Do you work for a firm where managers think employees really have to work (what is called) “full time”? That fourty hours per week (or whatever is considered “full time” in your profession) is really a necessity? Perhaps you are one of those people with that conviction yourself — that in your job it is really not possible to work ‘part time’.
Of course you are wrong: working five out of seven days is really just as arbitrary as six days, or three – or twenty-eight for that matter. Chopping up the total amount of work that needs to done in your firm into blocks that suit our human physiology has nothing to do with the actual work. If the total amount of work that needs to be done in a firm in one week equals 20,000 hours, it is just as arbitrary to chop that up into 500 40-hour work weeks as it is to chop it up into 800 blocks of 25 hours. A five-day work week consisting of eight-hour days happens to be the social norm in many of our societies at present, but I have long thought that a company that disrupts that kind of social norm in its industry could potentially build a momentous competitive advantage out of it.
Let me give you an example. The management consulting firm Eden McCallum, from London, does strategy work much like McKinsey, the Boston Consulting Group, and Bain – but with one important exception: none of its roughly 500 consultants are on the payroll. All of them work on a freelance basis. Around the time of the dot-com boom in 2000, founders Liann Eden and Dena McCallum saw that many of their ex-McKinsey colleagues would love to continue doing some consulting work, just not full time. Many of them wanted to do a few consulting assignments on the side while they started their own company, wrote a book, or took care of their children, or just worked less. Others, it appeared, did not mind working full time at all, but they disliked some of the other things that came with being a partner in a traditional consulting firm, such as working on internal committees and appraisals, or doing customer acquisition. Still others were happy to work full time but only eight months a year, or without having to fly someplace every week. But for the traditional consulting firms, it was always “all or nothing”, which meant that some highly capable and motivated senior consultants would drop out of the profession altogether, or would continue but only grudgingly.
Eden and McCallum’s idea was: Come work for us! If you’re good, we’ll find you a project that suits your desires. They now have 12 partners in the firm who manage customer relations and secure and define new client projects. The only thing the consultants (usually ex-McKinsey, Bain, or BCG) are responsible for is to execute these projects to the best of their abilities. Eden McCallum, thus, manages to keep its overhead and other fixed costs at a minimum. Consequently, they are able to offer their teams of consultants at comparatively low prices, while customers are happy that the senior people actually do the work. (A frequent complaint regarding traditional consultants is that the senior partner disappears after the work has been secured, letting more junior colleagues complete the task.) Does it work? Eden McCallum is growing swiftly, having opened an office in Amsterdam with further plans afoot to set up shop in New York City, while working with increasingly prestigious clients, including Pfizer, Shell, Philips, Danone, Barclays, and many others.
Eden McCallum built its competitive advantage on unbundling the work of consultants. Is Eden McCallum the ideal employer for everyone? Most certainly not. Traditionally, senior management consultants have a range of tasks: one of them is executing client projects, but they also have to acquire future projects, and secure work on them for more junior people, they have to do internal work, regarding knowledge development, appraisals, and managing the firm, and a variety of other tasks – all on a full-time basis. And that is exactly what many consultants like doing. However, there are also a significant number who do not want to do all of the above anymore, who are not good at all of them, or who don’t want to do it five days per week all year long. If these consultants are good at executing client projects, Eden McCallum will find them a project that suits their preferences.
Could an approach like theirs work in other industries? Eden McCallum has set itself up as a so-called “double-sided market”, tying together supply (consultants) and demand (clients) – similar to platforms like eBay, eHarmony, peer-to-peer betting company Betfair, or property search firm Zoopla. Leaders at the firm realize that for skilled people disillusioned with the employment model of traditional firms, there is a strong attraction to work tailored to their individual requirements. This allows the firm to hire good employees at a good price. Clearly, there are other industries where the skill level of a firm’s employees is crucial for competitive advantage.
In fact, many companies have begun to realize that real competitive advantage is usually based on people rather than patents or products. By customizing work for its employees, Eden McCallum has begun to upend the consulting industry. If unbundling work can give a firm access to superior skills at lower prices, it could very well change your industry, too.
