are additive specifically to the attention economy.

The arcs that carve inwards (shaded) represent existing economic value that is captured as compensation.

Stages of Growth

At stage 1 the new venture sets up shop somewhere on the frontier.  It begins producing an appropriate attention asset, generating small bubble of outward growth, and in so doing it captures a small portion of the existing pool of attention (shaded yellow).

The attention captured during stage 1 facilitates further growth in the attention asset (via user generated content, social marketing, social proof, etc).  Assuming that the product itself continues to improve, this creates a virtuous cycle allowing the venture to advance to stage 2.  By that point the attention asset has generated a larger growth bubble (solid yellow) resulting in a commensurate capture of the existing attention pool (shaded).

Once the attention asset expands beyond stage 2, the value produced (radius of the 3rd growth bubble) exceeds the depth of the existing attention economy (width of the yellow ring).  The third compensation arc reaches into the green zone.  At this point the attention asset has grown to the point that will begin converting a portion of that attention into financial revenue.

We can now answer our first question: Why do new ventures evolve in the opposite direction of the economy at large?

Value creation in any given form will tend to be compensated in kind.  When someone offers you access to an attention product it is only natural to reciprocate with a similarly illegible gesture, a social share for example.  If someone offers you free access to a social networking platform you reciprocate by contributing content to that platform and inviting your friends to join.

In the shell chart above, the radial width of any given shell can be thought of as the depth of value exchanged.  In stages one and two, the depth of value offered by our hypothetical attention asset is offset fully via attention capture.  In the current start-up lingo, we might call this the “scale first” phase.

Once we reach stage 3 we enter the “monetize later” phase.  The  russian-doll model illustrates why the “scale first, monetize later” strategies has become so popular.  It is the natural development path for a venture that gets its start on the attention economy frontier.

The further the venture grows beyond stage 3, the more thoroughly it will prioritize monetary compensation over attention reciprocity.  If it gets sufficiently large its growth trajectory will eventually bring it into contact with the political economy ring, at which point all sorts of dubious activity might occur.

The russian-doll model predicts that as the attention economy expands, the grow first phase will get longer and monetize later stage will be pushed ever later.  At some point in the not too distant future the current venture capital model, premised solely on financial returns, will begin to break down.

A Note on Product Market Fit

The growth trajectory described above explains why “product-market fit” has emerged as such a prominent issue for the entrepreneurial community in just the past 5-10 years.  It is not because no one ever thought to consider the issue previously.  It is because the issue did not exist in its current form prior to recent expansion of the attention economy.

What the start-up gurus really mean by product-market fit (at least as applied to the majority of consumer internet start-ups) is wedging a product designed for the attention economy into the transactional economy.  It’s all about bridging the green-yellow barrier.

We shouldn’t be surprised that even with all the methodology that has been codified, the best options that anyone has come up with are advertising and freemium.  There are only so many ways you can unilaterally change your business model without driving your initial customers away.  Smaller, more flexible ventures will find themselves able to manage the attentional/transactional boundary in far more nuanced ways than the large institutions.

The unfortunate side effect of all the focus on product-market fit is that would-be entrepreneurs are being taught to disproportionately focus on business models rather than prioritizing innovation.  They are being taught how to optimize for the capture side of the equation rather than the creation side of the equation.

In other words, entrepreneurs are being taught to act like MBAs.  They are being taught formula.

Competitive Ventures

What distinguishes an attention economy start-up from a more conventional competitive venture?

After working through the previous example the answer becomes obvious.  A competitive venture will face none of the complications associated with managing the boundary between two paradigms.

A competitive venture sets itself up well inside the frontiers.  As such, its development path is comparatively simple.  It immediately produces a legible product and immediately receives legible transactional currency in compensation.  Its activity has no meaningful impact on the size of the economic pie because it merely replaces incumbent competitors.

Growth does not result in any meaningful strategic shift because all activity (production and compensation) remains within the transactional ring.

This may seem like a preferable growth trajectory, but remember that the development of new paradigms is a direct response to diminishing returns (i.e. lack of viable opportunity) in the previous paradigms.  Innovators are migrating towards the attention economy because that is where open frontiers exist.

Commoditization

There are some innovative (pie expanding) ventures that start up in the transactional economy, but often these ventures end up being commodity businesses.

Here’s why: in order to achieve immediate market acceptance in the transactional economy a product must satisfy a want or need so obvious that it generates anticipatory demand.  However, such obvious opportunities only remain unaddressed if they are enormously challenging.  Otherwise someone would have seized them by now.

Even if you can crack the technological challenge, there will be sure be a host would-be competitors working on it at the same time.

