Is Your Company Ready to Operate as a Market?

Editor’s Note: This article is one of a special series of 14 commissioned essays MIT Sloan Management Review is publishing to celebrate the launch of our new Frontiers initiative. Each essay gives the author’s response to this question:

“Within the next five years, how will technology change the practice of management in a way we have not yet witnessed?”

New technologies are eroding transaction costs — and in the process creating a world that is increasingly connected. The resulting level of interdependence creates a radically new set of challenges for management.

In particular, complicated business situations are being replaced with complex ones. In a complicated system, even though there may be many inputs and outputs, one can predict the outcome by knowing how the system works. For instance, the global air travel system is complicated, and yet its unprecedented safety has been made possible by driving down the margin of error and correcting known defects. In a complex system, on the other hand, different parts can interact in ways that make predicting, and therefore controlling, the outcome nearly impossible. For instance, the interconnectedness of the global financial system means that events occurring in one part of the system have unexpected interactions with others, leading to unpredictable outcomes. As Janet L. Yellen, now chair of the U.S. Federal Reserve System, said in 2013, “Complex links among financial market participants and institutions are a hallmark of the modern global financial system. Across geographic and market boundaries, agents within the financial system engage in a diverse array of transactions and relationships that connect them to other participants.” Such interconnectedness was blamed for both the severity of the 2008 financial crisis and the difficulties encountered in resolving it.

Connecting parts of a system that used to be sealed off from one another can create enormous benefits. For instance, companies installing enterprise resource management (ERM) systems benefit from having different operations across silos able to share information. Companies using various electronic payment systems benefit from decreased costs of doing business. In a complex system, however, benefits for one set of players can create losses for others.

Consider, for instance, what shipping was like before the 1950s-era invention of the shipping container. It required tens of thousands of dockworkers to load and unload ships. Not only was this a time-consuming process, but it also left cargo vulnerable to theft, as it was very difficult to track the contents of an individual load. The introduction of a container that could be sealed at the factory, shipped, and then transported inland by train or truck transformed global trade. The Economist in 2013 reported that “new research suggests that the container has been more of a driver of globalization than all trade agreements in the past 50 years taken together.” According to The Economist, one study of industrialized countries found that containerization was associated with “a 320% rise in bilateral trade over the first five years after adoption and 790% over 20 years. By comparison, a bilateral free-trade agreement raises trade by 45% over 20 years and GATT [General Agreement on Tariffs and Trade] membership adds 285%.”

The dramatic fall in the cost of shipping fundamentally altered the assumptions management had accepted as given until that time. Once it became possible to ship even low-value goods and make a profit, the rules of competition changed. Rather than being a relatively fixed commodity located in one physical place — the docks — labor could now be sourced from anywhere containers could be packed. And rather than employer and worker being tied to each other in one relatively enduring relationship, an army of outsourced and freelance workers came into play and redefined the dynamics between management and labor. The advent of shipping containers created global competition for jobs and transformed entire supply chains. As former Intel chairman and CEO Andy Grove lamented in 2010, the unintended consequences of all this were to undermine job creation in the United States, even as employment growth among U.S. trade partners in Asia skyrocketed.

The markets vs. hierarchies concept, originally pioneered by the economist Oliver E. Williamson, suggested the conditions under which one could operate purely by contracting on an open market as opposed to requiring some kind of organization (a hierarchy) to accomplish one’s goals. Hierarchies are favored, in his formulation, when uncertainty is high, various parties face a risk of opportunism in market exchanges, and information about what is being exchanged is asymmetrically distributed.

As with containerization 60 years ago, new ways of sharing information today and, most likely, robotics and data analytics in the near future have the effect of continuing to push transactions that were once executed within an organization’s boundaries out into open markets. Consider how clearly the Ubers and Airbnbs of the world today demonstrate that one does not need to own assets in order to use them. And this phenomenon goes well beyond those popular examples, as the rise of Amazon Web Services and the proliferation of software-as-a-service offers demonstrates. The advent of blockchain technology further promises to distribute tasks that used to be centralized within organizations into markets — by offering an alternative to the centralized validation banks provide, for example.

How does management attention need to shift as the world moves more toward market forms of organizing? Clearly, we are moving from a business world dominated by hierarchies, in which assets are controlled by a company, to a world of markets, in which assets can be accessed when needed. The conventional relationship between buyers and suppliers then shifts to more complex configurations in multisided markets and ecosystems. Networks become a primary vehicle for exchanging information of all kinds. Increasingly porous organizational boundaries mean that information is less likely to be hoarded. And increasingly, customers are looking to organizations for complete experiences rather than product and service features.

Managing in such a complex environment requires not only traditional management skills such as planning and controlling, but also new ones, such as negotiating complex agreements, quickly detecting the unexpected, accelerating organizational learning, and fostering the creation of trusting relationships among groups and teams who may be only temporarily associated with one another. And this all takes place at an accelerated pace of change for which many will be unprepared. The lines between a defined managerial role in a traditional company and an entrepreneurial role in these newly emerging market contexts are definitely blurring.

Practically, what does this mean for managers looking for a new way of operating? First, the assumption that change is the unusual thing and stability is the normal thing is worth challenging. Today, leaders need to identify, as early as possible, the patterns that deserve their attention and make constant course-correcting adjustments. Instead of being precise but slow and reinforcing existing perspectives, leaders need to be comfortable with making roughly right and fast decisions and with challenging the status quo. Instead of just using traditional management tools such as net present value, managers need to be more discovery-driven and options-oriented. And they need to remember that one of the most valuable gifts colleagues can give one another in a complex environment is candor about what is really going on out there.

This article was originally published on June 29, 2016. It has been updated to reflect edits made for its inclusion in our Fall 2016 print edition.