digital vs physical businesses

In the first part, I will analyze how digital businesses and physical businesses are complementary to each other via the following dualities:

Risk of Death vs Potential for Growth
Controlling Demand vs Controlling Supply
Network Effects vs Scale Effects
Mind vs Body
Borrowing Space vs Borrowing Time

In the second part, I will analyze how the rise of digital businesses against physical businesses is triggering the following trends:

Culture is Shifting from Space to Time
Progress is Accelerating
Science is Becoming More Data-Driven
Economy is Getting Lighter
Power is Shifting from West to East

Duality 1: Risk of Death vs Potential for Growth

Since information is frictionless, every digital startup has a potential for fast growth. But since the same fact holds for every other startup as well, there is also a potential for a sudden downfall. That is why defensibility (i.e. ability to survive after reaching success) is often mentioned as the number one criterion by the investors of such companies.

Physical businesses face the inverse reality: They are harder to grow but easier to defend, due to factors like high barriers to entry, limited real estate space, hard-to-set-up distribution networks etc. That is why competitive landscape is the most scrutinized issue by the investors of such companies.

Duality 2: Controlling Supply vs Controlling Demand

In the physical world, limited by scarcity, economic power comes from controlling supply; in the digital world, overwhelmed by abundance, economic power comes from controlling demand.
- Ben Thompson - Ends, Means and Antitrust

Although Ben’s point is quite clear, it is worth expanding it a little bit.

In the physical world, supply is much more limited than demand and therefore whoever controls the supply wins.

Demand. Physical consumption is about hoarding in space which is for all practical purposes infinite. Since money is digital in its nature, I can buy any object in any part of the world at the speed of light and that object will immediately become mine.
Supply. Extracting new materials and nurturing new talents take a lot of time. In other words, in the short run, supply of physical goods is severely limited.

In the digital world, demand is much more limited than supply and therefore whoever controls the demand wins:

Demand. Digital consumption is information based and therefore cognitive in nature. Since one can pay attention to only so many things at once, it is restricted mainly to the time dimension. For instance, for visual information, daily screen time is the limiting factor on how much can be consumed.
Supply. Since information travels at the speed of light, every bit in the world is only a touch away from you. Hence, in the short run, supply is literally unlimited.

Duality 3: Scale Effects vs Network Effects

Physical economy is dominated by geometric dynamics since distances matter. (Keyword here is space.) Digital economy on the other hand is information based and information travels at the speed of light, which is for all practical purposes infinite. Hence distances do not matter, only connectivities do. In other words, the dynamics is topological, not geometric. (Keyword here is network.)

Side Note: Our memories too work topologically. We remember the order of events (i.e. temporal connectivity) easily but have hard time situating them in absolute time. (Often we just remember the dates of significant events and then try to date everything else relative to them.) But while we are living, we focus on the continuous duration (i.e. the temporal distance), not the discrete events themselves. That is why the greater the number of things we are pre-occupied with and the less we can feel the duration, the more quickly time seems to pass. In memory though, the reverse happens: Since the focus is on events (everything else is cleared out!), the greater the number of events, the less quickly time seems to have passed.

This nicely ties back to the previous discussion about defensibility. Physical businesses are harder to grow because that is precisely how they protect themselves. They reside in space and scale effects help them make better use of time through efficiency gains. Digital businesses on the other hand reside in time and network effects help them make better use of space through connectivity gains. Building protection is what is hard and also what is valuable in each case.

Side Note: Just as economic value continuously trickles down to the space owners (i.e. land owners) in the physical economy, it trickles down to “time owners” in the digital economy (i.e. companies who control your attention through out the day).

Scale does not correlate with defensible value in the digital world, just as connectivity does not correlate with defensible value in the physical world. Investors are perennially confused about this since scale is so easy to see and our reptilian brains are so susceptible to be impressed by it.

Of course, at the end of the day, all digital businesses thrive on physical infrastructures and all physical businesses thrive on digital infrastructures. This leads to an interesting mixture.

As a structure grows, it suffers from internal complexities which arise from increased interdependencies between increased number of parts.
Similarly, greater connectivity requires greater internal scale. In fact, scalability is a huge challenge for fast-growing digital businesses.