Why is it that engaging with charities has always been such a challenge for corporations? First and foremost, charities are quite a distinct stakeholder and one that corporations have the least experience in dealing with.
There is also a lack of mutual trust that raises suspicion and doubt regarding their respective goals and objectives. Some charities may perceive corporate engagement as a diversionary tactic used by corporations to deflect attention away from actions and behaviours that could cause them reputational damage.
Corporates tend to engage with charities through one-off direct corporate giving rather than considered campaigns. They provide a short-term boost rather than long-term support. Some people even argue that direct cash donations are a bad idea. They say that charities would benefit much more from the transfer of corporate expertise. This would include sharing knowledge and training in management, administration, growing an organisation, gathering resources and developing capabilities towards a clear objective.
Against this background then, how can corporations really engage with charities in a mutually beneficial, long-term oriented and effective way that is based on trust and co-operation? Here are some common pitfalls that I have encountered to date, together with suggestions on how best to avoid them.
SPEAK THE SAME LANGUAGE
Corporate language is significantly different from the language that charities and other non-governmental organizations use. Co-ordination and honest discussion become a key challenge. Corporates would be better off forgetting idiosyncratic corporate language, fancy financial acronyms and complicated accounting ratios, particularly at the early stages of the process. Instead, they should invest the time and effort towards establishing direct and honest communication channels with their potential partners, making sure that everyone around the table speaks and understands the same language.
Without a doubt, charities and corporations have substantively different objectives, and often enough both parties fail to be explicit about them right at the beginning of any collaboration. A corporation’s goal might be improved employee engagement, whereas a charity wants to maximise societal impact. These are not necessarily mutually exclusive, but a lack of clarity around the goals may typically generate significant co-ordination costs, slow implementation or even suspicion between the parties down the road. Consequently, it is critical for both charities and corporations to be explicit and forthcoming about the goals and objectives of the collaboration. Open and in-depth discussion can align everybody and so achieve maximum impact, and arrive at win-win outcomes.
INVEST TIME TO ENGAGE
Size isn’t everything. The effectiveness of corporate giving does not merely depend on the donation; instead it critically depends on the depth of the overall engagement. Often, corporations undertake desk research, locate the charities that exist in their close vicinity and then send cheques to a selection of them. They do not invest the necessary time and effort to understand the real needs of their potential collaborators. They don’t ask themselves: is a cash donation the best way to meaningfully engage? In addition to establishing a common language, and aligning goals and objectives, it is very important for corporations to invest in face-to-face relationship building with the charities they wish to collaborate with. Only this way will they establish common ground, start building trustful relationships, and profoundly understand their needs and the best ways to address them.
ESTABLISH INTERNAL STRUCTURE
Last but not least, establishing an internal corporate structure is very important. Time and again, collaborations with charities are forgotten internally because there is little accountability and fickle assumptions of responsibility. Corporations with a solid commitment towards developing such partnerships should establish relevant positions, processes and procedures. They must provide incentives and put in place controls to ensure the continuity and effectiveness of such initiatives in the long run. In doing so, they would also signal to their charity partners that their commitment is sincere, long-term oriented and an integral part of the corporation’s structure.
We live in the information age, which according to Wikipedia is a period in human history characterized by the shift from industrial production to one based on information and computerization.
Nothing surprising there, except for the idea that this is “a period in human history” – which tends to suggest it will come to an end at some point. The industrial revolution in the late nineteenth century ushered in the industrial age, and the digital revolution in the mid twentieth century spurred the emergence of the information age. So it is not entirely crazy to speculate about what might lie beyond the information age.
Of course, I am not arguing that information will become obsolete. Firms will always need to harness information in effective ways, just as most of them still need industrial techniques to make their products cheaply and efficiently. My point, instead, is that information will become necessary but not sufficient for firms to be successful. All this talk of “big data,” for example, feels like an attempt to strain a few more drops of juice out of an already-squeezed orange, just as Six Sigma was a way of squeezing more value out of the quality revolution. Both are valuable concepts, but their benefits are incremental, not revolutionary.
