To apply digitisation, Externalisation is something managers need to know of

Externalisation is the reason tech giants like Google and Facebook employ only a fraction of workers per dollar of revenue or market capitalisation, compared with traditional industrial firms like General Motors and Boeing.  It is also the reason crowdsourcing works.

It ups productivity, lowers costs, improves product designs, and keeps businesses up-to-date.  Used by tech startups today, this practice will meander into wider use as the economy digitises.

‘Early on the company hired a lot of editors to write book and music reviews - and then ­decided to use customers’ critiques instead. ‘ - Jeff Bezos's Top 10 Leadership Lessons, Forbes, 4 Apr 2012

‘On his new blogging site, Medium, although he did not say so, Mr. Williams is putting good tools out into the world and letting the users decide what the product is. That strategy worked out O.K. for Twitter.’ May 2014

Externalisation involves and uses an external element in order to achieve an organisation goal; task or business function.  Not to be confused with the use of contractors, it is best understood by comparing it to internalisation which is how most organisations operate today. 

Internalisation is a way of working, externalisation will complement it

As a manager, when tasked, the first thing that comes to mind is who in the team is the most suitable to handle it.  Tasks are carried out internally.  That’s internalisation and it’s something that comes naturally to us, and has for centuries. 

There is a reason for this.  As dissected by Ronald Coase in his seminal theory of firms (The nature of firms, 1937), it is really about transaction costs – it cost less to trust internal staff and processes compared to the external even if the latter’s capabilities (and unit cost) are better.

That was pre-internet, before widespread societal connectivity. 

From fringe to mainstream in a digital age

Today, the cost structure has changed and trust can be engendered without (rating systems is one way) at little cost.  Externalisation if used correctly can improve organisation effectiveness.

’What has provided a lifeline to Alibaba is the user-generated rating systems for the thousands of online small merchants that Alibaba would otherwise have no way to police.’

– China Daily Asia Weekly, 12 Aug 2016.

If Alibaba customers did not provide an alternative, it would have to build a huge internal team to carry out on-site reviews the traditional way and even then it may not be effective because of China’s vastness. 

Study tech startups up close and you will see sizeable aspects of externalisation in their operations, and the reason for their relatively small workforce.

“In 1990 the top three carmakers in Detroit had a market capitalisation of $35 billion and 1.2m employees. In 2004 the top three firms in Silicon Valley, with a market capitalisation of over $1 trillion, had only 137,000 employees.” – Economist, 17 Sept 2016. 

[If you protest that Ford has factories, Google also runs them – see ‘Value creation in the digital economy’.

Suggestion boxes transmuted

The suggestion box in banks has been around for a long time.  Though one can say it is an instance of externalisation since it engages outsiders - the customers, it is at the fringe.

Externalisation today is strategically used to achieve specific corporate functions.  AirBnB depends on ratings and comments in its business model, it is more than a suggestion box.  Alibaba turned it into an effective business mechanism. 

Firms already use contractors, an early form of externalisation, but they function primarily within itself.  Day-to-day work is done internally; product development, sales, design, marketing and so on.  And sometimes it’s augmented by partners such as ad agencies or IT outsourcing.  They are paid.  They play a supporting role.

With externalisation, this extends the eco-system to include customers (think Alibaba), the public (think Wikipedia) and in a different but strategic manner – freelancers (Uber).   Tasks are in fact augmented by external manpower but not in the conventional way.  

Participants are not usually paid and even if they are, like Uber, it is the clients who pay.

It is usually not contractual, at least not in the traditional watertight sense but mostly there is no contract at all.  Crowdsourcing is used.

In general the external elements are engaged indirectly.  And unlike outsourcing, they can play more than a supporting role.  Sometimes it’s not to augment an internal team but to replace most of it. 

