De-materialization — The Move to an Asset-Light Life

My new pattern requires renting cars at the airports as needed. I am progressively ceasing to own things, not on a political-schism basis,…but simply on a practical basis. Possession is becoming progressively burdensome and wasteful and therefore obsolete. — R. Buckminster Fuller, Operations Manual to Spaceship Earth

Fuller was a bit ahead of his time, but he was right to observe that the world has a lot of excess capacity: our cars sit unused for most of the day, our houses sit empty while we are away at work or socializing, just to name a few obvious examples. What companies like Lyft and AirBnB do is provide a platform for that spare capacity to be put to work. Technology is adding to and facilitating this process in ways large and small. For example, I loaned someone a book off my Kindle the other day — it was quick and easy, and further simplifying the process, the book will be automatically returned after a set amount of time.

Median income is down 7%, and median net worth is down 28% over the last 10 years (BLS) while costs have risen, but these business models, which offer access to goods and services without the substantial investment required for an outright purchase, have been successful during the downturn. The same thing is going on in the corporate world as US companies have been functioning with less capital and fewer people since 2008. Companies are also utilizing less space per employee as more people work from home. Similarly, there has been a rise of co-working spaces, a form of shared office space, as various companies, often (but not always) aligned around a single field or ideology, pool resources to time-share space rather than outright owning it.

The top three expenses for young people are housing, transportation, and education. The rental markets are strong, and the demand is increasingly concentrated in the form of micro-apartments in major cities. Home ownership has not bounced back from the housing bubble. On the transportation side, the number of people who have driver’s license is steadily decreasing, and the number of miles traveled per year is at a multi-decade low in the US. And with the rise of open online courses and other technologies, the traditional degree is under threat, a trend that will continue with the ongoing increase in the cost of physically attending brick-and-mortar universities. It would cost me twice as much today to get my degree from an in-state school, a cost that I simply could not have borne.

While this phenomenon is driven by the economy, I think that there is a generational effect here as well. When you grow up posting, sharing, and tweeting, you are used to being constantly connected, often to people you don’t actually know. All of a sudden, it doesn’t seem so strange to loan someone your car or rent them a room in your condo. There’s definitely a cultural spillover from growing up connected to sharing physical goods and spaces.

It’s interesting to think about what’s next. What big asset do you own that you don’t have to? Where else is there spare capacity? What is the most valuable thing you own, and would you share it with someone else? It’s fascinating to watch how mobile technology is manifesting change in the physical world, attacking everything from taxi to hotel business models. But that’s not a bad thing for society at large (the individual taxi driver or hotel owner is a different story, of course). At the end of the day, if it leads to more efficiency and less stuff, it will be a huge win.

The Economics of EVs — 12 months with a Tesla Model S

I’m a Tesla evangelist. The car is phenomenal and one of the smartest consumer products I’ve ever owned. It’s sharp, drives well, the software integration is amazing, and it received the highest rating ever from Consumer Reports. I’ve had the car for a little over a year and wanted to take a look at the economics of fueling.

I’ve driven 4,499 miles over the last year. During that period, the car used 1,932 kWh of electricity or 429 Wh/mile. I drive mostly in the city, continuously starting and stopping, so my efficiency is likely lower than the average. I pay $0.05 per kWh of electricity in Chicago (one of the cheapest rates in the country). There is a loss of about 10-20% when you charge (according to Wikipedia, which references studies on lithium-ion lifetime-charge efficiencies). We’ll compare these stats to the Honda Civic, which gets 28 mpg in the city. Gasoline in the Midwest averaged about $3.35 over the past year (according to the EIA).

1,932 kWh/0.85% = 2,273 kWh purchased from the utility (adjusted for charge efficiency)

2,273 kWh x $0.05 = $113.65 in electricity for 4,500 miles

$113.65/4,500 miles = $0.025 per mile in fuel costs

$0.025 per mile * 28 mpg = $0.70 per gasoline gallon equivalent

4,500 miles/28 mpg = 161 gallons of gas x $3.35 = $538.40 in gasoline costs

$538.40 in gasoline vs. $113.65 in electricity or a $424.75 difference (nearly an 80% reduction)

On a percentage basis, it’s clearly a large reduction. But I didn’t buy the car for the fuel savings, and I don’t drive enough miles for the economics to work. I’d have to own the car for a long time to get any real payback on the purchase price. However, this does give us some insight into mass-market adoption from an economic standpoint.

