June 05, 2014

Social “Inc-onomics” and the Z-Effect: An Excerpt


Bob Zukis, Kauffman Fellows Press Author

A Message from Managing Editor Anna Doherty

We created Kauffman Fellows Press to offer a publishing platform for Fellows, Mentors, and other members of the KF Society. With all our publications, we are interested in original research and thinking on topics affecting capital formation. In particular, we look for disruptive, cutting-edge perspectives. With Social Inc.: Why Business Is the Next Social Opportunity Worth Trillions, Bob Zukis does not disappoint. [Editor’s note: This article uses the (parenthetical citations) of KF Press books, rather than the footnote citations of this journal. Full information on the cited works appears at the end of the article.]

Social Inc. is an ambitious examination of social media and its effect on business in the twenty-first century, drawing on the author’s thirty years of experience as a global business consultant. By looking first at historical rounds of social technology innovation, Bob Zukis builds a thought-provoking case for how social technology should be shaping businesses across the world (see figure 1). The following excerpt includes almost all of Part 5—we hope you will agree that this is a book worth reading.

Part 1 The Business Management Opportunity of the Century
Part 2 Social Technology’s 802,013-Year Evolution
Part 3 Business Is the Next Killer Social Opportunity
Part 4 Michael Porter and the Holy Grail
Part 5 Social “Inc-onomics” and the Z-Effect
Part 6 CEOs, Boards, and Some Social Sobriety
Part 7 Taking Your Company from Social Misfit to Social Butterfly
Part 8 A 2020 Future Brought to You by Social Technology

Figure 1. Outline of Social Inc. by Bob Zukis.

Anarchy, One Connection at a Time

Economics is about people—how individuals choose, decide, and interact. Alfred Marshall said, “Economics is the study of men as they live and move and think in the ordinary business of life” (Marshall 1890, Book 1, Chapter 2, para. 1).

The first rule of Social Inc. is that social technology is about human behavior; when behavior changes, certain economic forces can also be altered. In this chapter I discuss social “Inc-onomics”: a key economic factor influencing the Social Company.

The core economic impact of social technology has its roots in Nobel laureate Ronald Coase’s work around transaction costs. His 1937 paper, “The Nature of the Firm,” analyzed the question of why companies form at all. Essentially, tightly linking, organizing, and controlling people in an artificial structure such a company was much more efficient than the alternative of trying to organize and engage in the external market.

Larry Downes and Chunka Mui updated this concept for the internet and the digital revolution, in their book Unleashing the Killer App (1998). Building on Coase’s work, Downes and Mui proposed a new law: the Law of the Diminishing Firm.

As the market becomes more efficient, the size and organizational complexity of the modern industrial firm becomes uneconomic, since firms exist only to the extent that they reduce transaction costs more effectively. (p. 7)

They predicted, from 1998, that the new technology would lower transaction costs, and as a result, the size of the firm would decrease based on Coase’s presumption.

While the practice of outsourcing exploded subsequent to Downes and Mui’s work and downsizings have been the norm of late, the net effect is not definitive. The data does not show that firms have shrunk in size—yet.

I think Downes and Mui were right, and just how right is only becoming apparent now in 2013, almost fifteen years after they introduced their theory. Social technology is finally enabling what they proposed and changing Coase’s conclusions from almost seventy-five years ago.

When transaction costs in the external market are markedly reduced because of information and social technology, as they are now, the corporation does not need to exist to wring transaction costs out of exchanges. The artificial structure and boundaries of the modern corporation, together with the handicaps that legacy IT imposes, have hobbled Coase’s version of the company with massive inefficiencies.

Downes and Mui also proposed a Law of Disruption, which states, “Where social systems improve incrementally, technology improves exponentially” (1998, p. 9). The truth of this law has also been altered because of social technology—social systems have both exploded and imploded because of social technology tools. Rather than incremental, changes in social systems have been significant because of these tools. Changes in society and business now mirror the rapid pace of technology development.

