The Internet's Ripple Effects upon Consumer Firms

Why do flat organizational structures and digitization matter so much for innovation?  The public eye is fixated upon startups, but massive change is also happening within incumbent corporations.  Since corporations are contemplating this question, we should retrace just how we got from the internet, to startups taking advantage of changing business economics and models, to enterprises now responding by prioritizing flatter hierarchies and digitization.

The internet prizes users

The internet has changed how companies grow and stay competitive (i.e. generate outsized or monopoly profits).  To paraphrase the peerless Ben Thompson, it used to be that a company either had to 1) gain a horizontal monopoly in one of the three primary parts of the consumer market value chain (suppliers, distributors, and consumers/users), or 2) integrate two of the parts so as to have a competitive advantage in delivering a vertical solution.  To achieve the latter, delivering a vertical solution, it was common to integrate supply and distribution.

Now, by making the distribution of goods and content free, the Internet has modularized suppliers, and rendered supplier-distributor relationships and integration less valuable.  Also, by reducing transaction costs to zero, the Internet allows distributors to reach or integrate with consumers/end users at scale.  All this is to say that the balance of power has tipped towards consumers.  Therefore, distributors no longer compete based upon exclusive supplier relationships, but rather now compete for consumers and users.

One example of where this has played out is with enterprise software vendors and systems integrators, whose businesses have suffered at the hands of Software as a Service (SaaS) and freemium.  Their business models revolved around selling all sorts of services through the exclusive sales team-customer relationships, and were such that as long as they had the best distribution or relationships, they would win regardless of how good the products were.  Now, in contrast, the most successful companies aggregate suppliers—meaning the suppliers come to them—and connect them to the consumers/users with whom they have developed an exclusive relationship at scale.  The perfect example of this is Facebook, which has achieved the historic task of monetizing a staggering 1.5 billion monthly active users.

Digitization and flat hierarchies are bridges to users

And that's precisely why flat organizational structures and digitization matter for innovation, because they both enable you to get closer to the customer or user, which in turn allows you to use data to adjust your strategy more quickly and make better decisions.

Digitization achieves this by integrating the practices of looking at data to learn more about the customer, and of using those insights to design better customer interactions and products, into one continuously improving and iterative process.  Because of the way that the internet has elevated the consumer and user, user experience has become the most important factor in determining success.  Companies that design the best user experience will gain the most consumers and users, and in turn attract the most suppliers.

The other element of digitization is reconfiguring organizational structures so that they can take better advantage of analytics.  Flat organizational structures, in particular, enable those with their ears closest to the customer data to be decision-makers.  At a corporation, the most valuable resource is people’s labor and time (what they work on, etc.), but it is often allocated by plan and command, non-price mechanisms (i.e. by hierarchy).  Ironically, free markets are generally seen as good, and corporations are themselves the emblem and engine of free enterprise, but the market for people's time at those places is an area that is relatively resistant to that principle.  Meanwhile, startups are often considered more nimble, “entrepreneurial,” closer to the pulse of the customer, and capable of identifying real issues quickly; all because they are flatter, and decentralize and individualize time and team allocations.

Yet flat hierarchies and democratization may not always suit every organization.  As an extreme example, you wouldn't want the military to be run that way.  Flat hierarchies still involve their own trade-offs, as they can still be subject to power politics, and can hide power structures and shield individuals from accountability, leading to abuse or dysfunction.

Digitization and reconfiguring structures is more broadly about getting all of the siloed data and putting it in front of the people who can make use of it, or putting those people in power to act upon those insights—and flatter structures are just one method of doing so.  Sometimes, this can entail ring-fencing certain initiatives or projects within a company so that they can grow and develop independently.  Other times, it can involve finding out where the silos of experts and dispersed talent are, and integrating them better.  Or, it can involve simplifying lines of accountability and empowering those further down the hierarchy with decision-making rights (i.e. having fewer cooks in the kitchen when it comes to making decisions so you can get things done).