According to the EPA, the average miles driven in the US was 11,493 in 2010.

11,493 miles/28 mpg (Honda Civic) = 410 gallons of gasoline x $3.35 = $1,375 in fuel costs

$1,375 in fuel x 80% reduction = $1,100 in fuel savings per year

The average commuter then would save $1,100 a year in an EV versus a Civic.

Let’s assume that this consumer is going to spend $20,000 on a Honda Civic (which starts at $18,000). The question is how much more would you be willing to spend to save the $1,100 a year?

If you spent $25,000, an increase of $5,000, you’d get a 22.0% return ($1,100/$5,000).

If you spent $30,000, an increase of $10,000, you’d get a 11.0% return ($1,100/$10,000).

If you spent $35,000, an increase of $15,000, you’d get a 7.3% return ($1,100/$15,000).

This all sounds about right and squares with the pricing of the Prius. People are willing to pay more, maybe $5,000 to $12,000 more, for the Prius because it’s more efficient, cleaner, and has a certain status. A mass-market EV would have to be near that price point. And even at a $35,000 price point, it still would offer a 7% return in fuel costs to the average consumer versus a leading car like the Honda Civic. Certainly it gets better if you travel more miles. If you are going 15,000 or 20,000 miles per year, then the fuel savings quickly add up. It seems very rational to me then that if EV costs can get close to $30,000 to $35,000, you should see widespread adoption on economics alone.

The car would have to have adequate range, but the required range is reasonable. Let’s assume that the 11,493 miles (the number of miles the average person drives per year in the US) are all driven on weekdays. 11,493/260 weekdays = 44 miles a day. Lets double to 88 miles just to be safe. Therefore, let’s round up and say that you’d want 100 miles of range for a commuter car.

The whole analysis is sensitive to a number of inputs. For example, where you live will determine your fuel and electricity costs, but these tend to be linked. California has higher electricity costs but also higher gasoline costs.

The biggest risk to EV adoption maybe improved fuel efficiency standards. These new standards are going to have a big effect on fuel efficiency in vehicles in the coming years and reduce the demand for gas. That along with cheap and seemingly now abundant oil in the US means gasoline prices are likely going to go down. All that being said, it feels like we could get there this time.

The Nature of the Firm — Why Start a Company?

He who gets commoditized last, wins. —Andy Grove

Background

In 1937, Ronald Coase, an economist, asked the question, why do firms (companies) exist? His answer appears to be a simple observation but one that has completely changed the way I think about markets and companies. This was something Coase made a habit of — simple observations with profound impacts — and which won him a Noble Prize in 1991. He lived an incredibly productive and long life, writing a book on China’s economy at the age of 100.

Why Start a Company?

I’ve started a number of companies but never really asked the question, why? And which companies? I think my answer — and the answer most entrepreneurs would give — is that I saw a problem and wanted to fix it. I believe most entrepreneurs would explain that there was no solution to a particular problem or that they thought they could do it better themselves. (The other reason I’d say is freedom — I wanted to control my time.)

[T]he operation of a market costs something and by forming an organization and allowing some authority (an “entrepreneur”) to direct the resources, certain marketing costs are saved. The entrepreneur has to carry out his function at less cost, taking into account the fact that he may get factors of production at a lower price than the market transactions which he supersedes, because it is always possible to revert to the open market if he fails to do this.

What Coase proposed was that firms were created when the internal transaction costs (decisions orchestrated by the entrepreneur) were less than the external transaction costs (decisions set by a price mechanism in a market) — i.e., “I’ll just do it myself.”

A firm, therefore, consists of the system of relationships which comes into existence when the direction of resources is dependent on an entrepreneur.

This was actually very counter to the traditional theory at the time. Adam Smith had shown that markets were efficient (the invisible hand and all): the market works so that the entity that can best provide a good or service mostly cheaply would do so. Thus it would always be better to contract the best than to hire someone who was suboptimal. So while we hear about the efficiency of markets all the time, what Coase proposed is that there is a real cost to operate and participate in a market and that firms are created to avoid this cost. Markets do have a cost and a value; you can simply look at the market capitalization of the Chicago Mercantile Exchange, one of the largest marketplaces in the world, to see this: it has a market capitalization of $27 billion and nearly $3 billion in revenue. These are market costs.