Hindsight is always the best teacher. In 1937, I’m pretty certain that it was much cheaper to organize as a firm than to transact in the free market. The telephone was still in its relative infancy, travel was time-consuming, information exchange was paper-based, and transaction costs were everywhere. Markets were a lot less efficient than they are today.

As technology has advanced, humanity has now reached a tipping point for business and society. Social upheaval now happens quickly, and so does business disruption. The historical economic concept proposed by Coase, which led to the modern incarnation of “the firm,” is now being disrupted by social technology.

“The firm” in its current incarnation is now the problem. The modern corporation is its own worst enemy in terms of getting things done—the bigger the company, the bigger the problem. Markets move faster than the speed at which modern firms can respond. The modern corporation or organization as it is conceptualized, organized, led, governed, and managed has become the weak link.

Managers exert tremendous effort trying to get employees to execute a certain set of behaviors, which it is assumed will achieve the goals that have been set for the company—that is, the goals that management has set for the company. As we now know, this model isn’t delivering up to our expectations as customers or employees. Management is not to blame for this situation, however: the cooperative model and inherited business teachings of the past are. It has proven difficult to align the many management tools and techniques used up to this point and achieve the desired outcome. Information systems have also been a big part of the problem, forcing employees to work the way that their IT systems worked, as opposed to the most productive and effective way. Layer on volatile markets and the limitations become even more apparent.

Early in this century, the U.S. government passed the Enterprise Integration Act (EIA) of 2002. The goal of the EIA was “to work with major manufacturing industries on an initiative of standards development and implementation for electronic enterprise integration” (para. 1). The act intended to “increase efficiency and lower costs” (Section 2.6). Viewed as being in the national interest, the EIA resulted from research identifying massive inefficiencies in different industry ecosystems. Notably, the U.S. automotive industry was identified as having over $1 billion of waste per year attributable to inefficient information flows across its supply chain (Brunnermeier & Martin 1999, p. 6-1), making it less competitive with international car manufacturers. By 2005, McKinsey & Company research put this figure at $10 billion (Hensley & Knupfer 2005, para. 1).

Coase’s (1937) theorems on transaction cost state that firms could be more efficient by controlling and internalizing exchanges—but in a time when information flowed at a much slower pace and smaller scale. Accelerating markets, massive amounts of information, and falling engagement and transaction costs have altered this premise. While the efforts of the EIA and National Institute of Standards and Technology (NIST) never made headline news, the external markets have.

Massive changes have taken place with electronic information exchange since 2002. The internet, the cloud, and now social technology have presented new ways to manage and integrate supply chains—the EIA actually referred to the emergence of the “World Wide Web” (Section 2.3) but did not contemplate what would shortly occur and what is now possible through social technology. While the EIA was well-intentioned and needed at the time, free market innovations and social technology advancements have already addressed the problem it was designed to address.

The 4 Cs of Social Inc. sum up why Coase reached his conclusions in 1937 and demonstrate that in 2012, his perspective no longer holds. The artificial boundaries of the modern corporation now get in the way to create more barriers, not fewer, and legacy IT compounds the problem. The firm as it has been designed and implemented is now less efficient than engaging with the market—social technology has made this happen.

When discussing transaction costs, or the cost of an exchange between parties or things, I prefer a derivative term as it relates to social technology—engagement costs. This term refers to the costs of an interaction between people, or between things, or between people and things. Engagement costs are the economic backbone of social technology, or more accurately, the elimination of them is. Social networking tools like LinkedIn have reduced—and indeed almost eliminated—any real costs of engagement between people. Finding and connecting with people has never been easier or more inexpensive.

Staying connected is now possible—the sustainability of networks through social technology is a powerful weapon for individuals and businesses. The historical approach to locating people through the telephone, directory assistance, and even the phone book were inefficient and laborious. Once a person was located, connecting with them was another challenge altogether. Today, the costs of searching, connecting, and engaging have virtually been eliminated between people, and are decreasing between people and things, and things and things. Social technology makes it nearly free to interact, directly or at scale—with millions, even billions of people. These costs might seem trivial on the surface, but when considered at scale, they are gigantic.

