Hal Varian (Google Chief Economist) – Combinatorial Innovation (2009)
Chapters
00:00:10 Combinatorial Innovation and Computer Mediated Transactions
Ways of Innovation and Combinatorial Innovation: The recent surge in innovation is attributed to combinatorial innovation. Combinatorial innovation involves combining existing component parts to create new inventions. Examples of combinatorial innovations include the sewing machine, automobile, and airplane.
Computer Mediated Transactions: The internet provides a set of component technologies that enable computer-mediated transactions. Computer-mediated transactions involve the exchange of information and value through digital networks. The internet has facilitated the growth of e-commerce, online auctions, and digital marketplaces.
Implications for Commerce: The shift towards computer-mediated transactions has significant implications for commerce. Businesses can reach a global audience and reduce transaction costs through online platforms. Consumers have access to a wider range of products and services and can compare prices and reviews easily. The digital economy offers opportunities for new business models and disruptive innovations.
Collaborative Computing: The internet has enabled collaborative computing, where multiple users can interact and share information in real-time. Collaborative computing has led to the rise of social media, wikis, and other collaborative platforms. Collaborative computing fosters innovation and knowledge sharing, enabling individuals and organizations to work together on complex projects.
00:08:23 Computer-Mediated Transactions: Implications for Economic Activity
A Historical Perspective: Computers are present in almost every economic transaction, from simple cash registers to complex web-based transactions. The original purpose of computers in transactions was to perform accounting and keep track of transactions.
New Opportunities with Computer-Mediated Transactions:
The presence of computer-mediated transactions brings forth five key opportunities: 1. Enforce new contracts: Better technology enables the creation of more elaborate and efficient contracts. 2. Align incentives: Computers can align incentives by verifying contractual performance, leading to improved economic efficiency. 3. Make data available for extraction and analysis: The data generated from computer-mediated transactions offers valuable insights and opportunities for data analysis. 4. Enable controlled experimentation: Computer-mediated transactions facilitate controlled experimentation, allowing businesses to test and optimize various strategies. 5. Enable personalization and customization: Computers can personalize and customize transactions based on individual preferences and data.
Example: Francesco Di Marco Datini and the Letter of Credit: Francesco Di Marco Datini, also known as the Merchant of Prato, invented the letter of credit. With the help of computers, transactions can be recorded and contractual performance can be verified, leading to more elaborate and efficient contracts.
Bullae: Clay tokens shaped like shipped items used in illiterate societies. One token per item, moved from one side of a desk to the other. Sealed in clay envelopes, stamped, and handed to the captain. At the destination port, tokens checked against items received.
Incorruptible Cashier: A cash register patented in 1883 with two key innovations. A bell rang when the cash drawer opened, alerting the owner. A paper tape recorded each transaction for reconciliation. Allowed businesses to expand by monitoring untrusted employees.
Vehicular Monitoring Systems: Computers in trucks improved efficiency and reduced fraud. Enabled route optimization and improved mileage. Eliminated fraud by monitoring fuel consumption.
Video Store Rentals: Old model: stores bought videos, rented them out, high prices, low availability. New model: revenue sharing, distributor gave videos to stores. Distributor got a cut from each rental, stores had more stock, customers always found videos. Barcode scanners and network computers enabled transaction counting.
Rental Car Insurance: Potential for lower insurance costs with more responsible driving. Vehicular monitoring systems now allow for speed observation. Drivers can get lower prices by driving more slowly or responsibly.
Conclusion: Efficient contracts rely on monitoring. Improved monitoring technologies have revolutionized industries. The more things that can be monitored, the more efficient contracts can be.
00:20:45 Reconciling Advertiser and Publisher Incentives in Online Advertising
Incentive Alignment: Advertisers want clicks and sales, not just impressions. Publishers want to sell ad space to the highest bidder in terms of impression value. Google’s challenge was to reconcile these different incentives.
Estimating Clicks: To reconcile incentives, Google estimates how many clicks an ad will get. This is a statistical machine learning problem that Google invests significant resources in. The click-through rate is used to rank ads and ensure publishers get the highest value ads.
Revenue Sharing: When an ad is clicked, Google and the publisher share the revenue. This revenue sharing model is similar to the one used in the video example.
Accountability in Advertising: Linking purchases to clicks or impressions makes advertising more accountable. Advertisers and publishers can run experiments to see what works best. This is possible with search advertising, display advertising, mobile, TV, print, and other forms of advertising.
