As part of my continuing series of posts on exciting business strategies, this time I would like to talk about the power of network effects. Network effects can have multiple fantastic properties, including simultaneously providing rapid adoption rates as well as erecting barriers to entry.
A network effect takes place when the value someone places on something increases with the number of people who use that thing. If I enjoy taking a taxi to work rather than walking in the rain, I don't value that taxi any more if other people also are taking taxis to work. However, if I use a certain operating system, I will get more value out of it if everyone else also uses that operating system - there will be more software, support will be more readily available, and costs will go down. This is how Microsoft has managed to maintain its lock with Windows, now that it is the dominant system. This is why VHS finally won out over Beta, DVDs over Div-X, and this explains the various successes and failures of the console gaming systems. Whichever system managed to establish a lead ended up dominating the market.
What does this have to do with Harry Potter? Well, after the release of the final book in the series I have been reading a flurry of posts on the book. However, one of the most interesting (I've looked for it, but I can't find the link) was a post describing one of the reasons for Harry Potter's success and this was due to the fact that the book had become popular enough to benefit from a network effect. Most books are enjoyed by the reader, independent of what other people are reading, yet because Harry Potter was so huge, the experience of reading could be shared with other Harry Potter readers. Harry Potter became more exciting because many other people were reading Harry Potter. Woe to the child who shows up in the schoolyard not knowing what happened in the latest Harry Potter installment!
So, if you are developing a business, if the business strategy can include a network effect, allowing for the value of your product/service to improve as the number of installed users increases, then you can be included in the same list as Microsoft, Nintendo, Sony, and J.K. Rowling, which is a pretty good list indeed.
Showing posts with label marketing strategy. Show all posts
Showing posts with label marketing strategy. Show all posts
Wednesday, August 01, 2007
Monday, July 30, 2007
Disruptive Technologies
I have been wanting to write a blog post about this topic for some time. I think it is one of the greatest concepts in technology marketing strategy, and yet I think it is one of the most misunderstood. When I use the term Disruptive Technology, I am referring to the phemonenon discussed by Professor Clay Christensen in his book, The Innovator's Dilemma. I highly recommend this book, and it's follow-up, The Innovator's Solution, for anyone devising a marketing strategy for a technology company. These books show how certain types of technologies, as they mature, can displant Sustaining Technologies, even though they originally may be inferior to these technologies.
Let me begin by describing what does not constitute a disruptive technology. Many people assume that a disruptive technology is one that is "really different"; specifically something that is technologically impressive, the "next generation", and generally a lot better than what it is replacing. As I will discuss, this is generally an incorrect way to look at these technologies. For example, some people mistakenly say that the CD was a disruptive technology over the audiotape, because, CDs are "really different" from audiotapes. By the same logic, it is argued that the Internet itself is a disruptive technology (in this case, it isn't even mentioned what technology the Internet "disrupts"), solely because, well, the Internet is really different, isn't it? I mean, it's a pretty big thing, so it's got to be disruptive, right? The same argument is used for iPods, GPS navigation, and DVRs. In some cases these are disruptive technologies, in most cases they are not.
A marketing manager at one of the companies I worked with in the past used to say to me, "Selling disruptive technologies into conservative markets is really hard." This company made a lot of extremely cool technological products, however, few of them could be argued to be disruptive technologies, and there were many other reasons that it was difficult for the firm to sell its products. The key thing to understand is that a disruptive technology will almost certainly be hard to sell into a conservative market - that's why you shouldn't try. The beauty of a disruptive technology is that it should be sold into the market that values the product. Most disruptive technologies, when tried to be sold head-to-head against traditional sustaining technologies will often lose.
The reason that the definition above is often incorrect is that a disruptive technology is often one which is inferior to a current technology on the metrics valued by the incumbant organization and market. However, the technology addresses market needs by a different market - often one without competition, and (here's the best part) often unattractive to the incumbant firm. This allows the startup to grow its product without competition.
The reason that the incumbant firm cannot compete effectively against the startup in these situations, is that the incumbant firm either cannot recognize the value of the inferior product, or it is making good margins selling a premium product, and the sales the incumbant loses to the startup (if any) are the low-margin unattractive customers. When this happens, the incumbant sees its gross margins increase - it actually feels good to lose its business to the startup, and thus it does not recognize the threat.
Because of this, the CD is not a disruptive technology to the audio tape. The metrics that the incumbant manufacturers and the market value about traditional audio tapes - recording quality, recording time, compactness - are the same metrics which are improved by the CD. It was very easy for cassette tape manufacturers to realize that the CD was a potential threat. Likewise, the iPod was a sustaining technology to the Walkman, GPS navigation was a sustaining technology to the map, and the DVR was a sustaining technology to the VCR.