The end result is that the costs of information exchange have been reduced to virtually zero. The fire, printed word, and telephone all dramatically reduced such costs, but social technology drops information exchange costs to the very bottom, as low as they have ever been.

Mathematics, and specifically Metcalfe’s Law (Gilder 1993), can illuminate the engagement costs inherent between everything. The inventor of the Ethernet, Metcalfe proposed that while the cost of expanding a telecommunications network is a linear function (a fixed cost for each added node or user), the value of the network (V) goes up much faster, proportional with the number of users (n) squared (G. Li 2008, p. 1):

V ~ n2

Although Metcalfe’s original observation focused on value as it related to connections between devices, not people, “[a]t its core [the law] captures the concept that value increases as the number of users increases, because the potential links increase for every user as a new person joins” (emphasis added; Hendler & Golbeck 2008, p. 1).

Social technology has leveraged this concept across people already, but an explosion in device-to-device and device-to-people connectivity is now at our doorstep. For a network with n people, there are: n * (n – 1) / 2 possible unique connections.1 For example, if you had 5 people at a party including yourself, you’d need to make 10 introductions for everyone to meet each other. Scaling up, there are 124,750 connections between 500 people, or between 500 things. You would be very busy at that party to try to get everyone introduced….

These numbers reflect the first phenomenon of the 4 Cs of Social Inc. in action: connecting. Facebook, Twitter, and LinkedIn have all tapped into connecting people efficiently. More importantly, those who are connected stay connected for as long as they want to. While previous iterations of social technology allowed people to connect (e.g., by telephoning a colleague in Germany or having a conference call with a team 5,000 miles away), the scale was much, much smaller and less efficient. In other words, the costs of engagement were much higher. With today’s social technology, a major step forward has been made in the reduction of engagement costs.

I believe a new law is emerging to reflect the fact that engagement costs are now approaching zero within the context of social technology: the Z-effect or Zero-effect. This rule centers around engagement costs, stating that when engagement costs approach zero, disruptive potential is maximized (figure 2). The Z-effect derives from the observation that the level of engagement goes up exponentially when engagement costs approach zero. Consequently, new forms of engagement occur that would not have otherwise, and these newly created interactions have the potential to drive massive change, disruption, and innovation.

Figure 2. The Z-Effect.
Figure 2. The Z-Effect.
Bob Zukis’s image, used with permission.

The sheer scale of participation and interaction that occurs when there are no engagement costs contributes to this disruptive capacity. The multiple benefits of social technology (making people smarter and more productive) get exploited in different ways, the more people and things interact. We simply figure things out better, faster, and cheaper. Lower engagement costs work to improve workplace productivity and also enable Daniel Wegner’s theories on transactive memory (Wegner et al. 1985; Wegner 1987). Eliminating engagement costs and releasing the full potential of these concepts drive the potential for maximum disruption—to enable the Z-effect.

“The internet of things” is also starting to emerge as a reality as advancements in wireless connectivity allow the efficient connection of objects through the internet and social technology. As data starts to flow between things and people, “engagement” will take on an entirely new meaning. A new human–machine interface will start to emerge, changing the experience of working with a company and its products or services in wildly unpredictable ways.

According to Dave Yarnold, CEO of ServiceMax,

The idea of extending the social construct out to your equipment on the customer’s site—so your equipment can “talk” to you, is amazing. For starters, I can see big-time savings in solving problems and getting customers up and running faster. (personal communication, 17 October 2012)

While the social technology learning curve is creating some distractions and disruptions for the early adopters, their understanding of what’s possible is growing considerably. These early Social Companies will establish and write the new rules of engagement and define what it means to offer an experience that others will need to react to and live by. The early adopters will survive and thrive because both the technology and the behaviors are changing, and when behavior changes, it rarely reverts back.

Tropicana Turns Oranges into Lemons, and Back Again

Even if businesses try to ignore social technology tools, these tools will definitely not ignore businesses and will still influence their future. Whether or not a company has committed to social technology as a powerful new competitive force, its markets already have.

