Open and Closed Systems

In the  21st century, economic success depends more on transforming information and ideas into electronic data, and less on turning raw materials into finished products and transporting them from point of manufacture to distribution point. To chart a path for yourself as a content creator, journalist or otherwise, you need to see where the organization of the traditional businesses is failing, and you need to explore the principles behind new ways of doing business. Marketplaces are messy compared to theories. From open and closed systems, to underground economies and pirates, you need to know how to negotiate and thrive in the marketplace and workplace.

We will look at underground economies and piracy and their impact on established markets, but first it is necessary to differentiate between an open and a closed system. Closed systems are top-down, hierarchical, organizations. The way they operate and produce anything is proprietary, or closed.

Most products are made of component parts that are interdependent. If the overall design of the product is proprietary, then the parts can only be made by authorized entities. This is the model of production, where the parts, whether they are screws, gears, sub-routines, or courses in an educational sequence, must be built by the same party because they control the specifications for each part. A proprietary product is often expensive and well-made, but it can’t be customized without being redesigned. Most education today follows this proprietary model. A course in one department is not interchangeable with one in another department, much less at another school. Most computers are closed systems, too. You need to get replacement parts from the device’s manufacturer.

By contrast, an open system is modular, or open. Using modular design, the specifications for parts and the overall design are based on open standards or open source. The fit and function of the elements is spelled out, so that anyone can make the parts, so long as they use the specified standards. The advantage of a modular or open product or service, is that it can be easily customized, without redesigning the interface or other parts. Linux operating system is a well-known example of an open system product. It is based on open source code, not a proprietary one.

Linux is a free operating system, no one pays to use it, nor is anyone paid to create it (at least in money.)

Red Hat
Image by biverson via Flickr

However, business that adopt the Linux OS often need support in using it. Red Hat is a company where people do make money from Linux. Their business model is based on sharing. Red Hat shares expertise, computer code, and knowledge about Linux. The company sells subscriptions for service, upgrades, and support to other businesses that rely on Linux OS.

Open systems produce more failures than closed ones, but the cost of failure is low, because each try is like an experiment. Open systems have an advantage over closed systems because the cost of failure is lower, and they don’t create biases in favor of predictable, but substandard outcomes. It’s simpler to integrate the contributions of all the people who only have one idea to contribute, but it’s a good idea. The way Clay Shirky describes this in “Here Comes Everybody,” is that it’s “…cheaper to try to try something than make a formal organizational decision to try it. “(p. 249) Another way to think about the two ways of organizing teams or production systems, is to compare the closed method to a cathedral, and the open method to a bazaar. The cathedral is hierarchical, top-down, traditional, slow to adopt to change, though stately and elegant. The bazaar is open, noisy, there is haggling and bargaining everywhere. Merchants and their products compete openly and the customers will find the best deal quickly and stream to it.

The growth of the open source movement shows that communal can be as desireable as commercial. Lowering the barriers to individuals taking action and being able to effectively aggregate individual actions are key to open projects. In this kind of organization, highly motivated people can create content more easily, and barely motivated people can be effective without being completely engaged. The electronic communication tools available today to promote collaboration and sharing and to make social networking as easy as pressing a key, are creating new market conditions. The organization and economic assumptions that made for business success in manufacturing, before computers and the Internet, can hold businesses back today. Business models that would have been impossible 20 years ago, can be money-makers today. Because markets are messy and economics isn’t a science, businesses and entrepreneurs struggle to find a system and balance in the modern marketplace. News organizations have been disrupted by new technology with its many unintended consequences.

See Eric Raymond explain the Cathedral and Bazaar:
Richard Stallman on the morality of open and closed systems.

Economies of Scale

Economies of scale are factors that cause the average cost of producing something to fall as the volume of its output increases. Hence it might cost $3,000 to produce 100 copies of a magazine but only $4,000 to produce 1,000 copies. The average cost in this case has fallen from $30 to $4 a copy because the main elements of cost in producing a magazine (editorial and design) are unrelated to the number of magazines produced.

From The Economist.com, adapted from “The Economist Guide to Management Ideas and Gurus”, by Tim Hindle.

Economies of scale are a cause and effect of consolidation of industries and growth of giant corporations during the 20th century.  Henry Ford’s revolutionary assembly line relied on economies of scale and consolidation. Prior to the recent collapse of the global economy, mergers and acquisitions were common in mass media and across businesses and industries. Sam Zell‘s purchase of the Tribune Company — already a giant conglomerate of news organizations, real estate holdings,printing, broadcasting, and advertising businesses with the Chicago Cubs baseball team in the mix for good measure– is a good example of an attempt to capture value from an economy of scale. We’ll consider Zell’s move, which has the Tribune in bankruptcy now, as we look at new ideas about the economy, and new business models.

Pharmaceutical research, is another area where economies of scale are leading to consolidation. Discovering the next blockbuster drug is enormously costly so pharmaceutical companies have been driven to mergers and acquisitions in order to spread their R&D expenditure across a greater volume of sales.

Economies of scale have a downside, called diseconomies of scale. Large organizations can collect economies of scale, but as they become larger, they are harder to manage and run. Complexity adds cost, and at some point, costs outweigh the savings gained from greater scale. In other words, economies of scale cannot continue forever. One problem of corporations in the late 20th century, was a tendency to manage and plan for the short-term, without regard to long-term problems and complexities, such as growing too big for it to pay. “Neoclassic economics is based on an irrational belief that unlimited growth can solve everything, without taking into account the long-term effects or social costs of such growth,” points out Matt Mason in The Pirate’s Dilemma.

T. Boone Pickens, the geologist turned oil magnate turned corporate raider, now a proponent of natural gas and a national energy policy, wrote, “It’s unusual to find a large corporation that’s efficient. I know about economies of scale and all the other advantages that are supposed to come with size. But when you get an inside look, it’s easy to see how inefficient big business really is. Most corporate bureaucracies have more people than they have work.”

On the one hand, we have traditional media companies, which are closed systems, cathedrals of business, facing limits on growth, inefficiencies because of their large size, and a new media, the Internet, where the cost of reproduction and distribution might as well be zero. When the economy of scale isn’t profitable anymore, it is a diseconomy. It is a prescription for downsizing, bankruptcies, and a scramble for new ways of making money. What was difficult becomes easy. What was easy can become difficult. Open source production is revitalizing the auto industry where parts manufacturers are small suppliers who compete with each other to make the best parts, instead of being arms of the same giant corporation. In the news business, companies are shedding full-time reporters and editors, and looking increasingly to freelancers. These freelancers are entrepreneurs, some involuntary, but a growing number are seeking open source kind of arrangements with publishers.

Chris Anderson, author of  Free: The Future of a Radical Price lists some characteristics of a “new new economy” that are disrupting the economic paradigm of the last half century. These include:

  • Diseconomies of scale in business and industry.
  • Mass collective action now organized by Web, not the state.
  • Nimbleness, risk-taking, reduced costs to enter market (cloud computing, etc.)
  • Open source production – suppliers work independently to create components – the best are chose by the manufacturer.

Technological developments are directly tied to these changes, as are sociological and political changes. A new but growing phenomenon, “involuntary entrepreneurship,” where individuals re-invent themselves as small business people because there aren’t other employment opportunities, are made possible in many instances because of digital information, electronic communication, and cloud computing. There is a wave of freelance journalists who are not involuntary entrepreneurs. Yet being an involuntary entrepreneur could become a voluntary one, if they begin to decipher the puzzle that is our current mixed up economy.

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