No, a true disruptive technology might be something closer to a comparison between Virgin Blue and Qantas. Virgin Blue (like Southwest Airlines, Easyjet, and others) is a discount airline. These types of airlines are great for value concious consumers. Qantas (and BA, United, and others) offer services for Business Class travel and enjoy fantastic margins on their premium business. Now, from this point of view, Qantas might say they have nothing to fear from Virgin Blue - all the low price rabble that fly on Virgin Blue lower Qantas' margins anyway. They may convince themselves that they are a premium product who cater to a more valuable customer. However, as has been shown many times already, as the discount airlines begin to succeed and offer better service, more frequent service, and become the airlines of choice for millions, it becomes harder and harder for the full service airlines to compete. In fact, faced with declining revenues, a full service airline will likely move upmarket in an effort to extract even more money from their premium customers. Virgin Blue is able to grow their market, with little competition from Qantas - not because Virgin Blue is better, but because Qantas has a harder time competing with Virgin Blue when Qantas' most valuable customers, the ones that Qantas will work the hardest to keep happy, are not demanding the discounts that Virgin Blue can apply. The metrics valued by the Qantas business class traveller are not the same as those valued by the Virgin Blue traveller.
So, if you can set up your business strategy to allow you to compete in a market niche along a different set of value metrics to an incumbant, you will likely not face immediate competitive threat. In fact, if you can position your business to attract a market untapped by the existing incumbants, that also is unattractive to the existing incumbants because of their current commitments to their current best customers, then you will be well positioned to grow your company, improve your product, and prepare to compete before your competitors even see you coming. It is that type of disruption which earns the title Disruptive Technology.
Let me begin by describing what does not constitute a disruptive technology. Many people assume that a disruptive technology is one that is "really different"; specifically something that is technologically impressive, the "next generation", and generally a lot better than what it is replacing. As I will discuss, this is generally an incorrect way to look at these technologies. For example, some people mistakenly say that the CD was a disruptive technology over the audiotape, because, CDs are "really different" from audiotapes. By the same logic, it is argued that the Internet itself is a disruptive technology (in this case, it isn't even mentioned what technology the Internet "disrupts"), solely because, well, the Internet is really different, isn't it? I mean, it's a pretty big thing, so it's got to be disruptive, right? The same argument is used for iPods, GPS navigation, and DVRs. In some cases these are disruptive technologies, in most cases they are not.
A marketing manager at one of the companies I worked with in the past used to say to me, "Selling disruptive technologies into conservative markets is really hard." This company made a lot of extremely cool technological products, however, few of them could be argued to be disruptive technologies, and there were many other reasons that it was difficult for the firm to sell its products. The key thing to understand is that a disruptive technology will almost certainly be hard to sell into a conservative market - that's why you shouldn't try. The beauty of a disruptive technology is that it should be sold into the market that values the product. Most disruptive technologies, when tried to be sold head-to-head against traditional sustaining technologies will often lose.
The reason that the definition above is often incorrect is that a disruptive technology is often one which is inferior to a current technology on the metrics valued by the incumbant organization and market. However, the technology addresses market needs by a different market - often one without competition, and (here's the best part) often unattractive to the incumbant firm. This allows the startup to grow its product without competition.
The reason that the incumbant firm cannot compete effectively against the startup in these situations, is that the incumbant firm either cannot recognize the value of the inferior product, or it is making good margins selling a premium product, and the sales the incumbant loses to the startup (if any) are the low-margin unattractive customers. When this happens, the incumbant sees its gross margins increase - it actually feels good to lose its business to the startup, and thus it does not recognize the threat.
Because of this, the CD is not a disruptive technology to the audio tape. The metrics that the incumbant manufacturers and the market value about traditional audio tapes - recording quality, recording time, compactness - are the same metrics which are improved by the CD. It was very easy for cassette tape manufacturers to realize that the CD was a potential threat. Likewise, the iPod was a sustaining technology to the Walkman, GPS navigation was a sustaining technology to the map, and the DVR was a sustaining technology to the VCR.
No, a true disruptive technology might be something closer to a comparison between Virgin Blue and Qantas. Virgin Blue (like Southwest Airlines, Easyjet, and others) is a discount airline. These types of airlines are great for value concious consumers. Qantas (and BA, United, and others) offer services for Business Class travel and enjoy fantastic margins on their premium business. Now, from this point of view, Qantas might say they have nothing to fear from Virgin Blue - all the low price rabble that fly on Virgin Blue lower Qantas' margins anyway. They may convince themselves that they are a premium product who cater to a more valuable customer. However, as has been shown many times already, as the discount airlines begin to succeed and offer better service, more frequent service, and become the airlines of choice for millions, it becomes harder and harder for the full service airlines to compete. In fact, faced with declining revenues, a full service airline will likely move upmarket in an effort to extract even more money from their premium customers. Virgin Blue is able to grow their market, with little competition from Qantas - not because Virgin Blue is better, but because Qantas has a harder time competing with Virgin Blue when Qantas' most valuable customers, the ones that Qantas will work the hardest to keep happy, are not demanding the discounts that Virgin Blue can apply. The metrics valued by the Qantas business class traveller are not the same as those valued by the Virgin Blue traveller.