00:24:15 Data-Driven Marketing and Optimization in the Digital Age
Key Points: Accountability in Advertising: J.P. Wanamaker’s quote highlights the need for measuring advertising effectiveness. Data-driven advertising allows businesses to optimize ad spending, identify high-performing creatives, and improve the purchase process. Examples include Google’s keyword bidding, where “diamonds” has a higher price than “diamond,” and Jeff Bezos’s focus on streamlining the Amazon purchase process. Assembly Line for Marketing: Data allows for the creation of an assembly line for marketing, fine-tuning each step to improve efficiency. The Venetian assembly line for shipbuilding, as mentioned by Dante, allowed them to quickly create fleets without maintaining a standing navy. Data Extraction and Analysis: Computer-mediated transactions enable more efficient contracts and line incentives. Data analysis reveals patterns, such as click variations over time of day, allowing businesses to align ad campaigns with user behavior. Predictive and causal models can be built to optimize performance. Controlled Experimentation: Google’s success stems from continuous experimentation and improvement. Controlled experimentation determines causality, as seen in the example of Ian Ayers’s AdWords account experiment to find the best book title. This approach helps avoid relying solely on “highly paid person’s opinion” (hippo) and enables data-driven decision-making. Customization and Personalization: Computer-mediated transactions allow for personalization, improving user experience and matching products to individual interests. The challenge lies in balancing the benefits of customization with potential negative consequences.
00:32:25 Rearranging Knowledge Work for Increased Flow and Efficiency
David’s Story of the Computer and the Dynamo: The shift from water wheels to steam power to electricity led to the miniaturization of electric motors, allowing for their attachment to individual machines. However, the traditional clustering of machines based on type persisted until the advent of the assembly line.
Henry Ford and the Assembly Line: Henry Ford’s assembly line revolutionized production by rearranging the flow of work based on efficiency rather than tradition.
Rearranging Knowledge Work in the Digital Age: Just as Ford optimized the flow of mechanical parts, we can now optimize the flow of knowledge and ideas through organizations.
Separation, Distribution, and Optimization of Tasks: We can optimize knowledge work by separating, distributing, and optimizing tasks.
Document Collaboration in the Digital Age: The current process of multi-author document creation, with multiple versions and extensive tracking, resembles pre-assembly line practices. We should strive for a single, cloud-based document that allows multiple contributors to modify and develop it simultaneously.
00:36:03 Technological Innovations and the Future of Knowledge Work
Benefits of Using Google’s Internal Products: Complete version control and clear identification of changes. Efficient workflow, leading to better optimization of tasks. Google’s dog food initiative demonstrates the value of using products internally.
Analogous Innovations to the Assembly Line: Technological advancements similar to those during the assembly line era will reshape knowledge work in the coming decade. Version tracking, experimentation, and fine-tuning are now possible in distributed environments.
Outsourcing Details for Efficiency: McKinsey’s example of outsourcing PowerPoint optimization to India highlights the potential for maximizing efficiency. This approach allows for the creation of micro-multinationals, where small businesses can operate globally.
Cloud Computing and Collaboration: Cloud computing facilitates collaboration by providing a master copy accessible from anywhere. This enables teamwork and simplifies the creation, maintenance, and access of multi-authored documents.
Lower Barriers to Entry for Online Businesses: Cloud computing reduces the scale barrier for online businesses. Businesses can purchase infrastructure, storage, and development environments on demand from providers like Google, Amazon, and IBM. This promotes combinatorial innovation by providing access to bits and processing power.
Rise of Micro-Multinationals: Micro-multinationals, with team members distributed globally, are emerging thanks to easy access to communication and collaboration technologies. Communication and computer mediation have become incredibly affordable, making multinational operations feasible for small businesses. Businesses can be born international and engage in parallel innovation in technology and commerce.
Conclusion: The technology-driven transformation of knowledge work is still in its early stages. A significant increase in productivity is expected, similar to that brought about by the assembly line. This transformation will enable knowledge work to be conducted much more efficiently.
Abstract
Combinatorial Innovation and Computer-Mediated Transactions: Transforming Commerce and Collaboration
Abstract:
The modern era of commerce and work is defined by two key concepts: combinatorial innovation and computer-mediated transactions. These ideas, as expounded by Hal Varian, demonstrate how the recombination of existing technologies and the facilitation of transactions through computers have revolutionized industries. From the evolution of commerce to the transformation of advertising and work processes, these concepts have reshaped our world. This article delves into these paradigms, exploring their historical roots, current applications, and future implications.
