Monday, January 24, 2011

Skills and Value Concentration

Many of my colleagues and peers complain about "wealth concentration" and the "superstar effect" without realizing these are natural trends in any group, regardless of size. As a community expands, the effect I am going to explain is magnified. The end result approximates a "natural monopoly." Seldom is there a nefarious plot to control products or knowledge -- it just happens to be more efficient to concentrate skills and products.

I'm going to use a large-scale, modern example to explain how skills concentration (specialization) leads to wealth concentration and the superstar effect. Afterwards, I'll offer other examples to help clarify the concept further.

For nearly 40 years, from the 1960s through the mid-1990s, when a company wanted to use computers to automate and improve a task's accuracy the firm would hire a team of programmers. As a result, companies of every size and type had customized software. This was great for programmers, but not so great for the companies.

Most early computer applications were financial in nature. This is one reason information technology departments within large companies traditionally report to Chief Financial Officers. The programmers worked on software for everything from basic payroll to client billing. Even departmental budgets were crunched by custom software.

The first big beneficiaries of skills concentration were small businesses. Because these smaller companies didn't have programming departments, they were either paying accounting firms (that used custom software) or dealing with finances by hand.

Along came VisiCalc, followed by Lotus 1-2-3, and a dozen other spreadsheet applications. Small businesses noticed. The owners and department managers purchased Apple II computers and the first IBM PCs specifically to use spreadsheet software. Over a decade, Lotus 1-2-3 emerged as a favorite because it was flexible, fast, and relatively easy to learn. It also didn't take long before large companies were arming everyone from accountants to sales representatives with spreadsheet software.

Programmers complained that Lotus 1-2-3 wasn't specialized. It wasn't optimized for each user, or at least not for each purpose. But, the reality was that one team of centralized programmers could and did displace thousands and thousands of developers.

This happened with databases, too. Databases are the core of almost any business. In the early years, these had to be custom. But, along came dBase and then FoxPro. Again, programmers were displaced.

In both of these cases, some displaced programmers became experts in customizing spreadsheets or databases. Other displaced programmers created new, groundbreaking applications. This is the process of "creative destruction" in any economy and it is not unique to capitalism.

Jumping to the middle of this story (where we are now, I believe), Microsoft is the dominant supplier of general-purpose business applications. Microsoft Office is a single suite of "everything you need" for many small businesses and corporate departments.

The benefits are many, from the perspective of businesses and individuals. But, this does mean programmers have to consider developing other types of software or specializing in "value-added" services.

Some of the benefits include:
  • Reduced software budgets, since the costs of software development are "shared" by all buyers of MS Office.
  • Reduced training budgets, since employees are generally familiar with Microsoft products while custom software requires extra training and documentation.
  • Improved responsiveness to business needs, since you can buy software instead of waiting for it to be developed and customized.
  • Increased efficiency, since data can be shared by individuals, departments, and even between companies and their customers.

Because one company provides this software, the employees of Microsoft are the "superstars." The company has the same "potential value" in economic models as all the programmers its software has displaced. Imagine all the custom software no longer necessary because of Microsoft Office. All that "value" is then shifted to one company. To that value, we have to add all the software now in use at smaller businesses that previously couldn't afford to hire programmers.

A company no longer has to worry about retaining one or two programmers with all the knowledge of a system or application. Microsoft developers might come and go from their employer, but as far as companies using their software are concerned Office is from "Microsoft" not "Bob" or "Sally" the programmer.

A significant portion of the handful of specialists in spreadsheet, word processing, and database development work at a few large companies, like Microsoft or Google. Together, they accomplish great things.

The results are:
  • Skills are concentrated among a few better providers as consumers select them over other providers.
  • Value is, therefore, concentrated at these same providers.
  • Wealth accumulates among these experts.
  • Investments are made by the wealthy in research and development, increasing their value.
  • Average (and below average) providers are displaced.

These trends leave us with superstars who earn a lot of money (or whatever represents "worth" in a culture). Once at the top of a field, an individual or company has to invest constantly in research and development. Failure to remain a leader is normal, though. One set of superstars will eventually be replaced by another set. These new stars might have an entirely different set of skills, providing a different product or service that displaces the previous leaders.

The superstars do not, in reality, earn every penny the displaced programmers would have earned. In fact, they earn much, much less than what the sum total would be if companies still had to pay programmers for basic tasks. However, the sheer volume of sales translates into individual wealth.

