(This text is the final draft of an article published in Transformation Spring 1996 Issue 8, London. Updated Jan 1998)
©Karl-Erik Sveiby 1 Jan 1998. All rights reserved.
Nick Leeson's sour half grin has become a symbol of the horrendous risks involved in the derivatives markets. The risks were made comprehensible. Scared bank managers then reassured us that the Barings Bank disaster was the works of a crook and that their systems would see to that it would not happen again. Rest assured and back to normal.
Do these managers know what business they are in? Did the sacked managers of Barings Bank know what business the Queen's bank had entered? A lot evidences that they did not. Derivatives are pure information and the business logic of the new information markets challenge lots of things that managers today take for granted.
In less than ten years the professional financial markets have become the most information-intensive environment in the world. They are extreme and they are therefore - for better and for worse - good illustrations of what we can expect in other environments when information in computerised networks replace physical goods and physical transactions.
The physical products of the financial markets - coins and securities - now exist almost exclusively in the form of Information on computer disks. Physical transportation of money is becoming increasingly rare; it is moved instead between computers in the form of Information. The marketplace exists only inside the computers, and stockbrokers "see" their business partners as blips on their screens, now that the stock exchange floor is no more.
We generally associate the word Information with both facts and communication of facts - hence the relatively positive connotation we usually give it. Information in this sense, however, has nothing to do with the concept of Information as used in Information theory and computer science. That concept of Information was formulated y Claude Shannon in 1948 in the classic A Mathematical Theory of Communication, and is actually an expression of the volume of Information carried by a telephony network (Shannon worked for Bell Telephone).
Shannon's concept is purely technical and says nothing about the content or meaning of Information. His interest was whether an "A" sent is an "A" received. This is why it fits so well with computers. A computer file contains nothing but electronic impulses. Software program can arrange them into words or images on screens or paper which human beings can interpret.
There we have two entirely distinct levels. One level is what is on the screen, data, numbers, blips or pictures or words, Information. The other level is how humans interpret what they see on the screens, knowledge. To a human being an "A" sent may be interpreted as an "A", a plough or a note. It sparks off a whole series of associations, depending on the context, earlier experiences and the emotional well-being of the interpreter. One person's interpretation is never the same as another's.
When Alan Turing and Norbert Wiener developed the mathematical model for the computer in the forties, they started with a theoretical model of how the human brain works. They - in common with many others - believed that systems science and Information theory reflected the way human beings formulate knowledge.
Information theory functions admirably when applied to communication between computers, but we know since the seventies that the operation of the human brain does not in fact match the model on which Information theory is based. What we call human knowledge is actually based on processes which are vastly more complicated than those available to the IT industry. Present day computers are however still based on Turing's and Shannon's concepts. This is why they will never be able to produce knowledge.
Somehow, still, we cling to the time-honoured notion that Information is linked to knowledge. We also live in a heavily computerized society where the way we talk about Information is strongly influenced by Information theory.
Computer managers, consultants, systems experts and representatives of the IT industry, all have a vested interest in preserving the association between Information and knowledge, so they use glowing terms to describe an informatized world.
The first thing we observe when an environment becomes as highly informatized as the financial markets is that transactions are made much faster than they used to be. The pace, moreover, is accelerating. The financial markets have now reached a stage when people no longer have fast enough reaction times to do business themselves; more and more transactions are being made by computer systems. In the financial markets we find program trading. In other industries electronic transfer of documents and automatic billing become increasingly common.
The second thing we observe is that prices of the informatised goods fluctuate much faster than they used to. This is particulary obvious in the financial markets but also commodity markets are much more volatile today.
Derivatives and other futures have been introduced to limit the risks. One buys or sells only the change in a share price or pork belly, not the actual good. Derivatives are thus pure Information. They were designed to afford protection to investors, but now it turns out that the derivative market is the riskiest of all, as the fate of Baring's Bank so glaringly demonstrates.
The risks appear to increase with increasing Information instead of diminishing as we would like to believe.
Thirdly, in no other environment has the investment in computers been greater than in the financial area. Have the moneys spent lowered the risk or increased the yields for their customers? There is no empirical evidence confirming that. The investment decisions appear as good or as bad as before computer era - despite they are supported by infinitely more Information.