Tapping the public to develop services

“Transport for London (TfL), an organization responsible for all public transit in London, wanted to provide its customers with a mobile app to help navigate public transportation options. Instead of spending public funds to develop its own app, TfL invested in a framework that allowed third-party developers to access TfL’s transportation data and use it to create innovative travel apps, maps, and services on their own. Since the program launched in 2009, more than 8,000 developers have signed up for it. One local startup, Citymapper, used TfL’s data to create an urban navigation app that has become the go-to resource for Londoners—and the company has expanded to cover more than 30 cities. Overall, every £1 invested by TfL in its open data framework has yielded £58 in benefits for Londoners. By embracing open data, TfL created much greater value for its customers, and did so much more quickly than it could have on its own, while also creating extraordinary opportunities for startups like Citymapper.” – “Acting on the Digital Imperative”

This is an example of an Open Data initiative, where outsiders are given access to internal data to encourage the development of useful services around it.

Two things from the above example; value is exchanged (see free now has value) for the participants - it has to for externalisation to work and secondly externalisation is used to achieve a goal.

Externalisation is not limited to tasks

Consider another example.

‘Once sacrosanct and only available in-house, Goldman Sachs is gradually transitioning to a more open-source model for technology, giving its clients more direct access to its in-house analytic tools and data platforms’, according to the Wall Street Journal. 

This is really for business development, to deepen ties to its (external) clients.  It’s like thinking ‘what if we open up, giving clients (externalising) access to the internal tools, what can that act of indirectly engaging clients do for the business?’. 

Fluevog might have thought the same.

“John Fluevog, a designer of high-end shoes created open source footwear by allowing customers to submit designs. They get to put their names on the shoes.  The best ones get put into production.”

Here the consumers are engaged to co-design shoes.  Through this, Fluevog gets new ideas (innovation), knows what customer wants (instead of best guess), reduces his number of designers (costs) and get plugged in to the latest trends with some sales to boot.  Trends can be tracked in situ and since keeping up-to-date is a perennial issue with established firms, this alone is quite a benefit.

Externalising goals, externalising organisation functions

This example shows one of the more impactful ways to use externalisation.

Externalising design and tapping ideas

‘BMW hosted a ‘virtual innovation agency’ on its website where small and medium sized businesses can submit ideas in hopes of establishing an ongoing relationship.’

It is the SMEs that create the ideas, BMW merely ask for them.  For this to work though, it helps that your organisation is well known.

The next is an example to externalise marketing and business development.

Global branding and expansion at a low cost

In 2009, as it was becoming well known, TED decided that instead of managing its brand more tightly as conventional wisdom instructs, it would create a free license for others to host local conferences, called TEDx.  Now six or seven TEDx events are held every day.  These events seem to add to the lustre of the main conferences, rather than dilute them.  The talks are also posted online free, with little advertising.  By not milking things, TED has inspired people to contribute to it for nothing: 8,000 volunteers have translated subtitles for thousands of videos into more than 90 languages.  And by getting consumers to do things for nothing, TED has managed to innovate with fewer resources.  All of this requires establishing a community of users and accepting some loss of control.  Such tactics might not work for say Coka Cola or Intel.  Yet they may work with others.  A kitchenware-maker might want to create a place on its website for amateur chefs to show off their skills and recipes, for ex., or a sporting-goods firm could encourage local tournaments with its brand.  While there are critics, it shows what is sometimes possible by taking what is valuable and giving it away.” – 3 Nov 2012 Economist.

This example shows one way branding can be carried out for an information-based business.  Note that TED does not have the resources to develop its market overseas and that quickly. 

The final example helps with the difficult task of R&D.

Externalising R&D

“NanoDoc (Bristol Robotics Lab) works like an online game. It allows bioengineers and anyone else who would like to have a go, a chance to model nanoparticles. As in most computer games, players need to earn their spots and work through the first levels to become a master or in this case a certified NanoDoc. Their reward is a real challenge; for example designing a nanoparticle that can detect a rare event such as a sudden cancerous mutation.  The best solutions are tested in the lab. And if successful, will be tried in animals and ultimately in human trials.  Since its launch in Dept 2013, NanoDoc users have performed over 80,000 simulations. – Economist Dec 2014.

In this post, through examples, I have shown the rise in the use of externalisation, a method important in a digital economy, first from internet startups and then some traditional firms.  In the next post, I’ll touch on ‘How’.