In February 2009, Tropicana’s long-standing product packaging was replaced by a new design in a traditional repackaging move. One month later, amid public outcry, negative publicity amplified through social technology, and the declining sales that resulted, Tropicana decided to go back to the old packaging (Elliott 2009). Leo J. Shapiro & Associates (LSJ) studied the impact of social media on the Tropicana product launch and recall of 2009 with some enlightening findings.

For starters, only a minority of consumers—approximately 20%—even noticed the new packaging (proprietary LSJ analysis, used with permission). Opinions among the 20% who did notice were markedly mixed (figure 3). With a relatively balanced (or even slightly favorable) reaction from the market, how did the campaign go sour?

Figure 3. Feedback on Tropicana’s New Packaging.
Figure 3. Feedback on Tropicana’s New Packaging.
Bob Zukis’s image, used with permission. Data from Leo J. Shapiro & Associates; the survey did not receive responses from 9% of those asked.

Owen J. Shapiro, a Partner at LSJ explains, “Part of the story is the relatively small percentage (1%) of consumers who knew of the issues and broadcast messages, generally negative, about the new packaging through social media” (personal communication, 1 October 2012). A small group of socially enabled consumers were upset (figure 4), and social technology gave them a way to vent their frustrations.

Figure 4. Distribution of Social Media Attention Among Those Aware of the Packaging Change.
Figure 4. Distribution of Social Media Attention Among Those Aware of the Packaging Change.
Bob Zukis’s image, used with permission; graph reproduced with permission from Leo J. Shapiro & Associates.

This story illustrates the first lesson that has been learned with these tools: With social technology, customers no longer suffer in silence. Even in a situation where there is a favorable majority, social technology has incredible power to amplify a minority message and affect a company’s behavior. NM Incite, a joint venture between Nielsen and McKinsey & Company, quantified this amplification at 500%. That is, a single negative comment has as much impact as five positive comments, on average (2012, p. 2).

As events unfolded with Tropicana, consumers started to get confused. Prior to the new launch, social media comments about price and ingredients dominated internet conversations about premium OJ. During and after the launch, the online conversation changed to every business’s nightmare—confusion at the point-of-purchase, in the store (Owen J. Shapiro, personal communication, 1 October 2012).

The numbers are quite interesting. Only 20% of customers noticed the switch in packaging, and of these, 1% posted comments on social media. So, that’s actually 1% of the 20%. For every 10,000 customers, only 2,000 noticed the packaging change; of these 2,000, only 20 went online and said something negative.2

A socially engaged and vocal customer base equivalent to 20 people out of every 10,000 created enough “negative noise” to cause Tropicana to revert back to their old packaging—in about a month. The New York Times reported at the time:

It was not the volume of the outcries that led to the corporate change of heart, Mr. [Neil] Campbell [President of Tropicana North America] said, because “it was a fraction of a percent of the people who buy the product.” Rather, the criticism is being heeded because it came, Mr. Campbell said in a telephone interview on Friday, from some of “our most loyal consumers.” (Elliott 2009, para. 17)

If Tropicana had ignored the very vocal minority, what would have occurred? While the 1% of customers who posted online did negatively impact sales, would sales have rebounded? Did the real-time and iterative nature of Tropicana’s approach save the company from a much bigger calamity that could have materially impacted their business? Possibly, though it might have blown over on its own. At a minimum, by monitoring and reacting quickly, Tropicana certainly avoided spending an inordinate amount of time and other resources fighting what could have been a losing battle, or a no-win struggle.

Did they reinforce the strength of their relationship with the market by listening and responding so quickly? Tropicana demonstrated that it was monitoring the social media conversation—which is a leading practice. The next lesson here is for companies to act quickly. A singular voice amplified through social technology can influence thousands or even millions of others; Tropicana’s leadership understood this, and then engaged and acted.

When these events occurred, there was no blueprint or guide for what to do in such a circumstance. Brands like Tropicana were figuring this new medium out as they went along. Tropicana leadership set an example and listened to their markets, in real time.

