Artificial Intelligence and "The End of Scale" (PG; AMZN)

From MIT's Sloan Management Review:

The End of Scale
by Hemant Taneja with Kevin Maney. 

Hemant Taneja (@htaneja) is a managing director at General Catalyst Partners, a venture capital firm with offices in San Francisco, Palo Alto, New York City, and Boston, and a lecturer at MIT and Stanford. Kevin Maney (@kmaney) is an author and a journalist, who writes weekly about technology and society for Newsweek. Taneja is the author, with Maney, of Unscaled: How AI and a New Generation of Upstarts Are Creating the Economy of the Future (PublicAffairs, 2018). This article is adapted from that book.

For more than a century, economies of scale made the corporation an ideal engine of business. But now, a flurry of important new technologies, accelerated by artificial intelligence (AI), is turning economies of scale inside out. Business in the century ahead will be driven by economies of unscale, in which the traditional competitive advantages of size are turned on their head.

Economies of unscale are enabled by two complementary market forces: the emergence of platforms and technologies that can be rented as needed. These developments have eroded the powerful inverse relationship between fixed costs and output that defined economies of scale. Now, small, unscaled companies can pursue niche markets and successfully challenge large companies that are weighed down by decades of investment in scale — in mass production, distribution, and marketing.

Investments in scale used to make a lot of sense. Around the beginning of the 20th century, the world was treated to a technological surge unlike any in history. That was when inventors and entrepreneurs developed cars, airplanes, radio, and television, and built out the electric grid and telephone system.
These new technologies ushered in the age of scale by enabling mass production and offering access to mass markets. Electricity drove automation, allowing companies to build huge factories to churn out a product in massive quantities. Radio and TV reached huge audiences, which companies tapped through mass marketing. The economies of scale governed business success.

Scale conferred an enormous competitive advantage. It not only lowered fixed costs — it also created a forbidding barrier to entry for competitors. Organizations of all kinds spent the 20th century seeking scale. That’s how we ended up with giant corporations, and universities with 50,000 students, and multinational health care providers.

Today, we’re experiencing a new tech surge. This one started around 2007, when mobile, social, and cloud computing took off with the introduction of the iPhone, Facebook, and Amazon Web Services (AWS), respectively. Now, we’re adding AI to the mix. AI is this century’s electricity — the technology that will power everything.

AI has a particular property that supplants mass production and mass marketing as a basis of competitive advantage. It can learn about individuals and automatically tailor products for them at scale. This is how the GPS navigation app Waze gives you a route map tailored to your destination at a specific moment in time — a map that probably won’t work for anyone else or at any other time and doesn’t need to. AI enables mass customization for increasingly narrow markets. If a product is custom built specifically for you, you’ll probably prefer it to a product that’s built for millions of people who are only kind of like you.

This is the basis of economics of unscale. The winning companies in today’s tech surge are companies that profitably give each customer exactly what he or she wants, not companies that give everyone the same thing.

There is another, equally important way in which the current tech wave is propelling economies of unscale. Because companies can stay nimble and focused by easily and instantly renting scale, they can adjust more quickly to changing demand and conditions at much lower cost and with far less effort.

Thus, scaled companies find themselves beleaguered by unscaled competitors. Stripe is an unscaled financial services company based in San Francisco that is challenging the big banks. Airbnb, also based in San Francisco, is an unscaled hotel company that is taking customers away from the big chain hotels. Warby Parker is a New York City-based unscaled eyewear company that is threatening the big eyewear brands.
If economies of unscale will rule in this new world of business, how can a corporation, which, by definition is a large, scaled-up enterprise, compete and thrive?

P&G as a Consumer Goods Platform
Smart corporations will learn to harness economies of unscale, but that will require a significant shift in the managerial mindset. Leaders might take cues from the evolution of Procter & Gamble Co. (P&G).

In 1837, William Procter and his brother-in-law, James Gamble, formed a company in Cincinnati, Ohio, to make candles and soap. The company grew slowly and got a boost from contracts with the Union Army during the Civil War. Its breakthrough came in 1878, just as newspapers were reaching consumers en masse and railroads opened that could efficiently carry products to any major city. According to lore, one of the company’s chemists accidentally left a soap mixer on during lunch, stirring more air than usual into P&G’s white soap. The air made the soap float. The company branded the product as Ivory and marketed it nationwide. P&G began to scale up.

After World War II, as the consumer market took off, P&G brought out Tide detergent, the first mass-market soap specifically for automatic clothes washers. By the end of the 20th century, P&G had scaled up to a behemoth, offering more than 300 brands and raking in yearly revenues of $38 billion.

In 2016, analyst firm CB Insights published a graphic showing all the ways small, entrepreneurial unscaled companies were attacking P&G. (See “Unbundling Procter & Gamble.”) In it, P&G no longer appears as a monolithic scaled-up company that has powerful defenses against upstarts; instead, it is depicted as a series of individual products, each vulnerable to upstart, technology-enabled, product-focused companies. P&G’s Gillette razors are being challenged by Dollar Shave Club’s and Harry’s Inc.’s subscription models; a niche of buyers of P&G’s huge Pampers brand of disposable diapers are getting peeled off by The Honest Co.’s environmentally friendly diapers; Thinx “period panties” are going after P&G’s Tampax tampons in a new, uncharted way; and eSalon’s “custom” hair coloring is competing with P&G’s Clairol mass-appeal hair coloring.1

This is a clear indication of what big corporations are facing in an era that favors economies of unscale over economies of scale. Small, unscaled companies can challenge big companies with products or services more perfectly targeted to niche markets — products that can win against mass-appeal offerings. When unscaled competitors lure away enough customers, economies of scale begin to work against the incumbents. The cost of scale rises as fewer and fewer units move through expensive, large-scale factories and distribution systems — a cost burden not borne by unscaled companies.

P&G is aware of the challenges unscaled competitors pose, and it is responding. For about a decade, P&G has been running a program called Connect + Develop. After 175 years of inventing most of its new products in-house, the company’s executives came to understand that there were more smart inventors outside of P&G than could possibly be contained inside P&G, and the internet provided a way to reach them.

Connect + Develop invites anyone who has a product that might be a good fit with P&G to submit a development proposal to the company. Though it isn’t phrased this way, Connect + Develop positions P&G as a platform for niche products in a way that benefits the company (which captures some of the value of new, unscaled products, instead of competing against them) and product innovators (who can “rent” P&G’s distribution, marketing, and knowledge to bring their products to market)....

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