A timely example of this phenomenon is the market for photovoltaic technology.  The potential market for affordable renewable energy is so enormous that it might as well be unlimited.  Because the opportunity is so obvious and because the monetization strategy is so direct, the competition is tremendous.  Even as demand for solar products has grown exponentially, prices have fallen even more rapidly and most producers have lost money.

Future Directions

The russian-doll model can be extended in a number of directions to produce practical insights about specific strategies.  A few worth considering:

  • What would a platform strategy look like?
  • How would the strategies of dominant tech firms be depicted?
    • Apple
    • Google
    • Facebook
  • What might that exercise reveal about their future prospects?
  • What types of products and strategies will be most successful assuming various potential economic scenarios?
    • Acceleration of attention economy growth?
    • Political collapse?
    • European financial collapse?
  • How would this model describe the struggles of incumbent companies to adapt to new technologies?

I may need to upgrade my artistic capabilities to appropriately depict some of this stuff but conceptually it isn’t all that difficult.  Let me know in the comments if you come up with any intriguing scenarios…

 

photo courtesy of Adrian S Jones

Save & Bookmark

  • alex ragus

    I know the main point of this post isn’t prehistoric speculation, but I have to take issue with this:

    ” Larger populations and more investments in long-term resources demanded new forms of organization.  Political hierarchies emerged to provide the needed stability.  These political institutions initially took the form of simple feudal arrangements and gradually developed towards more elaborate structure.”

    Where do I begin?  First off, even archaeologists disagree and speculate about whether food supplies became more stable or less stable as agriculture replaced foraging.  Of course, both probably happened in different places.  We just don’t know.  Which makes it fertile soil for projecting dubious grand narratives. 

    Second, the causal link of “more stability needed” –> “hierarchies emerged”  seems completely wrong.  I think the most believable explanation for why hierarchies emerged was that grain constituted the first way of storing wealth.  Once wealth could be stored, it was inevitable that it would produce hierarchies and begin to form feedback loops. 

    Third, I don’t know enough to dispute this, but did feudalism really arise shortly after agriculture did?  As in, there was a warrior class, and a landowner class who received rents from farmers? 

    And anyway…

    I don’t buy that any of the economies depend on the preceding layers.  Black markets are sometimes healthier and freer than their “politically supported” counterparts.  Strong “relationship economies” can cause problems for political hierarchies, like nepotism and corruption.  In fact, political structures might work most smoothly when the people involved have a certain emotional detachment and social insulation from each other (allows for whistleblowers to avoid lifetime shunning, for example). 

    And I’m not convinced that new ventures move in a consistent pattern between these different economies.  Where was is that you explained/argued that claim?  If anything, it seems like new ventures start in bizarre places, but tend to grow roots into whatever economy is most stable/established in order to stay alive in the long term. 

     If you’ve decided that the 2×2 has reached the limits of its explanatory power, maybe it’s time to stop thinking in those four categories.  In the grand narrative you’re telling now, the difference between relational and attention economies has grown very murky.  Weren’t neighboring farmers just as specialized, just in a different way that’s not intuitive to us moderns?

    • http://OnTheSpiral.com/ GregoryJRader

      Aren’t all narratives dubious?  If the pattern were entirely clear then there would be no need for narrative to explain it.  Narrative explanations can only be so precise, particularly in the space of one blog post.  Where that imprecision detracts from the explanatory value the narrative evolves, as this one surely will.

      Clarifying where possible…

      On the hierarchy/agriculture relationship – This is a chicken/egg question that can’t be answered definitively in either direction.  I chose to phrase it in one way though we could just as easily say that the development of hierarchy facilitated the development of agriculture.  

      In the long run each was necessary for the development of the other.  Hierarchical structure could never develop beyond the simplest forms in small hunter gatherer tribes.  Agriculture would never develop beyond a certain point without structures to mediate issues related to long term investment and land holding.

      On feudalism – With regard to the formal definition you are correct.  I am using it informally to refer to simple hierarchical social structure consisting of land “owners” and laborers.  If there is a more appropriate terminology let me know…

      On dependencies between layers – The notion of dependency can be construed in different ways and so far I have only addressed it in passing.  My thinking is analogous to the relationship between parent and child.  The child can only be born through the parent.  Initially the child is dependent on the parent for survival, but eventually (if it survives) will become self-sufficient.  The relationship between parent and child can be healthy or pathological to varying degrees.  

      The strictest sense of dependency only applies to the inception of a new paradigm.  A self-sustaining transactional market cannot emerge directly out of relationship economy.  Sure, primitive tribes did engage in some trade but such trade was deeply embedded in ritualistic custom.  It was not really transactional in nature (as defined in the 2×2: legible + unrelated).  