Since 2009, Tropicana’s story has been reenacted by other companies and brands who have been getting up-to-speed with social technology tools (Fiegerman 2012). However, these early social media mishaps have proved far from fatal, despite the amount of press they’ve received. Tropicana may have even reinforced their brand and the experience they provide to their customers by showing that the company is listening and engaged with what customers are saying. Tropicana’s customers know that their opinions matter—what a great experience that always is.

One of the key findings of the InSites Consulting Social Media Around The World 2012 survey is that 80% of internet users would be willing to help a company co-create its products or services. In return, however, they expect feedback on what the company does with their input (Van Belleghem, Dieter, & De Ruyck 2012, slide 20). In China, nearly 100% of consumers are willing to help a brand they like. Australia is at the low end of the scale, but still at almost 70% (slide 91). Consumers want to be engaged, they want to help, and they’ll work for free…what are companies waiting for?

Zappos Delivers Big Bucks Through Social Sharing

(Section not included in this excerpt.)

How Social Companies Create Value…Lots of It

Any corporate initiative, technology-driven or not, boils down to business impact and therefore to financial impact or P&L (profit and loss). Being smarter and more productive sounds good, but until these capabilities are translated into financial statement impact, business doesn’t usually budge.

Fortunately, some metrics are starting to emerge and what’s striking is that they are not incremental in nature. Compelling numbers are being reported by early social technology adopters and researchers (see below), with the realized benefits starting to get a lot of attention.

The business impact behind social technology is more than Facebook or broadcasting a marketing message into a social channel. Understanding the many economic and financial implications behind these tools and creating a business case for social technology across an entire business is a complex undertaking.

McKinsey & Company has published an annual survey since 2007, looking at the ways in which organizations use social tools and technologies.3 Their research provides not only results but also a trend line to learn from. Their 2011 summary of over 4,200 global executives reports:

When adopted at scale across an emerging type of networked enterprise and integrated into the work processes of employees, social technologies can boost a company’s financial performance and market share. (Bughin et al. 2011, para. 1)

They also show increases in the number of respondents reporting benefits from prior years across many categories, which may reflect the experiential nature of social technology. The more people use it, the more they understand how to get business value out of it.

Highlights of their 2011 survey results include the following.

These results support my overall premise that Social Companies are getting smarter and more productive. The following additional data points illustrate the range of observations and results being reported around the business impact of social technology. The Allstate Heartland Monitor XIII survey4 conducted in 2012 illustrates several key points around social influence and trust:

In summary, people are less trusting of what corporate leaders tell them than they are of their own network, who are extremely influential to people’s opinions and purchase decisions. With social technology, customers are more than just individuals—as the example of Zappos illustrates, the “best customers” may be defined differently when their influence and networks are factored in. Not only does business need to continue to focus on the individual, but companies need to start to consider and understand how each individual’s network comes into play.

A Deloitte survey in 20125 provided some curious data points around how far businesses still need to go to enable social technology effectively, and also identified a massive gap between leaders and their staff on the use of social media to build what I term a Social Company.

The authors conclude by calling out executives for faking it:

Executives may be using social media as a crutch to build culture and seem accessible—but good leadership can’t be dialed-in. Norms for building an exceptional culture and organization have not changed. (3rd bolded results section)

Accountability is both the Beauty and the Beast of social technology. The collective voices of employees and customers will no longer tolerate platitudinous efforts.

Social Media Examiner’s 2012 Social Media Marketing Industry Report6 identifies the following benefits from marketing into external channels (Stelzner 2012, p. 14):

Visibility, market intelligence, stronger customer connections, business development, and finally, cost reduction and improved revenue—not a bad mix of marketing outcomes for a large percentage of users. Imagine extending these benefits across your entire business.

A Telligent 2012 survey of social technology in the UK workplace7 identified latent demand for these tools in the workplace.

Employees want social technology and they know that it works—companies that are social laggards need to pick up the pace or be left behind. A 2012 joint MIT/Deloitte survey8 on the expanding footprint of Social Companies indicates trend lines pointing to the unavoidable destiny of social technology and its impact on business (Kiron, Palmer, Nguyen Phillips, & Krushwitz 2012).

