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‘Digital economy’: you don’t have a choice

digital-economy“The last 10 years of IT have been about changing the way people work. The next 10 years of IT will be about transforming your business.” — Aaron Levie, CEO of Box

This is a shallow dive in a deep pool. What is the digital economy? What does it mean for companies that must operate within it? What does counsel need to know in order to advise management? What does counsel tell its board of directors?

What is it?

The digital economy is an inclusive catch phrase understood to capture the impact of digital technology on everything in your business. The definition includes what happens inside your company: how your people work together, how you communicate, how you market and sell, how you order parts or services and manage inventory, how you bill and collect, how you hire, how you use big data and artificial intelligence (AI) to achieve efficiency, identify opportunities and increase profitability, how you determine what business you should be in (if not the business you conduct today).

The digital economy is about using hard tools (computers and communication systems) and soft tools (software that connects your people, including APIs [application programming interfaces that permit various software programs to communicate]). Digital expertise is essential to future internal operations, external operations, and achieving profitability by defining your market and your deliverables.

Disintermediation

It is an economy that will cause significant disintermediation.

Part of it is blockchain, a method of open record-keeping that eliminates intermediaries, steps and entities. (This extends far beyond crypto-currencies, and is far more important.) In the financial sphere, blockchain may eliminate or alter the functions of banks, credit cards, securities exchanges, accounting and auditing firms, and other intermediaries. Blockchain is further described below.

Big data also disintermediates: it can obsolete consultants, surveys, market researchers, pricing firms, financial analysts, head-hunters and HR people. It can identify where you make and lose money. It can tell you which products and services to provide, where and at what price point.

The internet also disintermediates. It can replace entire intermediation functions: real estate brokers, physical stores, supply chain players like wholesalers, distributors, warehouses and sales people. Internally, it can reduce your staff, speed your production, cut your costs, and solve delivery issues where speed is king (plotting routes, robots, self-driving vehicles, things that fly).

Digital economy skill is a mindset that is the ultimate future weapon in the business world. Your company plays in that world whether you know it or not. And knowing it is not enough, you need to be ahead of it. Ask Blockbuster. Ask Toys R Us. Ask Kodak, which is now remaking itself entirely.

What laws apply?

The law of the digital economy is scattered and nascent. The reason is that digitization of business affects everything. The law cannot keep pace. Counsel needs to search for the ever-expanding legal impact of the digital revolution by looking for the newest developments relating to the various applicable legal issues present in transactions currently effected by traditional means. Today, the most obvious area of legal involvement is dealing with cyber-risk, which can be catastrophic but, in the long term, will not be the most profound legal issue.

There are multi-volume treatises covering the law of the internet, and how to sell, contract and communicate. Companies providing the hardware and software must deal with all the IP issues, and push antitrust concepts in that inter-connectivity requires competitors or future competitors to work together on standards, interfaces and connectivity with each other’s technology. Users of digital technology must adapt promptly to rapidly changing methods of internal and external operation. Non-users of digital technology run a good chance of being left in the dust.

Sellers of goods and services (not to mention political parties) need to be aware of future laws that will limit access to data amassed from social media and databases through “scraping” or analysis. Use of improper data creates reputational risk and ultimately will create legal liability. Congress presently is considering regulation of these practices.

Sellers also need to learn how to protect their copyrights, marks, and trade dress in electronic commerce. Companies in health care already have their data closely regulated. Offshore legislation impacts what data an online vendor may gather from a foreign jurisdiction (see the new EU GDPR regulations effective May 25).

But these issues in current awareness are only the tip of the iceberg. The digital revolution will remake hiring, labor and discrimination laws. It will ultimately force alterations in the Uniform Commercial Code and will change our structure of dispute-resolution mechanisms (courts, arbitration, other tribunals) and issues of choice of law and forum.