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Introduction
Combinatorial innovation, a concept highlighted by Hal Varian, describes the process of creating new inventions by reassembling existing components. This approach has led to significant breakthroughs, such as interchangeable parts in the 1800s, integrated circuits in the 1960s, and the advent of the internet in 1995. Similarly, computer-mediated transactions, which involve using computers to facilitate transactions between parties, have gained prominence with the rise of the internet, enabling phenomena like e-commerce, online banking, and social media.
These concepts have profound implications for commerce, allowing businesses to reach a global audience and providing consumers with more choices, resulting in increased competition and lower prices. Moreover, collaborative computing, an extension of computer-mediated transactions, is revolutionizing work and collaboration methods.
Historical Perspective and Evolution
The integration of computers into economic transactions marks a significant evolution in commerce, enhancing contract enforcement, aligning incentives, and facilitating data extraction and analysis. This evolution traces back to ancient practices like the use of clay tokens for tracking goods and extends to modern advancements like vehicular monitoring systems and barcode scanners, illustrating a steady progression in transaction management and efficiency.
The concept of combinatorial innovation has its roots in various historical innovations, such as the Venetian assembly line for shipbuilding and the development of interchangeable parts. These innovations laid the groundwork for contemporary practices where existing technologies are combined to create new solutions, enhancing efficiency and sparking further innovation.
The presence of computer-mediated transactions brings forth significant opportunities. It allows for the enforcement of new and more efficient contracts, aligns incentives through contractual performance verification, and enables the extraction and analysis of valuable data. Additionally, it facilitates controlled experimentation, allowing businesses to test and optimize strategies, and provides personalization and customization based on individual preferences and data.
Current Applications and Implications
The integration of computer-mediated transactions in advertising, particularly Google’s approach, exemplifies the power of data-driven marketing. By using statistical machine learning to estimate click-through rates, a more accountable and efficient advertising system has been established, benefiting both advertisers and consumers.
The principles of combinatorial innovation are evident in the evolution of production efficiency, from the use of water wheels to modern assembly lines, notably Henry Ford’s rearrangement of production workflows. In knowledge work, the flow of ideas can be optimized through technology, mirroring the efficiency gains seen in physical production.
Technologies like cloud computing have democratized access to infrastructure, reducing barriers to entry for businesses and enabling the rise of micro-multinationals. Collaborative technologies facilitate outsourcing and efficient workflow management, as evidenced by Google’s internal product testing and development processes.
In online advertising, advertisers prioritize clicks and sales, while publishers seek to sell ad space to the highest bidder. Google reconciles these incentives by using statistical machine learning to rank ads, ensuring publishers receive high-value ads. This revenue-sharing model encourages alignment between advertisers and publishers.
The digital transformation with data involves data-driven advertising, which enables businesses to measure ad effectiveness and improve campaigns. An assembly line for marketing can be created using data to fine-tune each step. Controlled experimentation helps businesses optimize strategies based on data-driven insights, and customization and personalization improve user experience and product matching.
The optimization of knowledge work through computer-mediated transactions includes the shift from water wheels to electricity, leading to the miniaturization of electric motors. Henry Ford’s assembly line revolutionized production by rearranging work based on efficiency. Similarly, knowledge work can be optimized by separating, distributing, and optimizing tasks. Document collaboration in the digital age can be enhanced with a single, cloud-based document for simultaneous modifications.
The future of knowledge work and micro-multinationals is facilitated by cloud computing, which enables teamwork and simplifies the creation, maintenance, and access of multi-authored documents. Cloud computing reduces the scale barrier for online businesses, allowing them to purchase infrastructure, storage, and development environments on demand. This promotes combinatorial innovation and the rise of micro-multinationals, with team members distributed globally, making multinational operations feasible for small businesses.
Future Outlook and Conclusion
The early stages of these technological advancements suggest a significant boost in productivity and innovation, akin to the impact of the assembly line on manufacturing. As knowledge work becomes increasingly efficient through these technologies, a new burst of productivity and global collaboration is anticipated.
In conclusion, combinatorial innovation and computer-mediated transactions are not just historical phenomena but are actively shaping the present and future of commerce and work. Their continued evolution promises to bring further advancements, transforming how we conduct business and collaborate on a global scale. The recombination of existing technologies and the facilitation of transactions through computers have already shown their potential to revolutionize various industries, from commerce to advertising and work processes. As these concepts continue to evolve, they are expected to drive even more significant changes, ushering in new levels of efficiency, innovation, and global interconnectedness in the way we work and do business.
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