Shifting Economics | Technology's Impact on Capitalism

Entropy is the second law of thermodynamics. In essence, entropy deals with heat consolidations within systems. Putting it simply (overly simply), heat in a particular system spreads out, or becomes more entropic. For example—if I have a heater in the center of a large room, and supposing there are not physical convection systems (wind, fans, etc)—the heat from that heater will spread out throughout the room. If I turned off the heater, and if the room was perfectly insulated—without entropy, the heat would just be consolidated to where the heater was. However, given that entropic systems are a physical law of our known universe—that heat over time would spread evenly throughout the room, which would create equilibrium. So if the room was 70 degrees, and I had the heater turned up to 90 degrees for a few minutes—as the room found equilibrium, it would be a bit warmer than 70 degrees. Without Entropy, there would be a 90 degree area in the room and the rest of the room would be 70 degrees.

You’re now probably wondering, “what does this have to do with capitalism?” Despite historical models—I believe we will be underway with an entropic capitalistic event—driven by technological advancement in AI, meta data computing, and natural language processing (resulting from the Trident Shift see diagram on page 6). What do I mean by ‘entropic capitalism?’ Aside from being esoteric and obscure, but what does it mean? Capitalism generally acts against entropy. If entropy is the distribution of energy (power), then capitalism’s miserly ways certainly is the antithesis, since capitalistic systems generally consolidate. The reason for this—again, a massive over-simplification of a very complex, nuanced, and intensively researched subject—is that capitalism is defined by ownership. Those that own goods can sell them, lease them, or create some other business models to create wealth from those goods. Essentially, to be the significant earner in a capitalistic system—one has to own the goods of service. There are certainly economies for those who don’t own—but generally speaking, those economies create capital for those who do own by laboring for those who own. Entropic Capitalism is a system in which ownership begins to decentralize. As ownership systems decentralize and become more distributed—so too will wealth, this paper will examine this concept.

Let’s look at and compare services or systems that compete with one another—where one is a centralized system and the other is a distributed one: Conventional hotel chains vs. Airbnb. Marriott International is a 90 year old company which generates nearly $14.5b in revenue per year. They currently employ nearly 200,000 employees across the globe, and own multiple subsidiaries, including Marriott, Strawood, and Ritz-Carlton—and they operate over 30 brands within those subsidiaries. Across those subsidiaries and different brands—Marriott International owns more than 5,700 properties in over 110 countries. Within those 5,700 properties is over 1.2 million rooms. As you can see, Marriott is an old, successful, and massive enterprise. Wealth from over 30 brands and multiple subsidiaries is all centralized to this massive operating company. Let’s then compare this to airbnb. As of the time of this writing (2017) Airbnb is 8 years old—having been founded in 2008. It has 3,100 employees, and operates across 191 countries. Airbnb does not own any of their leasing properties—that ownership is distributed—airbnb is simply a platform to list and consume lodging services. As of now, Airbnb is a private company, so data isn’t as accessible as it is for a public company like Marriott International—but reports have it shown that Airbnb will generate nearly $3B in revenues for 2017. They generate that revenue based off of commission charges for the nearly 3 million listings on their platform, which has access to a user base of 150M. It’s probably reasonable to assume that those 3 million listings each has on average 3 rooms—so we’re looking at roughly 9 million rooms on this platform! See the below chart for an easy comparative analysis:

From these numbers—you can see the value of Airbnb. Airbnb is going to be substantially more profitable than Marriott because of the distributed ownership economy. Marriott has to employ over 200,000 employees to operate, manage, and upkeep their properties. In addition to that, Marriott has to handle the operational expenses of maintaining the 5,700 property infrastructure it has built—which is no small cost. Airbnb on the other hand, only needs to spend money on attracting users (marketing); and maintaining a safe, and efficient website for consumers to transact on—of which are both expenses Marriott also needs to invest significant sums in. This is why the RPE (revenue per employee, which is a very important measurement as we view the efficacy of an entropic capitalism system) of Airbnb blows Marriott’s out of the water by over 13x—they don’t need to spend nearly as much money maintaining their ownership infrastructure—instead, they rely on that of their landlord ownership network. For perspective, as it stands today, Airbnb is the 3rd most valuable private company in the world—following Uber (same exact distributed economy model) and Xiaomi.