Examples/Firm Size (Internal vs. External)

Every day, general contractors pick up day laborers or subcontractors for a day or week of work. They’ve made the decision to use the pricing mechanism of a market to pay for a small unit of labor. Most of us use outside services for our firms — accounting, legal, benefits. We do this because it’s cheaper “to buy than to build” these services in-house —  i.e., the market pricing mechanism is more efficient than we could be.

But let’s look at a bigger business, a vertically integrated commodity producer, like a large farm, for example. Their product’s price is transparently set by the market (corn is listed in the Chicago Mercantile Exchange, for example). The founders of this hypothetical firm made the decision to create a company because they believed that their internal costs would be less than the market’s, that they could produce corn for less than the market price. It doesn’t stop there though — should they buy fertilizer, or should they produce their own? Should they process and package their product or just sell a commodity? Should they own or lease their land? All of these are decisions based on internal vs. external transaction costs. Large firms can gain tremendous advantages — internal information, bargaining costs, the effective protection of their intellectual property and trade secrets; thus, we see the success of large, vertically integrated businesses. Often, the more transactions, the more economies of scale, the lower the coordination costs. Think about Amazon in this context — they own retail because they have the lowest coordination costs due to their size and efficiency.

However, there is a limit to the size of the firm. There is a reason we often describe big firms as slow or bureaucratic.

First, as a firm gets larger, there may be decreasing returns to the entrepreneur function, that is, the costs of organizing additional transactions within the firm may rise.

As a firm scales, overhead costs go up‚ and it becomes harder to orchestrate lots of people and to share information. The better the entrepreneur’s management skills, the better he or she can coordinate an organization, and the more the organization can scale without losing efficiency. But eventually, forces start to work against the firm — orchestration costs rise; smaller, more nimble competitors can deliver similar services less expensively.

Conclusions, Observations, and Questions

If you are going to start a firm, you better believe you can minimize the transaction costs, which for almost everything — from software to manufacturing — are collapsing. And you need to believe that you can not only minimize them initially but also keep them lower over the long haul. Secondly, what gets internalized is again a function of transaction costs. During the life of a company, there is a perpetual debate about “buy vs. build” (a dichotomous analysis that, by the way, could be extended to the question of buying from the market or starting a new company in the first place). Before you make that hire, are you sure it’s cheaper? Does the cost of managing more people outweigh the benefit you could find in the market? We like to measure and judge companies by their number of employees, which is often the wrong metric. Bigger doesn’t always mean better. It often means plodding and inefficient.

Additional Reading

The Theory of the Firm, Ronald Coase, 1937

Polis—Cities not Countries are the Organizing Unit of the Future

A look at the trend toward urbanization and its effects on the environment, governance, and development

Background and urbanization rates of cities

The Greeks called the city the polis, meaning city-state, and believed it to be the highest form of governance, one that allowed men to fulfill their potential (of course, men—and not even all of them—were the only ones allowed to reach their potential at the time, but that’s a different discussion). The city-state was more than just a geographic region—it was an ideal.

Cities are the oldest human organization in existence. There are religions that date back 3,500 years, universities that have lasted about 1,000 years, and corporations that have existed for 700 (Stora Enso in Sweden is 700 years old, and Sumitomo Group in Japan is 400). But the town of Jericho has been continuously occupied for 10,500 years and Jerusalem about 5,000. (The Whole Earth Discipline, Stewart Brand, 2009) And not only are cities enduring, they are growing. I’ve quoted the stat before—half of the world’s population currently lives in cities, and that number will reach 75 percent by 2050 (for some perspective, it was 10 percent in 1890). Indeed, we have seen the rise of the megacity:

In recent decades, we have grown a network of megacities; 23 cities with more than 10 million people now compromise 5% of the world’s population. Greater Mumbai’s population is now larger than the population of Norway and Sweden combined; likewise, Greater Sao Paolo’s population is now roughly equal to Australia’s. (The Endless City, Ricky Burdett and Deyan Sudjic, eds., 2010)

We are moving toward a collection of connected city-states—maybe nodes are a better name for them. (This idea of nodes is beautifully represented in the art of Aaron Koblin, work that shows the world’s flight patterns—scroll down to the video.) These nodes will not only be connected to each other as never before, they’ll also produce and consume vast amounts of data, enabling what’s been called intelligent cities.