So, if you can set up your business strategy to allow you to compete in a market niche along a different set of value metrics to an incumbant, you will likely not face immediate competitive threat. In fact, if you can position your business to attract a market untapped by the existing incumbants, that also is unattractive to the existing incumbants because of their current commitments to their current best customers, then you will be well positioned to grow your company, improve your product, and prepare to compete before your competitors even see you coming. It is that type of disruption which earns the title Disruptive Technology.
Monday, July 16, 2007
Business Strategy
One of the first things I look at when evaluating a deal is the business strategy that is being proposed. If I understand the strategy, I have a pretty good idea of whether the business will make money, and how likely it may be to succeed. Most of the business plans that I've decided to pass on have been because of a bad strategy, or having no strategy at all (or at least one that wasn't made clear).
So, I thought that a good thing to write about, at least over a few posts, would be to talk about some of the best things I've learned about strategy - marketing strategy, technology strategy, etc.
One of the simplest places to start is by examining the supply curve. The profit of a venture is shown in the green area. Q is the quantity of a good sold, P is the price of the good being sold, and C is the cost of delivering the good.
So, when starting any business, ask yourself, what can you do to make the green rectangle bigger? You can either increase the price by offering a premium product, decrease the cost, by being more efficient, or shift the supply curve to increase the quantity sold.
Once you have thought about how you are making money, the next question is - how is this sustainable? What can be done to ensure that these profits can be made over time.
The next model helps examine how easy it will be to protect profits over time. This is the famous five forces analysis (Porter). The five forces analysis helps determine where the value is likely to end up in the value chain. A mantra of management consultants is the notion of creating value and capturing value. Most inventors only think about creating value. One of the most important parts in determining the success of a business is its ability to capture value. This can be determined through the five forces analysis. These forces are:
Supplier power - The strength of a company's suppliers in negotiation.
Buyer power - The strength of a company's customers in negotiation.
Threat of new entrants - The ease by which competitors can enter the marketplace to compete with the company.
Threat of substitution - The threat that other, different, products can compete with the company's products.
Threat of competition - The strength of the company's competitors.
The higher each of these forces are, the less attractive the industry is for that company. When devising a strategy, it is important to work to weaken these forces. Reduce supplier power by purchasing commodities from multiple suppliers. Reduce buyer power by selling to several customers. Erect barriers to entry through IP protection, exclusive agreements, and switching costs to prevent other competitors from entering the market. Reduce substitution threat by developing unique products. Reduce the threat of competition through entering untapped markets.
All of this sounds easy to say, but understanding these frameworks can help entrepreneurs frame business strategy which is profitable and sustainable over time. And it is these business plans which are most attractive.
Stay tuned for further posts including a discussion of some of my favourite technology strategy books - Crossing the Chasm, the Innovator's Dilemma, and the Innovator's Solution. Lot's more to discuss!
So, I thought that a good thing to write about, at least over a few posts, would be to talk about some of the best things I've learned about strategy - marketing strategy, technology strategy, etc.
One of the simplest places to start is by examining the supply curve. The profit of a venture is shown in the green area. Q is the quantity of a good sold, P is the price of the good being sold, and C is the cost of delivering the good.So, when starting any business, ask yourself, what can you do to make the green rectangle bigger? You can either increase the price by offering a premium product, decrease the cost, by being more efficient, or shift the supply curve to increase the quantity sold.
Once you have thought about how you are making money, the next question is - how is this sustainable? What can be done to ensure that these profits can be made over time.
The next model helps examine how easy it will be to protect profits over time. This is the famous five forces analysis (Porter). The five forces analysis helps determine where the value is likely to end up in the value chain. A mantra of management consultants is the notion of creating value and capturing value. Most inventors only think about creating value. One of the most important parts in determining the success of a business is its ability to capture value. This can be determined through the five forces analysis. These forces are:
Supplier power - The strength of a company's suppliers in negotiation.
Buyer power - The strength of a company's customers in negotiation.
Threat of new entrants - The ease by which competitors can enter the marketplace to compete with the company.
Threat of substitution - The threat that other, different, products can compete with the company's products.
Threat of competition - The strength of the company's competitors.
The higher each of these forces are, the less attractive the industry is for that company. When devising a strategy, it is important to work to weaken these forces. Reduce supplier power by purchasing commodities from multiple suppliers. Reduce buyer power by selling to several customers. Erect barriers to entry through IP protection, exclusive agreements, and switching costs to prevent other competitors from entering the market. Reduce substitution threat by developing unique products. Reduce the threat of competition through entering untapped markets.
All of this sounds easy to say, but understanding these frameworks can help entrepreneurs frame business strategy which is profitable and sustainable over time. And it is these business plans which are most attractive.
Stay tuned for further posts including a discussion of some of my favourite technology strategy books - Crossing the Chasm, the Innovator's Dilemma, and the Innovator's Solution. Lot's more to discuss!
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