How is it that an 8 year old company has significantly greater market reach and nearly 8x the number of rooms to rent as that of a massively successful, 90 year old hospitality conglomerate? It’s simple—it created a business model in which it leveraged existing infrastructures and services. Airbnb created a mechanism for everyday home owners to distribute their property. Those who own a property now have the ability to effectively market to a 150,000,000 person network (and more joining daily). Historically, there have always been bed and breakfasts—but they relied on newspaper ads, or word of mouth. Then came the internet and sites like Craigslist—where people could post on some form of marketplace. This wasn’t a secure and safe marketplace, which lead sometimes to dubious results—which scared a lot of people away from leveraging that marketplace due to them being wary and suspicious of word of mouth bad experiences they’ve heard by others. By creating a specific marketplace that could leverage secure billing and escrow like systems, contracts between renter and landlord, and a massively intuitive and easy to use platform that would market specific properties to specific and defined searches—it boomed the hospitality industry. Airbnb is projected to be a $30B annual revenue company, which is a number Marriott will likely not see anytime soon, especially as online, distributed market services continue to snipe their business.

The economics of this, conceptually, are rather simple. Lodging is a service that requires a commodity. That commodity is housing (bed, walls, security, etc). Hotels managed this by building more and more hotels—but they always had to be careful about how large they scaled up, because rooms that weren’t being used still cost them money, and building multi-million dollar hotels created significant business risk if they made the wrong decisions. For Airbnb, they handled the commodity issue by giving people the chance to make extra money by leasing out their properties. There are significantly more houses in the world than hotels, and even more different owners of houses than owners of hotel chains. Since the main restriction for growth for a lodging service is the physical infrastructure or lodging commodity—hotel chains are now at a severe competitive disadvantage. Airbnb can operate with impunity to the commodity related investment risks—buying and selling land isn’t their business—providing folks a platform for renting and leasing lodging is.

Airbnb vs. the traditional hotel chains is a massive disruption to an old and reasonably successful business model. For the intent of this research, however, I’m less interested in the business case study, and more interested in the economic one. Airbnb charges hosts about 3% to utilize their service. Guests also get charged 5%-15% when they book on Airbnb. What this means, is that Airbnb nets around 15% gross profit across the $3B they generated—the remainder of that money was distributed across the home owners. $2.55B was distributed amongst the hundreds of thousands of property owners that listed their homes. Think of that for a moment and let that settle in while we review Marriott’s financials. Marriott made $14.5B, of which they generated $1.99B in gross profit—bringing their net incomes to $859m. That $859m in profit is shared across the largest shareholders of Marriott International. That breakdown is as thus:

As you can see—most wealth is deeply consolidated into large mutual funds or into company ownership (employees or former employees of Marriott). A more detailed breakdown is provided on the next page. The important thing to consider when reviewing the next data set is the amount of wealth owned by a significantly small population of people and institutions. Nearly 40% of the wealth Marriott generates is shared between 17 people and institutions. Admittedly, this is an inaccurate representation—as the large investment firms own multiple funds within Marriott—these were just the biggest ones they had. Again, though, consider the non-entropic state of this money. If wealth or capital was heat—and we turned off the heater in the middle of the room, in this current system, the heat would not distribute evenly throughout the room—instead it would remain very centralized. A very select few people control the profits and wealth of Marriott International.

This is not designed to be a treatise on the morality and ethics of the economics of “haves and have-nots.” While I have my opinions on this particular issue—I won’t distract the reading with it. What this is merely showing is that in Marriott’s particular business model—which is indeed an overwhelmingly popular business model economically (large company owning a majority of commodity or assets needed for their service)—very few people have ownership of the wealth. Comparatively—if we look at Airbnb, it’s reasonable to expect that they’ll eventually turn public—in which case, we’ll see a very similar breakdown of shareholders and investors—that said, ~85% of airbnb’s revenues are captured by the landlords who lease their homes. What does this mean for the individual? It means that because of a technological and business model advancement—I, as a homeowner, can reasonably compete against a multi-national hospitality juggernaut who has dominated the industry for decades. This was simply not the case 8 years ago.

