Dealing_with_Darwin

Very Small Businesses: Stuck in the Middle (with Mossberg)

It’s so much more fun to read The Wall Street Journal on vacation because you get to linger over pieces that you only have time to scan otherwise.  Case in point: a 12/29 column by Walt Mossberg entitled “Computer Makers Cater to Big Business, Slight the Rest of Us.”  Well, yes they do, but not for the reasons that Walt proposes.

Mossberg argues that computer systems vendors are overly infatuated with enterprise IT customers and inappropriately inattentive to the rest of us.  Baloney.  First of all, computer vendors for the most part are complex systems vendors, not volume operations vendors, and as such their primary job is to tackle the kind of complexity that entails when enterprises seek to operate of a global scale.  But to be fair, Mossberg was not really thinking of these folks so let’s just set them aside.

The vendors he really has in his sights are Dell and HP.  They both do run volume operations businesses around the PC, and both do strongly prefer enterprise customers to consumers, for reasons of profitability.  (Reminder to Walt: This is a key value espoused by your editors who routinely reams these folks when they are not profitable)

That still leaves hanging, however, the question of what happens to the entrepreneur caught out in between these two models.  The truth is, as Mossberg notes, direct vendor-to-customer service to this customer is inherently compromised.  The reason why, however, is not inattentiveness on the vendor’s part.  It is that neither the complex systems model nor the volume operations model is designed to meet their needs—and there is no third model to draw upon!

In other words, volume operations PC vendors are appropriately neglecting the VSB customer because their business model allows no other option.  Very small businesses (VSBs) need more complex functionality than consumers but cannot afford the dedicated IT infrastructure to implement it. 

There are two solutions to this problem.  The first is to leverage a disaggregated value chain and let the resellers provide the necessary services.  Specifically, independent value-added resellers use the resale of products as an entrée to establish an ongoing service provider relationship with the VSB owner/operator.  It is not a great solution, but it does all the VSB to leverage a lot of horsepower at pretty close to free pricing.

The long-term solution to the VSB dilemma, however, involves transitioning to a new business model altogether.  This model will combine complex systems hubs with volume operations outlets—akin to the telephone network—creating a business model people are calling software as a service.  In this model there will be IT, but only at Service Central where it belongs.  The VSB will act as a utility customer.  There will be much less customization than the current system allows, but ask yourself, how much “value” has all that customization created, particularly if value is defined as advantages minus headaches, heartaches, and moments of near-suicidal desperation.  Unless computing is core to its competitive advantage strategy, a VSB should be more than happy to make these trade-offs.

The key point is, software as a service is unlikely to come from Dell, and certainly not from Apple, both of whom are strongly ensconced in product models.  In the shrot term it is showing up from the likes of Salesforce,com, but in the long run, because of their superior reach, it looks again like the Yahoos and Googles of this world will be the service providers of choice, with the AT&T’s and Verizons grumbling in the background about how they are getting money for nothing and using their pipes for free.

Movies: From Product to Platform Innovation

Good op ed piece by Edward Epstein in 12/29 Wall Street Journal explaining why box office receipts are no longer the keys to the moviemakers’ kingdom.  Makes all kinds of sense financially, but it could be misleading strategically.  Here’s why.

Epstein argues that only 15% of the revenues of major studios come from theater receipts, the vast majority coming from free TV, paid TV, DVD, and videos.  This is a great illustration of how movies have migrated their innovation strategy from product innovation to platform innovation.

Product innovation recaptures its investment primarily in the first sale of the product, secondarily in after-sales warranties and consumables.  This is how movies made money prior to the digital economy.

Platform innovation recaptures its investment by having other entities incorporate the platform offer into their product innovations, thereby leveraging the investment across many more markets.  This is how the great tech sector franchises of IBM, Oracle, Microsoft, and Intel have been built. 

The key thing to remember, however, is that an offer cannot present itself as a platform until it has achieved ubiquity of use as a product.  In the tech sector, many “superior” platforms never made it out of the chute because, although meeting every design spec requested, they could not achieve widespread ubiquity.  No one wants to help another company gain a monopoly for its proprietary technology.  So the only way platforms can happen is either “by accident” (the Trojan horse approach) or “for free” (the Netscape, Adobe, Linux approach).

Ubiquity for a movie means widespread audience engagement with the characters and costumes involved so that they have the drawing power desired by the downstream vendors who license them.  The early weeks of box office performance constitute the launch event for creating this drawing power.  The power of the platform—its ultimate reach—is set by the trajectory of this launch.  So it matters hugely whether we go out or stay home.

In a world where it is increasingly more comfortable to stay home, this poses a genuine challenge for the movie business. Winners in recent years have taken advantage of the Internet to create desired buzz, but that is now an increasingly over-exploited ploy.  What will be next?  Some form of marketing innovation, to be sure, but as to what kind, I leave to the creative types in Hollywood.

