Disruption

Digitalization poses a much more fundamental challenge to the traditional network industries than what we have described so far, as it challenges the role of the established firms as coordinators of the complementary elements that make up each industry.21 New digital players, most of which are based in Silicon Valley, are disrupting one industry after another. It has often been noted that these digital players disintermediate the disrupted industries. Network industries are no exception.

Let us remember that, in addition to managing infrastructures and services, network industry firms fulfill a third, most important, function, serving as the coordinators of the complex infrastructure system only thanks to which infrastructure services can be provided. As we have shown above, digitalization actually provides coordinators with new tools to better manage and coordinate all these infrastructure assets more efficiently.

Digitalization is more transformative than that, however, as it also reduces transaction costs. The internet reduces coordination costs. Algorithms reduce search, information, and bargaining costs. In Coase’s terms, digitalization reduces transaction costs, which means that coordination in the market can become more efficient than coordination by the entrepreneur inside the firm. This is only part of the story: digitalization also enables a new type of coordination beyond the traditional coordination through the market,22 namely coordination by algorithms.

Digitalization is also creating a new type of industrial players, now at the data layer. These players use digital technologies, particularly algorithms, to mediate between the different parties. Mediation can take place between businesses (B2B), between businesses and consumers (B2C), between consumers (C2C), or even between businesses or customers and third parties, such as governments, advertisers or others (B/C2X). In this sense, these new industrial players are intermediaries. The traditional direct link between supply and demand is being substituted by a new, digitally intermediated relationship.

This new form of industrial organization is spreading. It typically involves two or more distinct types of users interacting through a third party, called the platform. Network effects are key here. The more parties there are involved in the interactions, the higher the value for each of the parties. Platforms are central to this new model of industrial organization. First, they reduce transaction costs. They make use of the internet to reduce communication costs to almost zero, use algorithms to match supply and demand, and provide information about the counterparties. Second, platforms invest in growing the ecosystem around them to make the network effects possible. Third, they coordinate the “market place” - or, rather, the transaction space - by setting the standards, the rules and the distribution (or not) of the benefits created by the network effects to the different parties involved.

Scale can now be built by coordinating the assets that are managed and owned by third parties. An alternative is emerging to the large-scale firms that have coordinated industries for more than a century: platforms can put together more assets than individual firms and can coordinate them more efficiently.

As infrastructures are digitalized, and as a digital twin or mirror is created at the data layer, new players have the ability to take a leadership role in the management of such data and extend their leadership role to the management of the underlying systems, transforming the use of the infrastructure and substituting traditional infrastructure managers as coordinators of the systems. Traditional players will keep operating the infrastructure and manage the provision of the traditional services over the infrastructure. However, the new digital players take over the interface with the customers as they have the ambition to lead the third role of current network industry firms as system coordinators and to intermediate the network industries.

Economists have used the term multi-sided markets to describe this form of industrial organization. Even though there were precedents before the internet went mainstream, multi-sided markets have proliferated as digitalization has reduced transaction costs. With the popularization of the internet and big data, these new intermediaries, often based in Silicon Valley, have disrupted one industry after another.

 
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