The Increasing Returns Economy

Supported by Greenhaven Road Capital, finding value off the beaten path.

When Michael Mauboussin brought up Brian Arthur’s work in his conversation with Ted Seides it woke my curiosity. In this podcast episode, we’ll cover Arthur’s 1996 Harvard Business Review Paper.

In summary; there are two economies

  • The innovation economy which is defined by increasing returns, positive feedback, heavy on know-how and light on resources.
  • The optimization economy which is defined by bulk processing, genteelism, and heavy on resources and light on know-how.

Arthur wants managers to be aware of their economy. Innovative economies require commando units who can move fast and break things. Optimization economies require hierarchy and baby steps.

Instagram‘s success aligns with Arthur’s “properties that have become hallmarks of increasing returns.” They weren’t the first or best photo filter app but they did enter an unstable market with multiple potential outcomes and the ability to “lock in” the market.

Arthur notes that all companies are some blend of innovation and optimization. Apple’s App Store, iTunes, and iOS integrations are innovative while Apple’s hardware manufacturing is optimized. What matters most for the innovation parts of a business is adaptability, “when the games themselves are not even fully defined, you cannot optimize. What you can do is adapt.”

Arthur explains that here, in my favorite passage.

Screen Shot 2018-01-10 at 11.37.37 AM.png

The podcast includes examples from Nate Silver, Jeff Luhnow, Ed Thrope, and Jerry Kaplan.

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