So just as night follows day, the information age will eventually be superseded by another age; and it behoves those with senior executive responsibility to develop a point of view on what that age might look like.
So here is a specific question that helps us develop this point of view: What would a world with too much information look like? And what problems would it create? I think there are at least four answers:
1. Paralysis through Analysis. In a world of ubiquitous information, there is always more out there. Information gathering is easy, and often quite enjoyable as well. My students frequently complain that they need more information before coming to a view on a difficult case-study decision. Many corporate decisions are delayed because of the need for further analysis. Whether due to the complexity of the decision in front of them, or because of the fear of not performing sufficient due diligence, the easy option facing any executive is simply to request more information.
2. Easy access to data makes us intellectually lazy. Many firms have invested a lot of money in “big data” and sophisticated data-crunching techniques. But a data-driven approach to analysis has a couple of big flaws. First, the bigger the database, the easier it is to find support for any hypothesis you choose to test. Second, big data makes us lazy – we allow rapid processing power to substitute for thinking and judgment. One example: pharmaceutical companies fell in love with “high throughput screening” techniques in the 1990s, as a way of testing out all possible molecular combinations to match a target. It was a bust. Most have now moved back towards a more rational model based around deep understanding, experience and intuition.
3. Impulsive and Flighty Consumers. Watch how your fellow commuters juggle their smartphone, tablet and Kindle. Or marvel at your teenager doing his homework. With multiple sources of stimulation available at our fingertips, the capacity to focus and concentrate on a specific activity is falling. This has implications for how firms manage their internal processes – with much greater emphasis being placed on holding people’s attention than before. It also has massive consequences for how firms manage their consumer relationships, as the traditional sources of “stickiness” in those relationships are being eroded.
4. A little learning is a dangerous thing. We are quick to access information that helps us, but we often lack the ability to make sense of it, or to use it appropriately. Doctors encounter this problem on a daily basis, as patients show up with (often incorrect) self-diagnoses. Senior executives second-guess their subordinates because their corporate IT system gives them line-of-sight down to detailed plant-level data. We also see this at a societal level: people believe they have the right to information that is in the public interest (think Wikileaks), but they are rarely capable of interpreting and using it in a sensible way. The broader point here is that the democratization of information creates an imbalance between the “top” and “bottom” of society, and most firms are not good at coping with this shift.
Consequences for individuals and for firms:
So what are the consequences of a business world with “too much information”? At an individual level, we face two contrasting risks. One is that we become obsessed with getting to the bottom of a problem, and we keep on digging, desperate to find the truth but taking forever to do so. The other risk is that we become overwhelmed with the amount of information out there and we give up: we realise we cannot actually master the issue at hand, and we end up falling back on a pre-existing belief. For example, in debates about fracking or genetically modified food, very few people get to grips with the scientific data, and even fewer change their views. The challenge for individuals is to steer a course between these twin perils. This puts a premium on an individual’s ability to monitor her own analytical style –knowing when to stop digging, when to ask an expert, and when to rely on personal experience and judgment.
For firms, there are three important consequences. First, they have to become masters of “attention management” – making sure that people are focused on the right set of issues, and not distracted by the dozens of equally-interesting issues that could be discussed. A surplus of information, as Nobel Laureate Herbert Simon noted, creates a deficit of attention. That is the real scarce resource today.
Second, firms have to get the right balance between information and judgment in making important decisions. As Jeff Bezos, founder and CEO of Amazon, observed, there are two types of decisions: “there are decisions that can be made by analysis. These are the best kind of decisions. They are fact-based decisions that overrule the hierarchy. Unfortunately there’s this whole other set of decisions you can’t boil down to a math problem.” One of the hallmarks of Amazon’s success, arguably, has been its capacity to make the big calls based on judgement and intuition.
Finally, the ubiquity of information means a careful balance is needed when it comes to sharing. Keeping everything secret isn’t going to work anymore – but pure transparency has its risks as well. Firms have to become smarter at figuring out what information to share with their employees, and what consumer information to keep track of for their own benefits.