The trend is clear—the world’s population will live in intelligent connected cities or nodes. This phenomenon, which is accelerating due to increased mobility, will create an unprecedented level of connectivity and a staggering amount of complexity.

How cities mirror biology

What is even more interesting about this trend is that the growth and activity of a city mirror processes observed in biology. Indeed, it seems that we naturally self-assemble into an organism in ways no different than any other biological process that can be modeled and, in theory, predicted.

In the field of biology, Kleiber’s law states that as an animal’s mass scales, its metabolic rate scales at a rate of 3/4 to the power of the animal’s mass. An easier way to say this is as an organism grows, its metabolism becomes more efficient (i.e., if an animal doubles in weight, its metabolism is 1.68 times greater [2^3/4], not twice as great).

In the paper Growth, Innovation, Scaling, and the Pace of Life in Cities, the authors found that certain characteristics of cities follow a power law similar to Kleiber’s law and scale in proportion to population—Mumbai with 20 million people is a much more complex organism than Chicago with 4 million. The really interesting property here is the value of the exponent in the power law and its implications: when the exponent is greater than 1, the characteristic grows and thus is amplified. For values less than 1, there is a minimizing effect, representing an economy of scale.

According to the authors, the fastest growing factors and those with increasing returns or wealth creation were, in order, New Patents (1.27), Inventors (1.25), Private R&D Employment (1.34), “Super-creative” Employment (1.15), R&D establishment/employment, Total Wages, GDP (1.15), and Total Employment (1.01). The neutral-to-declining factors (i.e., those representing economies of scale) were Total Housing (1.0), Gasoline Stations (.77), Length of Electric Cables (.87), and Road Surface (.83). Cities thus have an amplifying and modelable characteristic in relation to wealth, information, and knowledge that follows a power law of roughly 1.2. Conversely, cities have economies of scale in physical infrastructure (following a power law of roughly 0.8). This is directly related to something I wrote about in an earlier post, Information vs. Real Assets—i.e., how there probably won’t be rapid growth or outliers in energy as there was information technology investing.

But here’s the rub, according to the paper:

The character of the solution changes dramatically when growth is driven by innovation and wealth creation…. Growth becomes faster than exponential, eventually leading to an infinite population in a finite amount of time given by…. This solution is characteristic of biological systems…. Thus, cities and, more generally, social organizations that are driven by economies of scale are destined to eventually stop growing.

Therefore, if cities rely on growth from only infrastructure (water, energy, roads), they’re destined to collapse, but if growth comes from innovation and wealth creation, growth is theoretically unbounded. What this means is if cities are not sustainable—i.e., if they are resource-dependent—they collapse. Think Detroit versus Singapore. But if cities can make the transition to sustainability, they end up with waves of wealth creation and innovation (think Silicon Valley, as well as non-city entities or phenomena like the Internet and, lately, social media).

However, to maintain continued growth, major innovations or adaptations must arise at an accelerated rate—not only the pace of life but how fast change occurs (the world has a wicked second derivative). In effect, the city is a form of miniaturization of infrastructure and thus is related to Kurzweill’s Law of Accelerating Returns, which posits that miniaturization and acceleration are the drivers for continuing returns. As the paper states:

Although population increases are ultimately limited by impacts on the natural environment (controlled by resources), we have shown that growth driven by innovation implies, in principle, no limit to the size of a city, providing a quantitative argument against classical ideals in urban economics.

There’s a big limit in there: the natural environment (“controlled by resources”). A certain amount of resources is required to fuel innovation. While on a relative per-capita basis, a city uses less of these resources, it requires an ever-increasing amount of resources on an absolute basis.

The conclusion is very powerful, though—the highest populated and most sustainable cities will continue to outpace the economic growth, innovation, and wealth of their peers. It works on a smaller scale as well—London has created the “silicon roundabout,” an area with very interesting start-ups, and I used to work in the same building as GroupOn, a space that has now become a magnet for all sorts of innovative companies.