Hence, physical businesses thrive on scale effects but suffer from negative internal network effects (which are basically software problems), and digital businesses thrive on network effects but suffer from negative internal scale effects (which are basically hardware problems). In other words, these two types of businesses are dependent on each other to be able to generate more value.

As physical businesses get better at leveraging software solutions to manage their complexity issues, they will break scalability records.
As digital businesses get better at leveraging hardware solutions to manage their scalability issues, they will break connectivity records.

Note that we have now ventured beyond the world of economics and entered the much more general world of evolutionary dynamics. Time has two directional arrows:

Complexity. Correlates closely with size. Increases over time, as in plants being more complex than cells.
Connectivity. Manifests itself as “entropy” at the lowest complexity level (i.e. physics). Increases over time, as evolutionary entities become more interlinked.

Evolution always pushes for greater scale and connectivity.

Side Note: "The larger the brain, the larger the fraction of resources devoted to communications compared to computation." says Sejnowski. Many scientists think that evolution has already reached an efficiency limit for the size of the biological brain. A great example of a digital entity (i.e. the computing mind) whose growing size is limited by the accompanying growing internal complexity which manifests itself in the form of internal communication problems.

Duality 4: Mind vs Body

All governments desire to increase the value of their economies but also feel threatened by the evolutionary inclination of the economic units to push for greater scale and connectivity. Western governments (e.g. US) tend to be more sensitive about size. They monitor and explicitly break up physical businesses that cross a certain size threshold. Eastern governments (e.g. China) on the other hand tend to be more sensitive about connectivity. They monitor and implicitly take over digital businesses that cross a certain connectivity threshold. (Think of the strict control of social media in China versus the supreme freedom of all digital networks in US.)

Generally speaking, the Western world falls on the right-hand side of the mind-body duality, while the Eastern world falls on the left-hand side.

As mentioned above, Western governments care more about the physical aspects of reality (like size) while Eastern governments care more about the mental aspects of reality (like connectivity).
Western sciences equate the mind with the brain, and thereby treats software as hardware. Eastern philosophies are infused with panpsychic ideas, ascribing consciousness (i.e. mind-like properties) to the entirety of universe, and thereby treats hardware as software.

We can think of the duality between digital and physical businesses as the social version of the mind-body duality. When you die, your body gets recycled back into the ecosystem. (This is no different than the machinery inside a bankrupt factory getting recycled back into the economy.) Your mind on the other hand simply disappears. What survive are the impressions you made on other minds. Similarly, when digital businesses die, they leave behind only memories in the form of broken links and cached pages, and therefore need “tombstones” to be remembered. Physical businesses on the other hand leave behind items which continue to circulate in the second-hand markets and buildings which change hands to serve new purposes.

Duality 5: Borrowing Space vs Borrowing Time

Banking too is moving from space to time dimension, and this is happening in a very subtle way. Yes, banks are becoming increasingly more digital, but this is not what I am talking about at all. Digitalized banks are more efficient at delivering the same exact services, continuing to serve the old banking needs of the physical economy. What I am talking about is the unique banking needs of the new digital economy. What do I mean by this?

Remember, physical businesses reside in space and scale effects help them make better use of time through efficiency gains. Digital businesses on the other hand reside in time and network effects help them make better use of space through connectivity gains. Hence, their borrowing needs are polar opposite: Physical businesses need to borrow time to accelerate their defensibility in space, while digital businesses need to borrow space to accelerate their defensibility in time. (What matters in the long run is only defensibility!)

But what does it mean to borrow time or space?

Lending time is exactly what regular banks do. They give you money and charge you an interest rate, which can be viewed as the cost of moving (discounting) the money you will be making in the future to now. In other words, banks are in the business of creating contractions in the time dimension, not unlike creating wormholes through time.
Definition of space for a digital company depends on the network it resides in. This could be a specific network of people, businesses etc. A digital company does not defend itself by scale effects, it defends itself by network effects. Hence its primary goal is to increase the connectivity of its network. In other words, a digital company needs creation of wormholes through space, not through time. Whatever facilitates further stitching of its network satisfies its “banking needs”.