It will compel changes in laws controlling undesirable business behavior: contract remedies, tort definitions, business and product libel, credit facilities and regulation, product disclosure and misstatement, definitions of who can sue whom for what. We see also the current debate as what digitization means to the definition of money, with implications for the role of the national states.

But right now, today, the biggest impact is not on the law, which is typically a following indicator. The biggest impact is on your company, how it runs and whether it survives.

About blockchain

One element of the digital economy is blockchain technology. The term suffers from a lack of precise understanding of its mechanics and its possible impacts, not to mention its prominence in the marketing of unregistered securities disguised as crypto-currency and from its deceptive inclusion in company names and literature designed to hype investment or market values.

A functional definition is easy: a ledger of transactions of any nature, maintained in electronic form, accessible to multiple permitted parties to a given transaction. Specifically, information is recorded and stored in the “cloud” of computer networks, accessed only by transaction parties, and accessed by codes called keys. That information cannot be changed once finalized, nor amended except by a similar robust process.

Today, blockchain technology reportedly is being used as a simple ledger for numerous purposes, including for example the sale of livestock, inventory control, bitcoin transactions and management of securities portfolios.

You also could record stock trades directly, eliminating brokers and registrars and exchanges. Delaware has legislated permission for the blockchain maintenance of corporate ownership data. You also could replace registries of deeds, lawyers and title insurance policies by recording realty transfers and liens.

honig-stephen

Being a director at this moment of the burgeoning digital age is not necessarily only a young person’s game.

Blockchain contracting

The entire contracting process can be disrupted. Counsel needs to become adept at contract formation using blockchain. We have been trained to prepare “wet contracts,” those embodied in “hard copy.” Disputes arise in identifying definitive copies or tracking amendments. Who has the paper for the definitive deal? Using software, a “smart contract” can be created and performed through blockchain technology. A draft can be negotiated, accepted by all parties and electronically signed using electronic code “keys,” and locked into an unalterable data block.

But you also have created a “smart” contract that can facilitate actual contract performance. Let us say it calls for delivery of goods followed by payment. Protocols for proof of receipt of goods — say, from a shipper — can provide delivery confirmation. On receipt of that information, funds could be automatically transferred electronically. No human being need participate in any of these performance steps.

Technology does not eliminate all risk of error or fraud. Companies will need to attend to these risks. Data relating to proof of performance may be compromised. Poor processes may permit unauthorized access to a party’s key. Insurance against such risks may be indicated. There will be legal issues in assigning liability for design or technology failure, or for non-compliance with law relating to the subject matter of the contract (rather than to its manner of formation), and issues of enforcement (jurisdiction, venue, service).

But blockchain is disruptive and expanding quickly. Per the National Association of Corporate Directors’ Directorship magazine, “Companies today that do nothing about blockchain are at risk because you have consumers running hard on adopting new technologies. … If you are not in these conversations from a strategic point of view, there is a risk on the horizon of not understanding the changes that are coming.”

Counsel and boards

Management needs to understand the digital economy and take the lead in implementation. But boards are responsible for overseeing strategy, and its handmaiden, risk mitigation. Counsel needs to remind boards that they must monitor company response to all aspects of the digital economy: how the company works inside, what products and services it delivers, what data tools should be instituted, what major changes may be needed to stay competitive.

Though directors typically understand this fiduciary obligation, the pace of change is such that counsel needs gently to make sure that these matters get the attention they deserve, and to facilitate the communication channels between management and the board.

I see boards struggling to understand the issues and the depth of focus they must apply, not to mention the bravery it takes to engage major rapid change. I also see would-be board members, often with a technology background, searching to join boards so that they may participate in this sensitive task.

Being a director at this moment of the burgeoning digital age is not necessarily only a young person’s game. Directors don’t need to be MIT graduates to play. Directors need to be young of mind, however, to make sure that management is aware of change and is retaining the requisite implementation talent and tools.

