Structural change

As business leaders consider the future, and what they need to do to prosper in the years ahead, they can readily identify a range of important trends. Developments such as globalisation, increasing connectivity, pervasive use of mobile devices, price transparency, China’s economic growth, ageing populations and many other trends are evident and well discussed.

However, often a critical assumption is made in the planning process: that the structure of the economy will be the same in the future as it is today.

The reality is that the entire nature of value creation is shifting. Traditional economic perspectives built on assumptions of rigidly delineated industry sectors often mislead more than they elucidate.

The modular economy

Perhaps the most useful way to think about the changing economic structure is the idea of the “modular economy”, in which value is created in increasingly small units that are combined in a wide variety of ways across organisational boundaries and between individuals.

The Nobel Prize-winning economist Ronald Coase proposed that organisations exist because of transaction costs: it is more efficient to coalesce economic activities inside a company due to the cost of finding and working with external resources. Yet in a connected, globalised world, transaction costs are now a tiny fraction of what they were in the 1930s when Coase formulated his ideas.

Today, organisations are no longer the locus of value creation. Value is created by orchestrating many smaller elements, sometimes within firms, often beyond organisational boundaries and increasingly between many individuals or micro-businesses.

One example of the modular economy can be found in Chongqing in Western China, where novel approaches have helped the city become the world’s largest centre for motorcycle manufacturing.

The manufacturers in Chongqing dramatically overtook the previous industry leaders in Japan by taking a very different approach.

Rather than specifying requirements to their suppliers in minute detail, as the Japanese manufacturers do, they assemble their suppliers to discuss collectively the parameters of the motorcycle they wish to build, and let them work together to identify how the modules they create can fit together to achieve the group’s vision. The average export price of a motorcycle from Chongqing is just over US$100.

A modular approach to business processes or production flows will identify elements that can be done more efficiently externally.

In professional services, the UK law firm Hogan Lovells has a well-established system for modularising work. Its large corporate clients give it a wide range of work around their real estate transactions. Hogan Lovells breaks down that work into smaller elements, some of which are performed by its own lawyers, while others are farmed out to lower-cost regional law firms, then integrated to provide a seamless service to its clients.

In large organisations business processes are now routinely broken down into smaller components, with each element being assessed on how it can be performed most efficiently. The next phase, business processing outsourcing (in which entire business functions are outsourced), uses a more granular approach in which each part of a business process is performed where it can be executed most efficiently.

In large organisations business processes are now routinely broken down into smaller components, with each element being assessed on how it can be performed most efficiently. The next phase, business processing outsourcing (in which entire business functions are outsourced), uses a more granular approach in which each part of a business process is performed where it can be executed most efficiently.

Today’s headlines are being filled with news of the “collaborative economy”, with companies such as Uber in taxis, AirBnB in accommodation and Lending Club in lending, disrupting industry incumbents with established business models. These are also examples of a modular structure, in which individuals — enabled by intermediaries — collectively replace taxi companies, hotels and banks.

Implications and strategic questions

The forces underlying the rise of the modular economy have been in place for well over a decade. However, the real impact of this shift in the structure of value creation has become evident only over the past few years. This trend has far further to run, and organisations need to address the challenges and seize the emerging opportunities.

The implications will play out very differently depending on issues such as a company’s industry, size and geographical scope. To understand the actions they should be taking, leadership teams should be asking themselves three strategic questions:

1. How can we compete with modularised offerings?

Get a team of innovative thinkers in your organisation to imagine how a potential competitor might create a cheaper or better offering for your customers, using a modular business model or structure. Identify strategic responses for both the short-term and long-term, as a significantly different competitive landscape could arise in your industry.

2. How can we drive efficiencies through modularisation?

A modular approach to business processes or production flows will identify elements that can be done more efficiently externally. Other considerations include the costs of integrating processes, as well as the long-term benefits of building flexible, reconfigurable processes that can take advantage of future developments.

3. What governance structures are required?

The manifold risks of modular business include those around quality, performance and information flows. However there is a greater business risk in becoming uncompetitive by sticking to existing structures. Governance must address real risks while enabling innovative approaches.

In today’s intensely connected world, the very structure of how value is created is changing. Business leaders must help their organisations to be ready for these shifts. Addressing these three key strategic questions will provide a platform for building effective responses.

Ross Dawson is a futurist, speaker and author.

This article was first published in the July 2014 issue of Acuity magazine.