Has any player created a lasting competitive advantage from investments in computer technology? No, Information as well as the new instruments or programs to handle it, spread with lightning speed so but no one is able to achieve a competitive edge compared to the competitors. The main effect of informatizing a competitive environment is that the players are forced to speed up their pace - only to stay in the same place.
The focus of the financial markets is on Information as a fast medium for communication. In the mass media we can observe how Information behaves in the content sense. Information in this sense was primarily used for control purposes, today managers are urged by the management gurus to see Information as a resource.
In the mass media world, Information has been traded as a resource since the industry was born in the early 19th century.
The graph shows roughly what the market for business and financial Information looks like in Sweden today. The degree of value added in the Information is plotted on one axis, and the lead time from the source to the reader/listener on the other. From the chart one can distinguish three main classes of value added and three main spans of lead time. I have made a rough categorisation into three levels of value added to Information:
Real-time media via computer have captured the market for the very fastest Information. Ether media have developed into a low-price channel for financial news and stockmarket prices with the lowest value added levels. Print media occupy all levels and time niches except the fastest.
The prices vary according to both time and value added. Highly codified and easily disseminated Information (share prices) has the lowest market value. The three lines seem to describe a roughly logarithmic curve. A common feature of all three is the strong influence of the time factor.
The price of share price data has fallen to the cost of transmitting the bit-stream. This Information, generally speaking, is worth no more than what it costs to retrieve them from the computers. The price of such simple and strictly codified Information as straight share prices falls rapidly as it becomes more universally accessible.
The price of plain news text is likewise falling fast; the longer the lead time, the cheaper it is. The fall is slowest for Information with the most value added, but it, too, is quite time-sensitive.
The faster media are growing while the slower are stagnant. If people have to choose between lead time and added value they seem to chose lead time.
The media market in the mid-nineties is now experiencing a renewed boom; the last one was in the mid-eighties. This time it is mainly in the area of TV and business/financial Information aimed at investors. In Europe alone, four new channels have been launched recently to broadcast business news and entertainment practically around the clock: European Business News, BBC World, Sky News and CNBC Money Wheel.
Who will pay for all this Information? Not the viewers, for they will receive the Information free. Only very special cable channels nowadays are bold enough to demand that TV viewers pay for what they see. All the revenues are expected from the advertisers. Most launches in the printed press today are also freebies. Even established papers boasting paid circulation like Financial Times pocket 75% of their revenues from the advertisers.
The new computerised media offer access to gigabytes of Information stored in the databases in public networks free of charge. You only pay an entrance fee to the gate provider. The Information is then (with a few exceptions) free, paid by the supplier of it.
So, the suppliers of Information pay - not the consumers. Is this how a valuable resource behaves on a market? It rather seems that the mass media markets teach us that Information is a glut product with a very short economic life.
Information markets are characterized by chaos. A report with a string of figures is replaced next week by one with different figures. "Facts" from one database tell one story, facts from a second or third tell another. An alarming research report is contradicted by one from another source. Such contradictions are not due to errors in the reports, but to the fact that reality itself is contradictory. Is a chaos of Information better than no Information at all?
My own experience from the fifteen years I have spent in the Information business confirms that it is getting harder and harder to charge for Information. There is no trouble finding people who want to spread Information free of charge. The trouble is finding people willing to spare the time to read what others have written or listen to what others wish to say.
For Information requires the reader or listener to do a large share of the work; it takes knowledge and energy to convert passive Information into something that can be acted upon. Since you do not know until after you have read a text or viewed a TV-program whether it was worthwhile, Information may even acquire a negative value.
All Information markets today are characterized by an excess of supply over demand, and there is nothing to indicate that that situation is about to change. Information is growing ever easier to produce, whereas human capacity to absorb Information is changing only slowly. The capacity cannot be enhanced to any significant degree except by higher education.
The bottleneck is the limited time people have at their disposal to read, watch and listen, not their money. This applies to all kinds of knowledge packaged as Information products, such as books, newspapers, films, TV and radio programmes, as well as computerised data bases and multimedia shows.
People no longer bother to read a full story. Contrary to common belief, the value of subjective opinions is therefore often higher than objective Information. When thinking in "normal" terms I therefore see mostly paradoxes: When a market turns into an Information market, the commerical value goes down - not up.
The main effect of informatizing an environment is that the players are forced to speed up their pace - only to stay in the same place.