The bottom line
For the last forty years, firms have built their competitive positions on harnessing information and knowledge more effectively than others. But with information now ubiquitous and increasingly shared across firms, these traditional sources of advantage are simply table-stakes. The most successful companies in the future will be smart about scanning for information and accessing the knowledge of their employees, but they will favour action over analysis, and they will harness the intuition and gut-feeling of their employees in combination with rational analysis.
Check out my latest interview (video) with Prof. Karl Moore (@profkjmoore) posted in The Globe and Mail (@globeandmail)
You can read my latest interview about the Sustainability Agenda in the latest issue of the Business Strategy Review (Summer 2014) here:
Are business schools equipping the leaders of tomorrow with the skills they’ll need to face a number of urgent global challenges?
From climate change and resource scarcity to inequality, the business world is shifting rapidly and business leaders need to understand and tackle these in a transparent way. Yet business schools often fail to address sustainability at all, or address it only as a separate, niche add-on to the course.
In this podcast our panel of experts discuss, and disagree over, whether business schools are lagging behind on integrating sustainability in their curricula and explore what makes good business leaders able to respond to complex sustainability challenges. They also discuss Nespresso’s competition, which challenged MBA students to tackle a very practical sustainability problem.
Ioannis Ioannou, assistant professor of strategy and entrepreneurship, London Business School.
Polly Courtice, Cambridge Institute for Sustainable Leadership.
David Grayson, director of the Doughty School for Corporate Responsibility, Cranfield School of Management.
Why are corporate executives obsessed with growing their companies?
Growth is innately appealing. We all feel better when we are making and selling more than we used to. Growth provides opportunities for people to develop new skills and gain promotions. And growing is a lot more fun than downsizing – no-one likes making people redundant, or killing off money-losing projects.
But the trouble is, most executives seek to grow their companies faster than the natural rate of growth in their markets – often many times faster. “Double digit growth” is a commonly-heard goal. And this is where things become interesting, because faster-than-market growth means you are either taking share away from competitors, or you are moving into new market areas – both of which are pretty risky things to do. So why do corporate executives do this?
Consider a well-known example. McDonalds was a growth company for about fifty years, from its origins in post-war America through to its position as the global leader in fast-food restaurants in the late 1990s. But things started to go wrong – the company was feeling the heat from the healthy-food lobby, and had over-extended itself with too many new stores. There was no natural growth left in McDonald’s part of the fast-food market. In 1999 it made its first ever job cuts and closed some money-losing restaurants. It then embarked on a series of acquisitions into adjacent areas: Chipotle, Aroma Café, Donotas Pizza, and Boston Market, as well as a 33% stake in Pret a Manger.
But none of these new businesses helped at all. The company reported its first-ever quarterly loss in 2002. A new team was brought in, and the “I’m Loving it” campaign, launched in 2003, helped to refocus on the core business, and this business returned to profitability. The non-core businesses were gradually sold off, but a lot of money and executive attention was wasted in the process of experimenting with them.
Why did McDonalds’ executives pursue this ill-advised foray into other fast-food areas? Essentially, they were incentivised to do it. The stock market puts a high premium on growth stocks, so it was in these executives’ interests to continue to push for growth even though their market was mature and crowded. And they also believed they would succeed – most executives have strong self-belief, so the guys running McDonalds would have been confident they could beat the odds as they diversified into related business areas, even if many before them had failed.
So what is the alternative? A much better approach is to be honest about what you are good at, and to keep on doing it better than anyone else. Put yourself in the shoes of McDonald’s shareholders for a minute: they didn’t want the management team to dabble in new business areas in 1999; they wanted Mcdonald’s to be the best burger restaurant in the world, and to make lots of money doing it. Of course, this isn’t as sexy a strategy as trying out new formats and acquiring companies in adjacent markets, but it’s actually a much smarter long term bet.
The bottom line is that growth strategies are often pursued for the wrong reasons. There is a delicate tension between what shareholders really want from their CEOs and what CEOs find alluring. It is often claimed that executives are only pushing for growth to satisfy their shareholders demands, but actually this is not correct. Shareholders are very good at differentiating between the shares they buy for growth, and the ones they buy for their dividend. McDonald’s is a mature, well-run company, generating good cashflows. Shareholders don’t want their management teams to take excessive risks, they are content with a steady and predictable performance in line with the market.
