Hierarchy, market or network? The disruptive world of the digital platform
Economics traditionally considered firms and markets as two alternative ways of coordinating economic activities. Nobel prize winner Ronald H. Coase (1937) demonstrated that it all hinges on “transaction costs”, such as the need to search for a trade partner, the time needed to negotiate a contract, the legal expenses to draw it up and if necessary, to enforce it. When these costs are high, then hiring people in a firm is the right solution. When they are low, then a harmonious state will emerge spontaneously from the choices of independent, self-employed individuals. The difference, further emphasized by the work of Oliver Williamson, another Nobel, is between the world of bureaucracy, hierarchy and salaried work, and the world of the market and myriad micro-entrepreneurs.
This dichotomous description seemed reductive to economic sociologists, and Mark Granovetter (1985) pointed to social networks as coordination devices. Networks enable circulation of knowledge, formation of trust, emergence of shared norms in informal ways, thereby lowering costs and smoothing economic transactions. Walter W. Powell (1990) saw networks as an alternative to market and hierarchy, while others thought of it as a complement rather than a substitute. In some cases, the relevance of networks is flagrant: think of “collegial“, horizontal organizations such as legal partnerships, which are clearly not markets, and which have no vertical hierarchy either.
The rise of online platforms challenges these older views today. Powered by digital data and matching algorithms, platforms are meeting places for actors on the two sides of a market: riders and drivers (Uber, Lyft, BlaBlaCar), guests and hosts (Airbnb), buyers and sellers (eBay), and so on. Officially, platforms are intermediaries only, able to put in touch, say, those who need a lift and those who have a car, so that they can share the ride. Platforms don’t employ drivers and don’t own cars.
So, what are the coordination arrangements of digital platforms? Some of them initially used social-network rhetoric. “Sharing economy” enthusiasts talked about practices such as car-sharing as ways to make human contact, to devalue consumerism, to reduce carbon emissions. But this discourse soon appeared overstated, and it became clear that social networks did not tell all the story. Rather, large platforms like Uber quickly appeared as market facilitators. The very existence of their matching algorithms has created incentives that motivate some users to drive more, not for their own needs but in order to raise extra money from carrying passengers. On the other side of the market, relatively cheap tariffs motivate some passengers to book Uber rides more regularly. Users have gradually specialized into a role, driver or passenger, depending on what incentives matter more for them.
Uber has significantly cut transaction costs (specifically, search costs), making it easier for large numbers of drivers and passengers to meet each other. Its algorithm has achieved this, thank to an unprecedented capacity to monitor the market. By constantly observing users’ status through its app it can tell, with remarkable precision, what city areas are likely to experience higher demand, so that more drivers can be attracted there and close the gap. At first sight, this looks like the triumph of the pure market system. (The same would be true of Airbnb and many others).
And yet, there is something in Uber that very closely resembles hierarchy. Take surge pricing: the company says it just follows the market, allowing prices to go up when demand exceeds supply, so as to bring the system back to equilibrium. But in economics orthodoxy, a market-driven price change is a spontaneous reaction emerging from a multitude of separate interactions among “price-taking” actors; Uber looks more like a “price-maker”, who makes unilateral decisions and is able to impose it on all its users, partly through formal rules (drivers aren’t allowed to charge more), partly through soft rules (inducing drivers not to charge less, though they can formally do so). Economists would reckon that price-making is typical of situations where one or few firms enjoy market power, usually owing to their large size.
And, if it is true that Uber does not employ its drivers, it still actively manages them, as a recent HBR article demonstrates – way beyond mere incentivizing, let alone simply informing them of existing opportunities.
So, are platforms the new face of hierarchy? Partly. They are hybrid creatures, having integrated elements of all three coordination principles, market, network, and hierarchy. Interestingly, they have done so through digital technologies – data and algorithms. They have brought forward solutions to some old problems – chronic insufficiency of taxicabs in major cities, to name just one – but have raised many new ones – insurance and protection of workers’ rights are but the most notorious examples. They are a headache for the legal and regulatory system as they don’t quite fit standard definitions. But it is still an old-style, low-tech solution that is needed to solve them, not some algorithmic magic. As Ron Coase would have put it, regulation has the critical economic responsibility to minimize disruptive effects on markets, organizations, and ultimately people.