The lessons from the Information intensive world suggest that we should reconsider our mindsets as regards the concept of Information.
I believe that the unconscious analogy between computer/Information and brain/knowledge is a dangerous one and suggest that a radical mindset like. . .
Information has nothing to do with human knowledge, skills or competence. It is at best worthless garbage which pollutes our world.
. . . is likely to lead our thoughts in a way more in line with what we are to expect in the future, therefore save you as a manager a lot of money and your staff a lot of pain.
The analogy has certainly cost IT-industry itself a lot. As recently as five years ago the Japanese computer industry abandoned its attempt to build what they called the fifth-generation computer, an artificial brain based on Information theory.
Worse is that the analogy leads managers to the fallacious belief that human dynamic knowledge is the same thing as Information which in some way or another "exists" passively out there in the organization. Which like Information in databases, can be "reengineered" or turned into "intellectual capital" as easily as signals are transmitted from computer to computer.
Such intellectual misconceptions cost a lot both in money and in human pain. Managers should know by now that human brains do not operate at all like computer chips and hard disks. We do not even have to send signals to transmit decipherable messages. An absent daughter who has promised to phone home at the weekend if she does not feel well has sent a message without a single signal if she does not telephone. Two acquaintances who pass each other in the street without giving any sign that they recognize each other can generate more decipherable Information in each other's minds than if they had exchanged greetings.
We use our whole body tacitly as a very sensitive medium for communication. A multitude of studies claim that a lecturer's body language conveys up to three times as much meaning as what he/she says.
The human brain is constructed to allow us to operate in conditions of uncertainty and to deal with unpredictable events by acting creatively based on a multitude of complex signals.
There is more wisdom in one experienced managers' gut-feeling than in any amount of Information to be found in databases or in management books.
No, Information does not solve the problem that has been with us since Man first appeared on this planet: how to orient ourselves in the chaos that we call the world, how to cope with it.
So - don't expect a bucket of gold at the other end of the Internet rainbow, it is more likely a dustbin!
What can a manager or author do get attention in the Information markets?
The following are five factors from mass media markets.
A short diagnostic test.
Shut your eyes. Then try to touch the tip of your nose with your index finger. At the same time, concentrate hard on what you are doing and on where your arm is at all times. Do the exercise slowly. Take 20 seconds for it.
How did it go? Quite well, probably. You managed to touch the tip of your nose even though you could not see it. This is because you have tacit knowledge of where the tip of your nose is and how you must move your arm to touch it. In the exercise, moreover, you were consciously focussing on your tacit knowledge. Normally we do not concentrate so deliberately on the physical motions we make. If we did, we would never get anything done, because our conscious minds are hopelessly inefficient Information processors compared to our unconscious minds.
The conscious mind is capable of processing somewhere between 16 and 40 bits of Information (ones and zeroes) per second, whereas the unconscious can handle no fewer than 11 million bits per second. We are thus aware of less than a millionth of all the Information that our brains process. While you were deliberately and laboriously focussing on the movement of your arm, your brain was rapidly and efficiently dealing with an enormous amount of other Information to keep track of all your bodily functions.
Conscious thought is thus energy-intensive and inefficient. On the other hand it is very flexible. It can be switched in a fraction of a second to concentrate our attention on our heads or our toes, on listening carefully or on reflective thinking. Which hand did you use in the exercise? If you are right-handed, you probably used the right one. (About 90% of all the people I ask to do this exercise use their right hands if they are right-handed.) Why not the left hand? You never gave it a thought, it was purely automatic. Am I right?
Over the years we build up innumerable patterns in our brains that serve as unconscious rules of procedure to cope with every conceivable situation. These rules save us a great deal of energy, enabling us to act quickly and effectively without having to think about what we are doing the whole time.
These rules of procedure are also an essential part of acquiring and improving skills. But the rules of procedure are also a limitation. Since they are always there, they affect new knowledge like a filter or a pair of spectacles. If you used your right hand in the exercise, you missed the experience of trying it with your left hand. No great loss in this instance, perhaps, but consider how you act in more complex situations at home or at work. How much happens automatically? How much of your ability to create new knowledge do you unconsciously switch off?
Human beings, unlike computers, can never forget everything. The greatest difficulty lies not in persuading people to accept news ideas, but in persuading them to abandon old ones. (John Maynard Keynes)
Karl-Erik Sveiby
June 13th 1995