Bankers of the digital economy are the existing deeply-penetrated networks like Alibaba, WeChat, LinkedIn, Facebook, Amazon etc. What masquerades as a marketing expense for a digital company to rent the connectivity of these platforms is actually in part a “banking” expense, not unlike the interest payments made to a regular bank.

Trend 1: Culture is Shifting from Space to Time

Culturally we are moving from geometry to topology, more often deploying topological rather than geometric language while narrating our lives. We meet our friends in online networks rather than physical spaces.

Correlation between the rise of the digital economy and the rise of the experience economy (and its associated cultural offshoots like hipster movement and decluttering movement) is not a coincidence. Experiential goods (not just those that are information-based) exhibit the same dynamics as digital goods. They are completely mental and reside in time dimension.

Our sense of privacy too is shifting from space dimension to time dimension. We are growing less sensitive about sharing objects and more sensitive about sharing experiences. We are participating in a myriad of sharing economies, but also becoming more ruthless about time optimization. (What is interpreted as a general decline in attention span is actually a protective measure erected by the digital natives, forcing everyone to cut their narratives short.) Increasingly we are spending less time with people although we look more social from outside since we share so many objects with each other.

Our sense of aesthetics has started to incorporate time rather than banish it. We leave surfaces unfinished and prefer using raw and natural-looking rather than polished and new-looking materials. Everyone has become wabi-sabi fans, preferring to buy stuff that time has taken (or seems to have taken) its toll on them.

Even physics is caught in the Zeitgeist. Latest theories are all claiming that time is fundamental and space is emergent. Popular opinion among the physicists used to be the opposite. Einstein had put the final nail on the coffin by completely spatializing time into what is called spacetime, an unchanging four-dimensional block universe. He famously had said “the distinction between past, present, and future is only a stubbornly persistent illusion.”

Trend 2: Progress is Accelerating

As economies and consumption patterns shift to time dimension, we feel more overwhelmed by the demands on our time, and life seems to progress at a faster rate.

Let us dig deeper into this seemingly trivial observation. First recall the following two facts:

In a previous blog post, I had talked about the effect of aging on perception of time. As you accumulate more experience and your library of cognitive models grows, you become more adept at chunking experience and shifting into an automatic mode. What was used to be processed consciously now starts getting processed unconsciously. (This is no different than stable software patterns eventually trickling down and hardening to become hardware patterns.)
In a previous blog post, I had talked about how the goal of education is to learn how not to think, not how to think. In other words, “chunking” is the essence of learning.

Combining these two facts we deduce the following:

Learning accelerates perception of time.

This observation in turn is intimately related to the following fact:

Social progress accelerates over time.

What exactly is this relation?

Remember, at micro-level, both learning and progress suffer from the diminishing returns of S-curves. However, at the macro-level, both overcome these limits via sheer creativity and manage to stack S-curves on top of each other to form a (composite) exponential curve that literally shoots to infinity.

This structural similarity is not a coincidence: Progress is simply the social version of learning. However, progress happens out in the open, while learning takes place internally within each of our minds and therefore can not be seen. That is why we can not see learning in time, but nevertheless can feel its acceleration by reflecting it off time.

Side Note: For those of you who know about Ken Wilber’s Integral Theory, what we found here is that “learning” belongs to the upper-left quadrant while “progress” belongs to the lower-right quadrant. The infinitary limiting point is often called Nirvana in personal learning and Singularity in social progress.

Recall how we framed the duality between digital and physical businesses as the social version of the mind-body duality. True, from the individual’s perspective, progress seems to happen out in the open. However, from the perspective of the mind of the society (represented by the aggregation of all things digital), progress “feels” like learning.

Hence, going back to the beginning of this discussion, your perception of time accelerates for two dual reasons:

Your data processing efficiency increases as you learn more.
Data you need to process increases as society learns more.

Time is about change. Perception of time is about processed change, and how much change your mind can process is a function of both your data processing efficiency (which defines your bandwidth) and the speed of data flow. (You can visualize bandwidth as the diameter of a pipe.) As society learns more (i.e. progresses further), you become bombarded with more change. Thankfully, as you learn more, you also become more capable of keeping up with change.