Over the past few decades, several countries around the world have experienced unprecedented economic development as measured by unceasingly accelerating GDP growth rates. This explosive growth, however, has also led to overconsumption or even destruction of natural resources, and to an overwhelming and unsustainable increase in greenhouse gas emissions. The ensuing impacts of global warming and climate change have severely damaged the planet’s capacity to sustain human development. According to current estimates by the World Wildlife Fund ([WWF] 2012), by 2050, when the earth’s population is expected to reach 9 billion, we will need as many as three planets to sustain current levels of consumption.
Beyond the negative environmental consequences, this type of economic growth has generated several pressing social issues: ever-increasing income inequality; often uncontrollable urbanization; high unemployment rates, particularly within the younger segments of the population; and social immobility leading to social instability, and even social unrest, around the world (e.g., the Occupy movement). This is especially evident when one considers the proliferation of NGOs and their increasing demands and expectations of companies, governments, and transnational institutions. Or when one considers that, according to Oxfam (2014), currently the world’s 85 richest individuals own as much wealth as does the bottom half of the entire global population. In other words, we are witnessing a potential erosion of the social fabric across countries, despite our collective ability to produce more goods and services than ever before.
Meanwhile, in the business world, multiple corporate scandals, coupled with the recent dire crisis of the financial system itself, the numerous environmental disasters directly attributed to companies’ operations (e.g., the BP oil spill), and even the resulting and regrettable loss of human life due to compromised health and safety standards (e.g., the Savar building collapse in Bangladesh, suicides at Foxconn), have severely undermined the public’s trust in the modern business organization, and demands for transparency and accountability, as well as fierce debates on the broader role of the corporation within civil society, have begun to emerge.
These formidable environmental and social forces, in conjunction with the inherent pathologies of the capitalist system itself (e.g., short-termism), have threatened—or, in some instances, completely eradicated—the corporations’ traditional “license to operate”. Executives therefore now struggle to identify and prioritize their non-shareholding stakeholders and to understand the boundaries of their corporations’ responsibility. Thus, they face significant challenges when mapping a strategic course for their organizations within a fundamentally unfamiliar and fast-evolving environmental and social context. And they need to do this while also managing the more traditional and perhaps relatively better-understood economic context and meeting demands for financial profitability. Yet such demands, at least in the short term, may well directly conflict with actions they need to take to meet the expectations of their non-shareholding stakeholders—such as employees, local communities, or the environment.
These are both pressing and daily preoccupations for CEOs globally. The 2013 UN Global Compact–Accenture CEO study (Accenture, 2014) found that 97% of the 1,000 CEOs interviewed across 103 countries and 27 industries see sustainability as important to the future success of their business, and that 78% see sustainability as an opportunity for growth and innovation. Notably, 84% of the CEOs believe that business should lead efforts to define and deliver sustainable development goals, and 79% of them see sustainability as a route to competitive advantage in their industry.
From a strategy point of view, therefore, accounting for or even integrating environmental and social issues into a company’s business model, processes, and operations introduces critical new elements in the continuing quest to understand what drives persistent performance heterogeneity across firms over time—the question at the heart of strategy research. In this article, I suggest that the boundary of what constitutes corporate performance is being extended beyond the traditional financial (profitability) metrics to include environmental, social, ethical, and corporate governance metrics (i.e., what are termed ESG dimensions). Moreover, I suggest that the long-term persistence of superior performance no longer depends exclusively on the management of the economic context. Instead, it requires an integrated approach in terms of concurrently managing the social and the environmental context, thus delivering value both to shareholders and to non-shareholding stakeholders in a synergistic manner.