Education and Health Care: Complex Systems Dreams, Volume Operations Budgets

While different in many ways, education and health care share a common predicament.  The receivers of these services—parents and students on the one hand, patients and advocates on the other—are cultured to expect superior, personalized attention, the sort of thing that a complex systems business model excels at.  The immediate providers of these services, teachers and doctors, share these same aspirations as well. 

Unfortunately, the complex systems model is not scalable to the needs of a large society.  The only model that scales is the volume operations model.  (For a discussion of the contrasts between these two models, see Harvard Business Review, December, 2005, “Strategy and the Stronger Hand”).  It does so by transforming unique relationships into standardized transactions.  It is not driven to achieve excellence but rather to meet minimum quality standards as economically as possible.  This is the model that legislatures and health plans fund, that administrators seek to administer, leaving teachers, aides, doctors, and nurses with the task of mediating between complex systems expectations and volume operations budgets. 

It does not take a great deal of reflection to realize that the volume operations path is the only feasible one to take from a social safety net point of view.  More affluent citizens may avail themselves of the complex systems model, but only at a considerable price.  The key point is that such service is not, and should not be represented as, a social entitlement. 

And this is where things get hairy, specifically in a society dedicated to egalitarian principles.  The economics of education and health care do not support entitlements beyond a basic safety net.  Yet the public dialog implies those entitlements exist, or would exist if only the economically privileged would be more generous.  At this juncture in the dialog a liberal/conservative split ensues, something which has played out over my entire adult lifetime, with no end in sight, and no insight in sight either.

I think the constructive path forward begins with abandoning any expectation of providing broader access to the complex systems model and instead focusing our creative energies on raising the standards of the volume operations capability as much as possible.  This means focusing public investment on the mean, not the extremes, of the health care continuum, investing in more efficient, effective, and pervasive basic health services.  Private funding can pursue the esoteric edges—that’s its privilege—but public funds should not.  We need to focus those dollars more on process, on access, on communication, on methodology, and on resetting societal expectations about the nature and value of primary care. 

Southwest: Darwin Calling, Again

WSJ for December 19 has an interview with Gary Kelly, CEO of Southwest Airlines, which recaps the points made in an earlier interview (see "Southwest, Meet Darwin" entry below).  What is it that Kelly is missing?

Well, let's be fair.  All his first-derivative indicators are positive.  Southwest is the market leader, and they do have the most privileged fuel prices, and they are expanding into Fort Worth and Denver, and they do have a great company culture.  What more could we be asking of him?

For starters, a recognition that his second-derivative indicators have gone negative.  That is, he is no longer gaining, but rather losing, competitive advantage relative to the new crop of competitors he has attracted.  To be sure, he would argue that his competiion is benefitting from the law of small numbers, and that is true.  It is not that they are a better bet than Southwest, it is that Southwest, competing with them, is not as good a bet as Southwest competing with traditional airlines.  Kelly's stop-gap defense here is to assert that Southwest has better people.  Bad defense for a volume operations business model, where transaction efficiency, not personal attention, is the only differentiator sustainable at scale.

What we are witnessing is the playing out of Christensen's Innovator's Dilemma thesis from the attacker's point of view.  Clay's key point is that the low-cost , no-frills disrupter model is wickedly effective competing against entrenched high-cost incumbents, but when the last of them is ejected from the market, what ensues is profitless cutthroat competition, and the smart players move upstream to find another incumbency to attack. 

In Kelly's defense there is still a lot of market development to play out before we reach that end, and Southwest still holds the best hand at the table.  In the investors' defense, however, you hold stock in the expectation of stronger future performance compared to past, and Kelly, despite significant encouragement from the WSJ, has yet to offer a compelling story for that thesis.

Comments to George Colony on “My View: The Google Future”

I love the thesis of your argument and find myself about 75% in agreement with what you say about Google’s significance to the IT industry.  That said, let me outline what the remaining 25% consists of and get your thoughts on it:

1. You say Web pages will get replaced by programs.  I think it is more accurate to put the idea the other way around:  Programs will get replaced by Web pages.  Technically, this is the same point, but stated this way shows why Google is such a threat to Microsoft. 

2. You think Google will be significant in large corporations.  I do not.  The reason is that the monetization model that fuels its competitive advantage is inconsistent with use inside a corporation.  Corporations prefer a software licensing model to protect their privacy and secure their relationship to the vendor.  Google offers will either be well-behaved programs or be gelded at the firewall.

3. You think Google’s stock price may not be insane.  Of course it’s insane, but only because public markets have never found a way to properly discount the risk of disruptive innovations.

4. Finally, you think Microsoft needs to reinvent itself to respond effectively to Google’s threat.  I don’t.  I actually agree with Bill on this—it is 1995 all over again, only with a much tougher competitor.  Then it was, now it is Google, and there is nothing that better ignites the Microsoft competitive response engine than getting mooned. Bill (and Steve, and Ray) just have to properly fan the flames, harness the outrage, and let the games begin!