Technology is going to magnify this divide even more (in effect, resulting in an increasing Gini coefficient between cities as discussed in Moncultured Man). And this has always been so—cities that adopted the printing press grew faster then those that didn’t (Print Press by Paul Kedrosky).

What questions this raises for development, governance, and the environment

Cities make countries rich. Countries that are highly urbanized have higher incomes, more stable economies, stronger institutitions. They are better able to withstand the volatility of the global economy than those with less urbanized populations. (United Nations Human Settlements Programme, UN-HABITAT, State of the World’s Cities, 2010)

On the surface, there are no real surprises here—the higher up the production food chain you are, the more valuable your economy. Cities are thus amplifiers of economic development—high urbanization leads to innovation and wealth creation. Think about Israel, Hong Kong, or Singapore, the latter of which has a GDP of $217 billion and a population of just under 5 million.

This raises some interesting questions. I couldn’t help but think of my experience in Kibera, the largest slum outside Nairobi, Kenya, when I read this statement: “To accomplish this integration, life at all scales is sustained by optimized, space-filling, hierarchical branching networks, which grow with the size of the organism as uniquely specified approximately self-similar structures.” This really turns the typical assumptions about slums on their head. Slums are really cities in their own right, and cities, as we’ve seen, are wealth creators and amplifiers of innovation. I’ve seen the complex recycling systems and industries that exist in the slums of Kenya and India. Should we not think of slums then as positive amplifiers and work within their structures to amplify wealth, innovation, and job creation? Can we not leverage the community, the network, the node that they represent for positive growth? And thinking beyond slums, should we be encouraging the acceleration of urbanization in general? Would more people come out of poverty faster if we urbanized faster? If so, how do we accomplish this? As Steward Brand said in The Whole Earth Discipline, “nothing changes a city like a cellphone and a road.”

One problem is that many of our political structures are built around nations and states, but our economies and networks are being defined by cities or nodes—the government structure hasn’t kept up with this new geography:

The great top-down nation states will only be cosmetically alive, weakened by deficits, politicians misalignment of interests and the magnification of errors by centralized systems. The pre-modernist robust model of city-states and statelings will prevail, with obsessive fiscal prudence. (Nassim Talib, Economist World in 2011)

This disparity creates far-reaching problems. For example, there are now 14 states where more than half of the population lives within a single metropolitan area, as discussed in this post. The US population was roughly 2.5 million people when it was founded in 1776 and mostly concentrated in the northeast. With a census only every decade, this will create an electorate long emergency in the US as our representation structure lags behind our geographic structure.

Since the trend is toward urbanization, we should pay special attention to how cities grow and how we can influence that process. How we build a city is the ultimate intersection of private interest and public goods. This intersection is critical, as the authors state in The Endless City: “The fact that government intervention is essential, together with the reality that there are multiple possible designs for a city, makes urbanism one of the few remaining realms of ideology.” Therefore, we need a clear agenda and roadmap that will require private and public collaboration. The good news is we can model it, and if we can model it, we should be able to develop good policy, but it will require good leadership.

As we move from nations to nodes, the role of mayors is going to be much more important. They have a defined, governable node that, if well-managed, can amplify wealth and innovation. Was Rahm Emanuel thinking about this when he left the White House? Chicago represents a well-defined governable node where he can have a huge impact.

But what does this mean for the environment? Aren’t cities bad for the planet? Actually, counter to intuition, cities are some of the most environmentally friendly areas in the world—their per-capita consumption of energy is far lower than suburban or rural populations.

Most Americans, including most New Yorkers, think of New York City as an ecological nightmare, a wasteland of concrete and garbage and diesel fumes and traffic jams, but in comparison with the rest of America it’s a model of environmental responsibility. (Green Manhattan, New Yorker, 2004)

But this isn’t about the suburbs versus the city; it’s just biological law—again, back to Growth, Innovation, Scaling, and the Pace of Life in Cities: “Because metabolic rate per unit mass decreases with body size, this relationship implies an economy of scale in energy consumption: larger organisms consume less energy per unit time and per unit mass.” Cities thus represent a path towards environmental sustainability—decreasing our footprint while increasing our wealth.