Specifically, I first examine how strategy is defined and conceptualized through the eyes of the main schools of thought and the leading strategy scholars. I find that such definitions and resulting conceptualizations predominantly focus on financial metrics as measures of performance, and they provide guidance mainly on how to manage a corporation’s economic context. Next, I consider the literature on externalities and corporate social responsibility (CSR) to understand how environmental and social issues have been integrated. I find that despite the important insights generated by these literatures, they still suffer from what Edward Freeman and others term “the separation fallacy”: the notion that no business decision has ethical content or an implicit ethical point of view, or that no ethical decision has content or any implicit view of value creation and business. In other words, these literatures explore social and environmental performance either in isolation or by assuming a strong form of independence from financial performance and traditional notions of strategy formulation, thus failing to provide a holistic and integrated understanding of strategy.
In sum, in this article I characterize a clear gap in our understanding of the fundamental strategic problem in the age of sustainability and social responsibility. I highlight the rather urgent need for rigorous research around the phenomenon itself, as well as its theoretical implications for strategy as an academic field of inquiry. After reflecting upon the state of the field today, I offer an extended definition (i.e., a reconceptualization) of strategy, and I reference empirical evidence for the emergence of the “sustainable organization”—a distinct type of the modern corporation that effectively and profitably integrates environmental and social issues into its strategy. Finally, I briefly suggest fruitful avenues for future research.
Full Essay/Op-Ed available here.
When something seems too good to be true, it usually is. And management techniques, practices, and strategies are no different. When you read a business book or attend a presentation on a particular management practice, it is a good habit to explicitly ask “what might it not be good for?” When might it not work; what could be its drawbacks? If the presenter’s answer is “there are none”, a healthy dose of skepticism is warranted.
Because that’s unfortunately not how life works, and that’s not how organizations work. It relates to what Michael Porter meant with being “stuck in the middle”: if you try to come up with a strategy that does everything for everyone, you will likely end up achieving nothing. If you focus your strategy on, for instance, achieving low costs, you will likely have to sacrifice delivering superior value on other dimensions, and vice versa.
Similarly, “doing well by doing good” – enhancing your firm’s financial performance by achieving superior corporate social responsibility – is often easier said than done. When confronted with an ethical decision – e.g. whether to dump toxic waste in a developing country, where it may not be illegal, when all your competitors do so as well – sometimes it will cost you (a lot of) money to do the right thing. Dozens of academic studies have tried to establish a positive link between corporate social performance and profitability, but for every study that finds a (modest) positive correlation, there is one that doesn’t.
But it seems some organizations do pull it off.
Take the company Aravind Eye Care in India. It was founded in 1976 specifically to provide cataract eye surgery. They modeled their operations on McDonalds: high volume, highly efficient operations, based on division of labor and cost efficiency. It is a very profitable operation; the company has a gross margin of 50 percent. Yet, the remarkable thing is that they treat 70 percent of their customers for free. The 30 percent that do pay are relatively affluent people who can afford the operation, but who receive pretty much the same service. In fact, the company goes out of its way to actively recruit non-paying customers. It goes to look for them systematically in the countryside and transports them to their clinics for free.
This, while the clinical quality of their service – the cataract operation – is second to none. Similarly, other medical clinics are operating in India – for instance in heart surgery – that combine extremely efficient, low-cost operations, but at very high quality in terms of clinical outcome. To such an extent that various National Health Service hospitals in the United Kingdom are considering sending their patients to India; to save money, while providing them with superior quality treatment.
How can these organizations combine higher quality with lower costs? How can they combine doing well by doing good, and treat 70 percent of patients for free at 50 percent gross margins? The trick is that their business models are built for the long-term. Paradoxically, in the long-run, the lower costs enable them to provide better quality.
Ask yourself this: Could Aravind Eye Care make more money if it did not treat the 70 percent non-paying patients? Although it may seem that this would save them a lot of costs, in fact, the answer is very likely “no”. Every organization learns with experience. We call this effect “the learning curve”. With experience, firms increase the efficiency and quality of their production. These curves have been documented for airplanes, cars, bottles, pizzas, and so on. And cataract eye surgery is no exception.
It is because these clinics treat such very large number of patients, the company runs down its learning curve very quickly, giving it a substantial competitive advantage. Moreover, the vast number of patients enables it to divide labor to the extreme, creating specialist roles and highly-experienced people in all parts of the procedure. The 70 percent non-paying customers form the basis of this advantage. Consequently, the company would likely not be able to attract the 30 percent paying customers without them.