Because of technology—we are seeing more and more companies operate as platforms for both producers and consumers. Alibaba is the world’s largest retailer—yet owns no products of its own. Uber is the world’s largest taxi service, yet it does not own any of its own vehicles (yet that is. AI and self-driving vehicles will change this). Facebook is one of the world’s largest media providers, yet owns no content. Youtube hosts the most video content on the internet—yet doesn’t have a single film studio. This list could go on. The role of the company is changing. The role of the company is now to act as a platform to allow others to make money off of. It’s to give others the means to compete against the consolidated conglomerates—similar to what Airbnb did to the hospitality industry. Because these platforms can cost-effectively leverage large business services (data analytics, payments, logistics, marketing, outbound communications, customer support, etc) for small businesses or individual owners—it effectively allows them to compete big. In essence, a small company has all of the expensive (historically cost prohibitive) systems and tools as those of large companies.

For example—let’s pretend I had a passion for knitting sweaters. My mother and all of her friends tell me people would buy my sweaters for $100 (it’s a really nice sweater I can knit). In a more traditional business model—I would have to sell these sweaters myself at some arts fair or sidewalk sale. If I was really savvy, I could create a website for my sweaters—but that would either cost money or the time I would need to learn web development. However, even if I had a website—how would I get people to view it? How would I market the website? How would I capture the data and analytics from the website to improve it? How would I handle the payments processing? Would I need to buy my own servers? What risks are there with having credit card transactions over those servers? What if there was a breach to that server? How do I handle the logistics of shipping the sweaters? Are there different laws for shipping internationally? How would I handle the international tax and tariffs? The list of what ifs can go on and on and on. This is why retail companies have spent billions of dollars on technology. They do this to gain better insight into their customers, create operational efficiencies, and to meet consumer regulation governance.

The costs of running my own sweater business if I wanted to reach an audience greater than a sidewalk sale would quickly get out of hand. I would need accountants, lawyers, bankers, etc to handle just the administrative and financial side of the house—and for the consumer interaction side of the house, I would need web developers, designers, marketers, etc. These costs would have an impact on my customer pricing—which, guess what—people will pay $100 for my finely knitted sweaters—but after paying for all of the other services, I would likely need to charge a lot more than $100 just to break even and nobody is going to pay $300 for my sweaters.

Now enter into the picture Amazon.com. I can list my sweaters on Amazon.com—and I could even, for a fee, have my sweaters stored in an Amazon logistics warehouse. All I need to do is supply the sweaters and pricing—Amazon then takes care of the rest. I could spend a little money and have Amazon market my sweater as a prime deal—which would increase the number of searches it popped into. In this model—I’m not limited by my business infrastructure—but instead I’m just limited by the quantity of sweaters I could produce. Amazon is able to handle all of the payment logistics securely. They’re able to provide me real time data analytics on webviews and other important ecommerce analytics. They’re able to handle all of the shipping and storage logistics—which has much greater consumer confidence and security than my basement or garage has. Additionally, I’m able to interact with the consumers of my products from the reviews they leave and the information they use to transact.

Because of this web platform and service—my sweater will have the ability to compete with the sweaters Nordstrom’s or Walmart sells. I have reach to a very broad consumer base on a very credible and well-used and respected platform. Also, through all of the services Amazon offers—my one person shop is now legion. I can operate and make decisions from the data provided to me by the analytics and consumer feedback. I can reach a global audience. My sweater can compete against the likes of Polo, Ralph Lauren, Calvin Klein, Burberry, etc. These companies historically had a huge advantage because they had scale and distribution. They had agreements set up with the large retailers, who would pedal their goods. The entry point to pedaling goods is now much easier to get into—which will put more and more pressure on the large conglomerate retail companies.