These trends will fundamentally change development and governance and could have huge positive effects on the environment if handled right. Higher urbanization means higher incomes, more stable economies, and lower carbon footprints. It makes you think about where you live—and where you want to live.

Further Reading & References
Rise of the Creative Class and Great Reset, Richard Florida
The Endless City, Ricky Burdett and Deyan Sudjic, eds.
Kleiber’s Law, Wikipedia
Polis, Wikipedia
Growth, Innovation, Scaling, and the Pace of Life in Cities, Luís M. A. Bettencourt, José Lobo, Dirk Helbing, Christian Kühnert, and Geoffrey B. West
Whole Earth Discipline, Steward Brandt
Green Manhattan, New Yorker
Megacities on the Move, Forum for the Future
The Printing Press & City State Change, Infectious Greed
Intelligent Cities, USA Today
Predicting the Climate-Changed City of the Future, New York Times
The City-States of America, Samuel Arbesman

Fat vs. Lean Markets—Hint: We’re Fat.

I’ve always struggled with what word to use when describing poor markets. There’s the developed and the developing world. There’s the bottom or, a little better, base of the pyramid. There’s the emerging or frontier market, which evokes an image of covered wagons heading west—Manifest Destiny and all that. The UN classifies them as LDC, or Least Developed Countries. The problem with all these is that they define people by how much money they make and set the Western way of life as the ultimate goal—if you develop, climb the pyramid, and emerge, you’ll be like us, which is obviously what you want to do. It grades people based on purchasing power, which has always felt dehumanizing to me.

In manufacturing there’s a concept called Lean Manufacturing, which at a high level represents a philosophy of “maximizing value while minimizing waste.” Eric Reis has taken these ideas and applied them to startups, something he calls the Lean Startup. As I met one amazing entrepreneur after another last week in Kenya with Acumen Fund, I thought, what better word to describe the environment they operate in than “lean.” These guys are all about maximizing value and minimizing waste—they have to be. They’re capital-constrained, they face a shortage of skilled labor, their customers have little disposable income, and they are often at odds with state-backed incumbents or even the government itself. They operate in a lean market, and yet they are succeeding. I think back to a scene I saw earlier this year in China: two women were fighting over a discarded plastic bottle for the recycling refund. Now that’s a lean market.

The constraints of these markets breed innovation—it’s the reason startups beat incumbents. It’s why the Nokia 1100 cell phone with it’s monochrome screen and $20 price tag is the world’s best selling cell phone. It’s why Tata can build a car for $2,200 and why Visa’s mobile banking platform was developed in Africa and imported to the US and Europe. It’s why 37signals is so successful and why the Lean Startup methodology is being ever more widely adopted.

So if these markets are lean, I guess that makes us fat, and, really, is this so far off the mark? We have the highest obesity rate of any country in the world—about 30%. We consume more energy per capita than almost anyone else (the exception being a handful of very hot Middle Eastern countries). We have the shortest school year. We drive the largest cars and build the biggest houses. It’s hard to be innovative when you have everything you could possibly need, and thus we’ve become fat. On top of that, we’ve taken on a mountain of debt to pay for it all. From the World Economic Forum’s Global Risks 2010 Report:

According to IMF, by 2014, the average debt-to-GDP ratio of advanced economies that are members of the G20 is expected to climb from 2007 pre-crisis levels of 78% to 118% [various academic work has shown that a ratio above 90% becomes a serious head-wind to growth]. In sharp contrast, emerging economies, with smaller governments and lower exposure to the baning crisis, kept their fiscal houses in order. According to the same IMF analysis, between 2007 and 2014 the average debt-to-gdp ratio fo emerging countries that are members of the G20 will never exceed 40%. For once, and in contrast to the 1980s and 1990s, emerging economies are not the causal to global fiscal crisis.

So who emerges as the winner here? In a world of debt, who out performs? And what market do you want to emulate—the one that excels when faced with every constraint imaginable or the one that has everything? Which one figures out the environmental problems first—the one where waste is valuable or the one that can afford to ship and dump it? The one with the longer school day and year or the one with the shortest of both? The lean startup or the incumbent? Which one is your money on?

What you call a market matters—it frames the discussion—and in this case, we may want to reevaluate who is aspiring to what.