It is often said that Aravind’s paying customers subsidize the 70 percent that get the operation for free, yet, in many ways, it is the other way around: Treating the vast numbers of non-paying patients enables the company to deliver the quality that attracts the ones that do pay.
What enables companies such as Aravind to combine all of these things? Didn’t I say at the beginning of this piece that “when something seems too good to be true, it usually is?” and that “it is always a good habit to explicitly ask what might it not be good for?” Yes, but that is because there is a second question you should always ask, when considering a particular management technique, practice, or strategy, and that is “what might its long-term effects be?” What might seem a good idea in the short-run does not always work in the long term – and vice versa. Unfortunately, most companies make decisions based on their short-term consequences, because that is what they can see and measure. If, like Aravind, you optimize your business model for the long haul, you might be able to deliver superior quality at lower costs. And even do some good for society in the process.
Which company will win the battle for smartphone dominance in 2014? The latest data, released last week, showed Apple leading in the US (42% share), with Samsung ahead in the UK (58% share) and indeed most other markets. Others (notably Microsoft and Blackberry) are struggling to get a look-in.
Why do we talk about the battle for “dominance” in smartphones? In most industries – cars, financial services, soap powders — we expect to see large numbers of competing companies, often with quite similar market shares. But in the high-tech world, it is quite normal for one company to completely dominate – think of Intel in microprocessors, Cisco in routers, or Microsoft in personal computing software.
These high-tech markets have three distinctive features that allow the strong to get stronger. First, they are characterised by what economists call network effects - the idea that something becomes more valuable when more people use it. Think for example of the exponential growth of Facebook, which became more attractive the more people signed up. It’s the same with game developers – they all want to put their apps on the iStore because it has the most users, which in turn helps it to attract more users.
Second, there are significant switching costs between products, and customer get locked-in. If I want to trade in my Dell laptop for an Apple machine, I can expect many days of grief as I get used to the subtle differences between the two operating systems. If I want to change my soap powder, or even buy a different brand of car, the costs of switching are much lower.
Third, the value in high-tech products is mostly in the software, and the neat thing about software is that the variable cost of making it is zero. So once Apple has developed its new operating system, it has an incentive to get it into as many people’s hands as possible: whatever they pay goes straight to the bottom line.
Put these three points together, and it’s easy to see how some markets end up being completely dominated by one company, with the strong getting stronger and the marginal players being elbowed aside. And of course it isn’t necessarily the “best” product that wins in this world: VHS pushed out Betamax in the video tape market, and Microsoft dominated Apple in PC operating systems; both cases where the inferior product won out.
All of which helps to explain the strategies we see the smartphone companies using to gain control of their market. The operating system (Android, iOS, Windows) is the heart of the product, so to attract more users onto their system they are building “ecosystems” of suppliers, app developers, and mobile operators around it. They are also seeking to control their channels to secure their market share – hence Microsoft’s acquisition of Nokia, and Google’s acquisition of Motorola.
So what will happen to the smartphone industry in 2014? There is no way back for Blackberry or other lesser operating systems like Symbian. But in terms of overall winners, history doesn’t tend to repeat itself exactly. The switching costs between smartphone operating systems are falling, so we may end up with two or three players coexisting with each other. And there is another lesson from the PC industry that we shouldn’t forget, namely that the “open” architecture created by Microsoft, Intel and IBM ultimately attracted more followers than the “closed” system of Apple.
So here is my prediction: the Android operating system will continue to grow (through Symbian, LG, HTC and Motorola), because it increasingly does everything Apple can do, and at a lower cost to users and app developers. Apple will retain a loyal but gradually dwindling customer base – it will continue to be cool, but its best days are behind it. And what about Microsoft? Just as it did with the XBox, I expect Microsoft will continue to throw money at the problem, gradually building up sufficient market share to become a profitable third player.
High-tech markets like smartphones don’t follow the traditional rules of competition – they operate according to the logic of “increasing returns” to scale, where the strong get stronger. By understanding these different rules, you can make much better sense of the strategies of companies like Apple, Google and Microsoft.