Citicorp and Travelers Group, First Chicago NBD and Banc One, Bank of New York and Mellon Bank-these pending, or potential, deals are simply the latest in a flurry of monumental matchmaking attempts.

In this case, more is the shame, since the vast majority of these mergers arise from fatally flawed strategies.

Megamergers to build economies of scale are nothing more than a last- ditch stand by industry giants against the digital forces that are turning the rules of competition on their head. Rather than giving companies any competitive advantage, except possibly in the short term, such mergers are only likely to lock the players more deeply into old ways of doing business, making them more vulnerable to competition in the more efficient marketplace.

It is a 20th-century industrial approach to a 21st-century digital world.

The new economics of the digital age explain why most megamergers are doomed. We have all heard of Moore's Law, which states that computing power is doubling every 18 months, with costs holding constant, leading to faster, cheaper, and smaller computers.

Less well-known is Metcalfe's Law, an observation by 3Com Corp. founder Robert Metcalfe that networks-whether telephone, computer, or human- dramatically increase in value with each additional node or user.

Take fax machines or e-mail. With limited users, they were of limited use. But once they achieved critical mass, their usefulness multiplied greatly for all; just witness the rapid emergence and growing significance of the Internet to business.

Moore's Law and Metcalfe's Law have operated together in remarkable new ways. Moore's made possible the cheap digitization of nearly everything. Metcalfe's came into play once the Internet protocol was widely adopted as a unifying standard. At that point, the value of each additional node and user reached a critical point, and the Web began exerting a powerful pull.

The market today is improving its efficiency at the speed of Moore's Law and with the effectiveness of Metcalfe's Law-moving it ahead of those firms rooted in the Industrial Age, whose long histories of anti- competitive regulation and aging and expensive infrastructures often keep them from adopting new technology at anywhere near the pace of the market.

In short, as the market becomes more efficient, the size and organizational complexity of the modern industrial firm becomes increasingly untenable. Hence the growing trend toward outsourcing and downsizing, spinoffs, and carve-outs as a way to enhance economic and shareholder value.

As Nobel Prize-winning economist Ronald Coase noted in 1937, the rise of complex, geographically dispersed companies was a result of market inefficiency. Firms were created because the cost of organizing and maintaining them was cheaper than the transaction costs involved when individuals did business with each other using the market.

Corporations had a lock on technology and thus could use it to increase internal efficiency faster than the market. With the advent of cheap technology and massive public networks, the market now has the same access to technology, thus eliminating the historic advantages of scale.

Moore's Law and Metcalfe's Law are together creating a new digital marketplace, leading to what we call the Law of Diminishing Firms: As transaction costs in the open market approach zero, so does the optimal size of the firm.

Victims and beneficiaries of the Law of Diminishing Firms grow by the day. Auto-by-Tel, for example, uses the Web to remove many of the expensive and unpleasant transaction costs of buying and financing a car.

Not only is bigger no longer better, the new economics of the digital age explode other long-cherished business principles. For example, the electronic marketplace will not stand still while companies wait for previous investments to depreciate. So some trailblazers are preemptively destroying their own value chains before someone else can do it to them. The San Jose Mercury News, for example, gives away its content on-line. The hope is that by unleashing this type of killer application itself, the organization will be able to exert some control over how much earth is scorched in the process.

New entrants and early adopters of emerging technologies do not have fixed assets, which is how could become the world's largest bookseller without having to invest in bricks and mortar. The fallacy of "bigger is better" is that too much intellectual and financial capital is tied up in sustaining existing investments in stranded assets.

With the new economics, resorting to tried-and-true strategies for growth is misguided and downright dangerous. Each company must develop its own digital strategy, often by turning practices that would have been heretical under the old business paradigm into revolutionary new ways of doing business.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.