  1. “A majority of respondents (52%)…believe that social business is important or somewhat important to their business today. Fully 86% of managers believe social business will be important or somewhat important in three years” (p. 3).
  2. “Leadership and a clear vision are cited most frequently as critical to the adoption of social software. Lack of management support is cited most frequently as the biggest barrier to adoption” (p. 3).
  3. “Leaders most responsible for the strategic direction of an organization—CEOs, presidents and managing directors—are almost twice as likely as CIOs and CFOs to say that social business is important to their organization” (p. 3).

Leaders, particularly those with a strategic orientation, generally see social technology as an issue rising in importance. Moreover, implementing social technology cannot be done without leadership: Getting the board of directors and CEO on board is job #1 for a Social Company.

The use of social technology by your markets will feed changing expectations around what is viewed as acceptable levels of treatment and engagement. These tools are changing service and support expectations. A survey by the social media customer service company Conversocial (2012)9 found that, when contacting a company via social media, approximately

In Part 1, I started with the McKinsey Global Institute declaration that social technology is a business opportunity with a price tag of well over $1 trillion. The final point of their key findings section provides this assessment and warning:

The benefits of social technologies will likely outweigh the risks for most companies. Organizations that fail to invest in understanding social technologies will be at greater risk of having their business models disrupted by social technologies. (Chui et al. 2012, p. 4)

Are there other trillion-dollar business ideas out there? I’m not aware of any. Social technology is the business management opportunity of the next decade. The status quo for business—customer mistrust, lack of employee engagement, and slowing economic growth—needs a different answer. This is a leadership moment for business, and boards and CEOs need to take up the challenge.

Bob ZukisBob Zukis

Bob is the Founder and CEO of Saaskwatch Systems where he is reinventing the future of business. Bob is also influential in advancing IT governance in the corporate boardroom as a Senior Fellow, Governance Center for The Conference Board and as a member of the NACD SoCal board. He was recently named to the FT Agenda Digital 50 list of top IT governance executives in the United States. Bob was previously a PwC Partner where he spent the last 30 years working across 20 countries on 4 continents helping a global F1000 client base enter and succeed in emerging markets and with new technologies. He has an MBA from the University of Chicago and a BBA from Texas Tech University.

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1 Each person in a group of size n can make n – 1 connections, so the total number of connections possible is n * ( n – 1). However, for the number of unique connections among the group, we want to count a John–Mary connection once, not once for John–Mary and once for Mary–John. So, divide the total number of connections by 2, resulting in the formula above: n * ( n – 1 ) / 2.

2 Data from Leo J. Shapiro & Associates.

3 “The online survey included 4,261 respondents across sectors, geographies, company sizes, tenures, and functional specialties…The survey covers the adoption and usage of technologies, their benefits, and corporate performance” (Bughin et al. 2011, footnote 1).

4 Heartland Monitor surveyed one thousand U.S. adults to examine “how [their] views of government and major corporations are shaped by the information they receive and by their use of social media” (FTI Consulting 2012, p. 1).

5 Harris Interactive surveyed 1,005 U.S. adults (aged 18+, employed full-time in a company with 100+ employees) and 303 corporate executives on a number of questions related to culture in the workplace (see Deloitte 2012).

6 This study surveyed over 3,800 marketers with the goal of understanding how they are using social media to grow and promote their businesses (see Stelzner 2012).

7 Telligent surveyed 1,000 UK employees to gain their views on workplace communication and remote working.

8 This global survey included almost 3,500 “business executives, managers, and analysts” (Kiron et al. 2012, p. 21) from 115 countries, 24 industries, and both large and small organizations (p. 21).

9 Conversocial (2012) surveyed “589 American adults. These adults were approached exclusively online through social networking sites, forums and dedicated emails. There was a quota sampling technique applied so that it guaranteed the sample was reflective of the American population, with an average age of 39” (p. 3).

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Brunnermeier, Smita and Sheila Martin. 1999. Interoperability Cost Analysis of the U.S. Automotive Supply Chain. Research Triangle Institute (RTI) Project Number 7007-03.

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