Sweater analogies aside—why do I think Entropic Capitalism is going to displace a century old system of consolidated wealth and power? I believe technology has the ability to competitively advance or destroy companies and industries. For example, Artificial Intelligence and automation stemming from AI is going to have a massive ability to disrupt and shift hegemonies of power. Over the past few centuries—technology has been consolidated to those wealthy enough to own it or create it. Creating websites used to be very expensive, and only companies with significant resources could create them—now a 4 year old could make one (in fact, over a billion people have in some way created their own personal website with facebook). Historically, payment services were restricted to companies that could build hugely complex billing applications that needed to have inordinate amounts of money invested into securing them from hacking or system failures—today there is paypal or square (or even more down the road exchanges could be done with cryptocurrencies). I could carry on this list—but the trend is simple, technology is becoming more distributed, less restricted to those with massive operations, and cheaper at small scale.

With the advent of Cloud, Microservices, and Devops (effectively ran together, I call this a “Ubiquitous Infrastructure”)—highly nuanced and sophisticated technologies such as AI, metadata computing, and natural language processing become accessible for cheap (which can create “Meta Business Enablement Platforms,” which in essence allows big companies to operate small and small companies to compete big).

We are at an inflection point for future economies. With advanced automation and AI, human based work will decrease. Human capital incomes will necessarily change. With a decrease in a human based workforce—platform and ownership economies will need to emerge and proliferate. Ownership will be less restricted as a result—meaning, there will be more market competition for services and assets. The company of the future is a platform company—much like we just spent the past few pages describing.

Capitalism is driven by the value of ownership. Those that own can yield profits from what they own. Those that don’t own, work for those who do. As was represented with Marriott International, in today’s economy, ownership is centralized to a very small group of wealthy people and organizations. A distributed owner economy is one which the distribution of ownership is extended. Those without mass can now compete against those with mass. In fact, they can more than compete; they can absolutely disrupt and destroy through technology.

The challenges legacy companies will face is that changing and transitioning business models is far more difficult than starting out with the right technologies, infrastructures, and services. This change will be expensive, and it will take time—it will also culturally be resisted by stakeholders, employees, and leaders. A company that has managed shifting business models brilliantly is Netflix.

Netflix came onto the market 20 years ago in 1997. In that relatively short period, Netflix has pivoted and changed its operations and business model significantly 3 to 4 times. It first started off as a company that would mail DVDs to their customers. Meaning, they had to have a very robust supply chain, inventory management system, and billing application. This model put tremendous pressure on Blockbuster—which is a now a story taught in every business school—a lesson on the need for change and disruption.

Netflix’s next major shift was when they moved away from mailing the dvds and changed their business model to streaming movies through different media platforms. Moving to this model essentially turned them into a communications company—which is a significant departure from the logistics company that they were. They were able to make this change because they had a very nimble devops process—which allowed them to quickly and efficiently make the complex changes needed.

Now, in Netflix’s third iteration—they are creating their own original content—so they are now both a communications company and a creative studio. Furthermore, they’ve embraced technology more and more and as a result have very sophisticated algorithms within their platform that leverages predictive analytics around what individual viewers would enjoy.

Think about Netflix. Think about culturally how hard those changes would be? Think about how technically challenging those shifts were? With that said—the shifts were necessary, and as a result Netflix now serves over 100 million subscribers in 190 countries and delivers over $8 billion in annual revenue while holding nearly $14 billion worth of assets. If they were just mailing DVDs—another company would have introduced their streaming services and wiped them off the map (probably Amazon). Change is hard—change is often painful, but to not change and advance only invites others who are more willing and daring to do so themselves.

The goal of this paper was to outline the change in economy which is derived from a change in business model which is enabled by advances in technology. With the technology shifts and advancements that are forthcoming, more interesting and distributed platform based business models will sprout. These models will also continue to mature and evolve. There is the fear that computers will replace a lot of human work—and to be frank, it will. With that said—it will also create significant opportunity for individuals. It will allow smaller and less funded individuals or groups of individuals to compete against the Goliath’s of industry.