News
Blockchains will disrupt economies of scale
The ability to achieve economies of scale underlies much of the world’s modern wealth. At Ford Motor’s original plant in Detroit, the company gradually managed to increase the time it took to assemble a Model T from 12 hours to 93 minutes. The process of endless methodical improvement included everything from speeding up production to offering few or no options (“any color you want, as long as it’s black”) to finding a version of black paint that would dry faster than the other.
I believe we are at the beginning of a new cycle of disruption, fueled by public blockchains and the tokenization of industrial processes, as well as many other digital processes that change the economics of doing business.
Blockchains use the standardization that comes with tokenization, and the flexibility afforded by smart contracts, to drive efficiency without companies needing traditional economies of scale to keep costs down. The results will be extremely disruptive to industries, geographies and supply chains.
Now, ladder isn’t the only game in town. There are also diseconomies of scale. Government legislation regularly imposes stricter rules and targets on larger companies. Larger companies develop bureaucracy. The same systems that allow companies to operate consistently globally also eliminate local discretion.
In 1944 the CIA published a top-secret manual (since declassified) on how to do this sabotage the enemy. It contained useful guidance such as “do things only through the appropriate channels” and “negotiate over the precise wording of communications.” This is, unfortunately, timeless advice on how to succeed in many large offices.
Quite simply: bigger is not infinitely better. There is a range of scales to define what is “optimal”: large enough to benefit from economies, but not so large that it is strangled by bureaucracy. The lower limit of this range is known as “minimum economic scale” and is important because the smaller it is, the more businesses and competition can be supported in a market.
Traditionally, these numbers have been large, and the larger the scale of investment required, the more difficult it is for companies to enter and remain competitive. Some industries are still oriented towards the ever-increasing investment and capacity needed to reach significant scale. Today, building a new state-of-the-art semiconductor plant is so expensive – estimated at up to $30 billion – that only a few companies remain in the industry where there once were dozens.
Directly related to the shortage of cutting-edge semiconductor manufacturing capabilities is the shortage of chips used to train advanced AI models. Many of these orders are $1 billion and above; the cost per AI model is estimated at over $50 million for the most advanced ones.
Although technological changes are pushing some industries to consolidate because entities must become increasingly larger in size to remain competitive; others are tipped in the opposite direction. 3D printing is slowly transforming manufacturing while significantly reducing scale. Traditionally, metal stamping presses can produce a large number of parts quickly and cheaply, but the fixed cost is high and they can only produce one part at a time.
3D printers, on the other hand, can make a wide range of parts. Each printer can be slow, but you can simply add more. Research I conducted at IBM has shown that 3D printers can reduce scale requirements in some industries by up to 90%.
A similar story is happening in the IT industry. Web eCommerce has enabled even the smallest businesses to sell worldwide. API-enabled services allow you to integrate everything from credit card payments to shipping and tracking services.
So far, API-based web services have done a great job of simplifying relatively standardized systems and services. The next big change will come from blockchains which will enable much more complex and customizable integrations between companies using tokenization and smart contracts.
Systems integration – connecting businesses so they can work in tandem – is quickly becoming the key to maturing businesses and growing them. No company makes or produces everything alone. Instead, almost every business is a coordination game in which companies add their most unique and useful value to a long chain of partners.
Coordinating all these partners is very challenging. For example, if you have a supply restriction for a critical component, there is no point in ordering additional components as they will simply sit unused in the warehouse. Unfortunately, few supply chains can master this complex process. Companies routinely try to advertise and sell products that they cannot supply due to internal coordination problems.
The more closely companies are linked to each other digitally, the better this coordination process works. Representing all products as digital tokens, allowing visibility across multiple stops in a supply chain, would be transformational for most companies. The world’s largest companies already implement a version of this type of deep coordination with a blend of customized systems and human management. While every large company tries to create their own collaboration hubs, smaller companies find them expensive and difficult to maintain.
Blockchains will transform this dynamic because, instead of having to integrate into many different proprietary systems, companies can create standardized models of their products as digital tokens and then integrate them into one place: a public blockchain, like Ethereum. With the addition of privacy technology on Ethereum, companies can manage which partners see their information and prevent competitors or intermediaries from exploiting their data.
In every industry, where minimum scale decreases, markets can support more competitors. In research I conducted at IBM, we found that as 3D printing matures, it is possible to enable scale reductions of up to 90% in some manufacturing sectors. That means up to 10 times more companies can be competitive in the same space.
Imagine increasing by a factor of 10 the number of companies that can be sustainable across a range of industries using blockchain software. This would put an end to these markets.
When the minimum economic scale is high, you find yourself in a market with few products and very standardized products. When the minimum scale itself gets much smaller, you start to see huge variety. In these cases, local products adapted to local needs begin to prevail over global options. Even in these environments, small businesses perform better than larger ones, given their flexibility and proximity to the customer.
The most optimistic outcome is a return to a time when small businesses provided local services. That era now seems like a distant past, and the replacement of the small businesses of the past by the large corporations of today has not been harmful. This has been part of what has resulted in a huge improvement in everyone’s standard of living thanks to the resulting efficiencies.
With blockchain and other technologies reducing minimum economic scale, we could get the best of both worlds: locally enriched economies, extremely competitive markets, and all running at high operational efficiency.