G.E., Viacom, and the DreamWorks Deal

The Wall Street Journal did a front-page piece recently (December 12) on Viacom snatching DreamWorks from G.E., its expected acquirer.  The article contrasted G.E’s methodical analytics-driven approach to M&A negotiations with Viacom’s Hollywood-style go-with-your-gut deal making, the implication being that G.E. lacked the decision-making style necessary to compete effectively in a new media economy. 

Well, maybe.

The story highlights the differences between three business cultures that, respectively, celebrate invention, deployment, and optimization.  These are the three disciplines that must be coordinated in order to perpetually refresh an enterprise.  They are the key, that is, to what we are calling dealing with Darwin.  Ignore any one of them, and the system must go outside itself for repair.

In the case of Dreamworks, the discipline of choice is invention, most notably symbolized by the work of Steven Spielberg.  By teaming up with Jeff Katzenberg and David Geffen, the idea was that their deployment skills would combine with his creativity to make a terrific studio.  Alas, the deployers apparently became distracted, so Dreamworks never scaled the heights to which it aspired.

Enter two suitors.  General Electric came first.  It is a master of optimization.  It’s view of the media sector is that it’s made up of a bunch of cowboys who need a good dose of six-sigma discipline.  When the G.E. folks analyzed the cash flow of Dreamworks, especially when they factored in some of its latest misses, the initial valuation of the deal no longer computed, and they came back for a price reduction.  That created an opening for a competitor.  Nonetheless, it was totally correct procedure—for an optimization-oriented deal.

Now enter Paramount.  It approached Dreamworks as a deployment opportunity.  In that light who cares about the misses, it’s all about making the biggest bang you can from the hits.  Spielberg may not make a hit every time, but his batting average rivals a Barry Bonds.  You can’t do better than that, and Paramount, starving for good hitters, was quick to pay up.  It is confident its deployment engine can generate profits from the hits that more than make up for the misses.

So who was right?  Well, in one sense they both were, because both GE and Paramount played the game according to their own lights.  In this case, I’d argue the better fit was with Paramount because Dreamworks looks to me more like a deployment than an optimization opportunity.  Deployment cultures typically must acquire their inventions to keep them thriving (think of how well Cisco did this in the 1990s), and so Paramount is doing what is normal for it to do.  Optimization cultures, by contrast, are better served buying up flagging enterprises in solid markets and then installing the kind of management practices required to thrive.  Lots of GE acquisitions fit this mold, but not Dreamworks.

Ideally a company would be able to balance all three disciplines in a continual cycle of invention, deployment, optimization, with the last focused on generating the cash and freeing up the management resources needed to reinvest in the first two.  But no company is able to fire on all cylinders all the time—hence the value of an ongoing M&A capability.  The key principle to follow there is to acquire the kind of companies you can digest and not to let your competitive juices lead you to swallow something you can’t.

Google—What’s the big idea?

Everybody gets that there must be a big idea behind Google’s googoolian market valuation, but what exactly do we think it is?  Not product innovation, although arguably their original claim to fame, Google Search, was just that.  Not acquisition innovation, especially if you can believe BusinessWeek’s write-up of December 5.  No, the only way to decode their market cap is to say it is yet another public market attempt to value disruptive innovation. 

Our view on this is that public markets do not ever get this valuation right, and therefore that the stock is a horrible investment vehicle, but frankly there is little Google can do about that, and almost no upside to any action they might take.  We and they just have to let that scenario play out.

The more interesting question is, what exactly is the disruptive innovation that Google represents?  What is the big idea here?  Let me propose the following:  Any stream of electrons delivered over the Internet to a human being on the other end, regardless of whatever attributes it may also possess, is a form of media, and can be monetized as such. 

Obviously this is true of content.  The interesting thought is that it is also true of products and services.  Word processor, spreadsheet, presentation software, live update, back-up, auction, VOIP, video—if there is a human being in the room paying any attention at all, regardless of their other value, these products and services are all forms of media.  To be sure, some lack the capability to attract and then divert our attention in the moment, but all have the potential to help  differentiate and characterize us as end users, and that information can be used to create more targeted communications to be sent our way at a more opportune time.  Thus all can be monetized in an advertizing based modek, on a deferred basis if not in real time. 

So what?  Well, for starters, anything—and I mean anything—that Google throws against the Internet wall and that subsequently sticks will drive its media business model’s economic engine.  So giving everyone one day a week to think up weird stuff makes all kinds of sense—more stuff for the wall.  And the more stuff that sticks, the more diluted the competitive advantage of media properties with traditional content, like Dow Jones or Yahoo, becomes. 

But most importantly, in any competition with a product provider—say, Microsoft, to pick a non-random example—or with a service provider—say, SBC to pick another—Google can give away the elements which their competitors must monetize.  They have nothing to lose.  By contrast, their competitors have everything to lose, and therefore cannot counter their assault directly.  They must maneuver to respond, which takes time and costs them the initiative.

Is it any wonder that the osmotic migration of talent is moving toward Google at this time?