  • http://twitter.com/jwmares Justin Mares

    “The russian-doll model predicts that as the attention economy expands, the grow first phase will get longer and monetize later stage will be pushed ever later.  At some point in the not too distant future the current venture capital model, premised solely on financial returns, will begin to break down.”

    I think this statement is far too broad. I’d argue that the attention economy only applies to the consumer web, which only received 245 of VC money in 2011 (http://gigaom.com/2012/01/19/2011-q4-moneytree-vc-funding-web-startup-figures/). Maybe the consumer internet portion of investing will break down, but the majority of vc dollars don’t depend on the attention economy to function. This means that an expansion in the attention economy will not take down the vc structure, though it could significantly disrupt it.

    • http://OnTheSpiral.com/ GregoryJRader

      This is a fair point.  To be more specific, the growth of the attention economy suggests an increasing bifurcation of VC market.  The newer class of VCs focused primarily on the attention economy/consumer web (consisting largely of the “super-angels”, incubators, app design accelerators, etc) will need to continue to adopt new practices as the attention economy grows.  

      The traditional VCs will have to choose between chasing the new kids on the block and refocusing on what they have traditionally done: funding technical ventures with obvious monetization potential.  

  • http://www.ribbonfarm.com Venkat

    I think you’re going to end up in serious trouble with definitions. For example, your innovative/competitive distinction is at once too narrow and too broad. Disruption is usually considered an innovation move. I personally consider it a refactoring of market segment boundaries in most cases. It is often zero or negative-sum in its transactional economy effects, but positive sum in terms of attention economy effects (releases more attention than it occupies, in displacing an incumbent).  On the other hand, new frontiers are not necessarily non-competitive. You can have a Manifest Destiny race towards a theoretically identified goal for example, winner take all. 

    Your take on PMF is also not what startups usually mean by the term. 

    That said, this spherical shell visualization has potential. We’ve already debated about whether the attention economy belongs in the outermost ring. The logic of your shell arrangement is sort of phyllogenetic, in evolutionary order. But it is unclear to me that the structural order is necessarily the same (for example, spinal cords evolved after exoskeletal organisms… spines are “deeper” in a sense). I think it is the structural order that might matter. 

    From that point of view, the attention economy might actually be the innermost shell, pre-relationship. You then get increasing de-personalization as you head outwards radially. Maybe the outermost shell is a purely exploitative Gollum economy, where transactional economics degnerates into pure extraction/harvesting economics. The person goes from being a full person at the core, to a related person next, to a political subject, to an economic subject, to a chewed -up piece of trash. 

    • http://OnTheSpiral.com/ GregoryJRader

      I am not wedded to the innovative/competitive labels.  They are intended only to qualitatively distinguish the two scenarios described.  They are not intended to define distinct classes.  Perhaps I should have stuck with obvious references to the model such as “frontier ventures”. 

      In regard to your examples, both emphasize the long term outcomes while my proposed definitions were only describing the very early stages of growth.  I agree that things are not so clear once we consider consequences several steps removed.

      On PMF – I frequently see two definitions conflated: 1) achieving product traction 2) achieving business model traction.  The first may be the more accepted definition, but the literature is full of statements like the following from Marc Andreessen: 

      “Product/market fit means being in a good market with a product that can satisfy that market.”
      (http://pmarca-archive.posterous.com/the-pmarca-guide-to-startups-part-4-the-only)

      What is a “good” market?  Presumably a monetizable market…

      On ordering:  Yes, the ordering shown is based on the evolutionary trajectory.  To show the sort of stuff you are describing I think we would need a dynamic model that could  show the drift in structural dynamics as the dominant paradigm shifts.  Certainly transactional dynamics have come to pervade everything to some degree.  It might be reasonable to say that in a certain sense the dominant paradigm at any given point in time moves to the structural center.  

  • Pingback: Entrepreneurial Process vs Epiphany | OnTheSpiral

  • Vivek

    I like the idea of studying the boundaries of the economies that you have listed – I think there are possibly a lot interesting phenomena that we can model in those spaces. However, your ordering of the different economies in evolutionary order shouldn’t be the only way to look at it.  I would place the attention economy next to the relationship economy and try to use the boundaries to characterize the economies themselves. My gut tells me thats where it really becomes interesting to study. 
    Maybe layering these economies in different ways and figuring out the constructs that create a certain ordering would be interesting. Definitely the adjacency of the transactional and the attention economies does fit the evolution of business models that we seem to be seeing now but I think its not the most valuable way to look at it. Anyway I enjoyed the piece – thanks for making me think. 

31 Flares Twitter 19 Google+ 6 Facebook 3 LinkedIn 3 Email -- 31 Flares ×