The average age of a public company director (2016 data) is 63, and the average for a newly hired director is 57. I would not be surprised if successful privately held companies reflect a similar board demographic. Boards tend to be contemplative. Holders of traditional views must be motivated to move quickly. A static strategy today is an unmitigated risk.

Management also often is not the driver of this strategic imperative to respond rapidly. Management may be of an older generation, or used to an older pace of change. Management may not have experience in elements of the digital marketplace. Management may not be in a position properly to assess risk.

Management also may be enjoying current profitable performance, feeling safe during “normal” earnings lulls, and reaping the compensation benefits from cash bonuses and in-the-money options. Management also may believe, often rightly, that rapid major change is risky, may lose money, will temporarily depress economics and share price, and surely will fail in at least some areas.

Role of counsel

What does counsel do to assist its company?

I am a believer in providing education and exposure to both management and boards; creating an awareness of the growing buzz and pervasiveness of the digital economy is a way to make sure that focus is fostered at every level, and a sense of appropriate urgency created.

Looking around, there is a huge, varied and exploding readable literature about the digital economy. Accounting firms, law firms, consultancies, journals and business associations are publishing constantly. Indeed, the general press often runs articles on aspects of the digital revolution; for example, a recent Economist issue (March 31) contained a granular analysis of the expansion of AI from the technology sector to the governance sector, focusing on supply chains, customer service, HR and the workplace of the future.

Publications of the NACD, both online and in its Directorship magazine, should be shared with management and the board as suggestive of specific topics for focus. Recent articles have highlighted the role of millennials in fostering change, their appropriate challenge to preconceptions, their impact on work environments and the “gig” economy. An awareness over the broad spectrum of digital impact also may well help a board identify skill gaps in board membership which can be addressed by adding director expertise.

Indeed, a recent NACD Board Leaders’ blog post, noting that “our experience indicates that most boards do not fully grasp the opportunities and risks associated with digital transformation,” suggests four specific actions that boards might call upon management to institute:

First, conduct a corporate assessment of the competencies digital leaders must have. Assessments should cover the disciplines of vision and strategy; culture; organizational structure; communications and sales; technological innovation; and, big data analytics.

Second, adopt a clear digital strategy. Should your company lead as an industry disrupter, or alternately monitor and follow the competition, reacting only to defend market share?

Third, trust in people to effect changes which are clearly defined. Identify the desired processes and policies, assess the risks, and then implement. “Digital thinking requires organizations to solve the problem of rapid growth and scalability to rely primarily on technology rather than people, as opposed to the traditional focus on scaling ahead of demand.”

Fourth, continually monitor products, services and processes and rapidly adjust strategy to make sure that your business is focused on what is expected from an enterprise-wide digital strategy. It is the job of the board to ensure the alignment of the organization and to “recognize the signs of organizational short-termism and executive management’s emotional investment in traditional business models.”

Exposure to current literature and learning, together with insistence on board leadership in driving an enterprise-wide focus on the digital economy, should lead to boards placing all things digital on their regular agenda. This is an instance in which, if management is not placing elements of AI, big data and the digital economy on most or all of the board dockets, then the board itself needs to call for its inclusion.

Counsel can assist in this process, so that the relationship between management and the board remains cordial while the board can push the issue to the extent not being pursued with vigor by management. Indeed, the global impact of the digital economy is so broad for almost all companies that it may well be best served by suggesting a retreat where outside expert advice can be shared with management and the board, and then institutional alignment addressed.

Key director attribute

A recent panel discussion among sitting directors, held at a Boston breakfast meeting of the NACD (New England chapter), gave practical guidance for meeting the difficult role required of boards. Aside from asserting the pervasive and rapid impact of the digital economy and expressing amazement that so many companies with seemingly robust boards got blindsided (Polaroid, Circuit City, newspapers, box retailers), the panel identified the key underlying theme for directors: courage.

Boards need to understand, but be willing to undertake, identified risk to effect necessary change. Failure to act can be fatal.

Stephen M. Honig is a partner at Duane Morris in Boston.

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