No company could have Word or Excel developed for $150. But, that's the price most people now pay for Microsoft Office. Microsoft doesn't earn the $100,000 or more I would have to pay someone to develop a decent financial application. I pay a retailer $150, the retailer pays a distributor, the distributor pays Microsoft… and in the end, Microsoft likely collects $70. I "saved" thousands of dollars. Microsoft made far less than individual programmers might have, but it concentrates the value in one provider.

There was a time when superstars were regional. This limited their potential value to whatever their community could support. Now, though, the community is global and the value potentials are astonishing. Even the limits of shipping have been eliminated. Microsoft doesn't even need to ship physical media to provide MS Office applications to businesses anywhere and everywhere on earth.

Let us consider a more basic example: music.

Until recorded music came along, if I wanted the best performance it meant hiring the best local musicians. These musicians might be great, or they might merely be the best in my small town. Once I could buy a recording, I could replace the local talent with music matching my tastes.

With the ability to choose between mediocre live music and outstanding, but recorded, music, it was certain that the recorded would win.

Recorded music replaced thousands of musicians. It also allowed us to enjoy music in places where live musicians wouldn't be, well, desirable. I can't imagine driving around with a pianist in the backseat of my car.

In time, the value of musicians and composers was concentrated among the superstars. The result was that groups like the Beatles were able to invest in technologies that gave them yet more advantages over local, live musicians. The Beatles moved from dual-track, to four-track, to eight-track recordings in their studio work. The recordings were better than live music, technically. Each success allowed more investment, and that created yet more value concentration.

This concentration of skills is impractical in some fields, at least for now. However, any field that is technology-intensive and prone to automation will eventually have superstars. The end result of skills concentration is value concentration, leading to wealth concentration.

The financial industry is a highly automated, technology-intense field. As a result, a few individuals can and do manage immense sums of money. Fewer and fewer people are needed to move capital. The result is that the most successful firms invest in technology and training to become even more efficient. You can see where this is heading: a few superstars are astonishingly wealthy.

Even chefs are experiencing the superstar effect. Cooking is as mundane a skill as you might imagine, but the best of the best are concentrating the wealth of restaurant menu design. Executive chefs were once limited by space and time to single locations. Today, a chef can fly from city to city every week or month to test menus and train head chefs. With the same technologies altering other industries, a chef can send recipe changes and even training videos to remote locations in an instant.

At the turn of the twenty-first century there were 1000 "leading" executive chefs world-wide. Today, there are fewer than 150 "leading" chefs, according to Indeed.com. There are fewer top-tier posts for chefs because one executive chef is expected to oversee managing chefs and head chefs at dozens, or even hundreds, of restaurants. The best chefs are truly the best at creating new recipes, so other chefs are reduced to implementing menus — at lower pay.

We can argue that the superstar trend isn't fair — but what is or isn't fair? If I am the best chef, best musician, or the best programmer, shouldn't my services be available to as many people as possible? And if people choose my services or products over those of others, shouldn't I be compensated?

Skill and value concentration should be understood and then discussed, but it isn't reasonable to condemn something we all do. Yes, we all seek to concentrate skills and value, even within our families.

Every family has a "best" cook, a "best" mechanic, a "best" whatever. We turn to that person for those tasks, which in turn means that person is gaining yet more experience and expertise. The best cook prepares meal after meal, and because we prefer that individual's cooking, he or she gets more practice. Other members of the family do not develop the same skills in the kitchen, but they are called upon for other tasks. Specialization is not, therefore, unique to business.

Another example to consider: the best youth athletes end up getting the most "game time" as children. This increased time on the field or court means these "better" athletes get even more practice. Eventually, these young people become great, while those getting less game time lose skills but turn to other activities.

We can complain about skills concentration, but in an advanced civilization you cannot be an expert in everything. Someone is bound to be better than you at something, and that will enable him or her to work towards being the best. You will specialize, too. That's how advanced societies are.

The only alternative to skills concentration would be living independently on rural farms. Even isolated farms are connected by technology today, so even that idealistic alternative is fanciful. We could adopt Amish customs, but even they have specialists in their communities. What's different is that their specialists are rewarded in ways that are not financial, but even Amish "stars" are recognized within a culture that demands humility.

Instead of complaining about superstars, maybe we should focus on how to improve opportunities to become stars in a wider variety of fields. Also, we might ask why we value some fields more than others, so that a superstar in music is paid so much more than a superstar in science research. Cultural judgments of value/worth are important in determining what children decide to do later in life. If youth perceive superstar athletes are worth more than scientists, you can expect more hours spent developing athletic skills than math skills.

The superstar effect is not going to vanish. How we manage it is the real question.

Note: This blog entry is the first in a series I plan to write on basic economics and daily life. My goal is to explain how things work -- not how I wish they worked or how anyone else wishes they worked.

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