There is an important caveat here though.

Your mind loses its plasticity over time.
The type of change you need to process changes over time.

The combination of these two facts is very problematic. Data processing efficiency is sustained by the cognitive models you develop through experience, based on past data sets. Hence, their continued efficiency is guaranteed only if the future is similar to the past, which of course is increasingly not the case.

As mentioned previously, the exponential character of progress stems from the stacking of S-curves on top of each other. Each new S-curve represents a discontinuous creative jump, a paradigm shift that requires a significant revision of existing cognitive models. As progress becomes faster and life expectancy increases, individuals encounter a greater number of such challenges within their lifetimes. This means that they are increasingly at risk of being left behind due to the plasticity of their minds decreasing over time.

This is exactly why the elderly enjoy nostalgia and wrap themselves inside time capsules like retirement villages. Their desire to stop time creates a demographic tension that will become increasingly more palpable in the future, as the elderly become increasingly more irrelevant while still clinging onto their positions of power and keeping the young at bay.

Trend 3: Science is Becoming More Data-Driven

Rise of the digital economy can be thought of as the maturation of the social mind. The society as a whole is aging, not just us. You can tell this also from how science is shifting from being hypothesis-driven to being data-driven, thanks to digital technologies. (Take a look at the blog post I have written on this subject.) Social mind is moving from conscious thinking to unconscious thinking, becoming more intuitive and getting wiser in the process.

Trend 4: Economy is Getting Lighter

As software is taking over the world, information is being infused into everything and our use of matter is getting smarter.

Automobiles weigh less than they once did and yet perform better. Industrial materials have been replaced by nearly weightless high-tech know-how in the form of plastics and composite fiber materials. Stationary objects are gaining information and losing mass, too. Because of improved materials, high-tech construction methods, and smarter office equipment, new buildings today weigh less than comparable ones from the 1950s. So it isn’t only your radio that is shrinking, the entire economy is losing weight too.

Kevin Kelly - New Rules for the New Economy (Pages 73-74)

Energy use in US has stayed flat despite enormous growth. We now make less use of atoms, and the share of tangibles in total equity value is continuously decreasing. As R. Buckminster Fuller said, our economies are being ephemeralized thanks to the technological advances which are allowing us to do "more and more with less and less until eventually [we] can do everything with nothing."

This trend will probably, in a rather unexpected way, ease the global warming problem. (Remember, it is the sheer mass of what is being excavated and moved around, that is responsible for the generation of greenhouse gases.)

Trend 5: Power is Shifting from West to East

Now I will venture far further and bring religion into the picture. There are some amazing historical dynamics at work that can be recognized only by elevating ourselves and looking at the big picture.

First, let us take a look at the Western world.

Becoming. West chose a pragmatic, action-oriented attitude towards Becoming and did not directly philosophize about it.
Being. Western religions are built on the notion of Being. Time is deemed to be an illusion and God is thought of as a static all-encompassing Being, not too different from the entirety of Mathematics. There is believed to be an order behind the messy unfolding of Becoming, an order that is waiting to be discovered by us. It is with this deep conviction that Newton managed to discover the first mathematical formalism to predict natural phenomena. There is nothing in the history of science that is comparable to this achievement. Only a religious zeal could have generated the sort of tenacity that is needed to tackle a challenge of this magnitude.

This combination of applying intuition to Becoming and reason to Being eventually led to a meteoric rise in technology and economy.

Side Note: Although an Abrahamic religion itself, Islam did not fuel a similar meteoric rise, because it was practiced more dogmatically. Christianity on the other hand self-reformed itself into a myriad of sub-religions. Although not too great, there was enough intellectual freedom to allow people to seek unchanging patterns in reality, signs of Being within Becoming. Islam on the other hand persecuted any such aspirations. Even allegorical paintings about Being was not allowed.

East did the opposite and applied reason to Becoming and intuition to Being.

Becoming. East based its religion in Becoming and this instilled a fundamental suspicion against any attempts to mathematically model the unfolding reality or seek absolute knowledge. Of course, reasoning about Becoming without an implicit belief in unchanging absolutes is not an easy task. In fact, it is so hard that one has no choice but to be imprecise and poetic, and of course that is exactly what Eastern religions did. (Think of Taoism.)
Being. How about applying intuition to Being? How can you go about experiencing Being directly, through the “heart” so to speak? Well, through non-verbal silent meditation of course! That is exactly what Eastern religions did. (Think of Buddhism.)

Why could not East reason directly about Becoming in a formal fashion, like West reasoned directly about Being using mathematics? Remember Galileo saying "Mathematics is the language in which God has written the universe." What would have been the corresponding statement for the East? In other words, what is the formal language of Becoming? It is computer science of course, which was born out of Mathematics in the West around 1930s.

Now you understand why West was so lucky. Even if East had managed to discover computer science first, it would have been useless in understanding Becoming, because without the actual hardware to run simulations, you can not create computational models. A model needs to be run on something. It is not like a math theory in a book, waiting for you to play with it. Historically speaking, mathematics had to come first, because it is the cheaper, more basic technology. All you need is literally a pen, a paper and a trash bin.

Side Note: Here is a nerdy joke for you… The dean asks the head of the physics department to see him. “Why are you using so many resources? All those labs and experiments and whatnot; this is getting expensive! Why can’t you be more like mathematicians – they only need pens, paper, and a trash bin. Or philosophers – they only need pens and paper!”

But now is different. We have tremendous amounts of cheap computation and storage at our disposal, allowing us to finally crack the language of Becoming. Our entire economy is shifting from physical to digital, and our entire culture is shifting from space to time. An extraordinary period indeed!

It was never a coincidence that Chinese mathematicians chose to work in (and subsequently dominated) statistics, the most practical fields within mathematics. (They are culturally oriented toward Becoming.) Now all these statisticians are turning into artificial intelligence experts while West is still being paranoid about the oncoming Singularity, the exponential rise of AI.

Why have the Japanese always loved robots while the West has always been afraid of them? Why is the adoption of digital technologies happening faster in the East? Why are the kids and their parents in the East less worried about being locked into digital screens? As we elaborated above, the answer is metaphysical. Differences in metaphysical frameworks (often inherited from religions) are akin to the hard-to-notice (but exceptionally consequential) differences in the low-level code sitting right above the hardware.

Now guess who will dominate the new digital era? Think of the big picture. Do not extrapolate from recent past, think of the vast historical patterns.

I believe that people are made equal everywhere and in the long-run whoever is more zealous wins. East is more zealous about Becoming than the West, and therefore will sooner or later dominate the digital era. Our kids will learn their languages and find their religious practices more attractive. (Meditation is already spreading like wildfire.) What is “cool” will change and all these things will happen effortlessly in a mindless fashion, due to the fundamental shift in Zeitgeist and the strong structural forces of economics.

Side Note: Remember, in Duality 4, we had said that the East has an intrinsic tendency to regulate digital businesses rather than physical businesses. And here we just claimed that the East has an intrinsic passion for building digital businesses rather than physical businesses. Combining these two observations, we can predict that the East will unleash both greater energy and greater restrain in the digital domain. This actually makes a lot of sense, and is in line with the famous marketing slogan of the tyre manufacturing company Pirelli: “Power is Nothing Without Control”

Will the pendulum eventually swing back? Will the cover pages again feature physical businesses as they used to do a decade ago? The answer is no. Virtualization is one of the main trends in evolution. Units of evolution are getting smarter and becoming increasingly more governed by information dynamics rather than energy dynamics. (Information is substrate independent. Hence the term “virtualization”.) Nothing can stop this trend, barring some temporary setbacks here and there.

It seems like West has only two choices in the long run:

It can go through a major religious overhaul and adopt a Becoming-oriented interpretation of Christianity, like that of Teilhard de Chardin.
It can continue as is, and be remembered as the civilization that dominated the short intermediary period which begun with the birth of mathematical modeling and ended with the birth of computational modeling. (Equivalently, one could say that West dominated the industrial revolution and East will dominate the digital revolution.)

If you liked this post, you will probably enjoy the older post Innovative vs Classical Businesses as well. (Note that digital does not mean innovative and physical does not mean classical. You can have a classical digital or an innovative physical business.)