June 30th, 2008 seph250
Introduction to the Innovators Dilemma
In the Innovators Dilemma and the Innovators Solution, Clayton Christensen creates a framework explaining how established companies, with large amounts of capital and loyal customer bases, are disrupted and eventually replaced by smaller companies with little capital and no customer base. This model of disruption introduces several insightful concepts, but fundamentally says that by offering products with less performance, but at a significant price discount, new companies have the opportunity to take initial market share and then move up market and disrupt the incumbents.
With consumer internet web services these rules may no longer apply. YouTube, Facebook, Skype, Kayak, and Pandora are free services for consumers. If it’s impossible to undercut these companies with lower prices, is it impossible to disrupt them? This paper will apply Christensen’s framework to web services that are free to consumers and examine possible strategies for disrupting market leaders.
Consumer Internet – Services for Free
In 2008, Chris Anderson, the editor of Wired published an article titled “Free! Why $0.00 Is the Future of Business”. Anderson discusses how, for web services, the swiftly decreasing cost of bandwidth and data storage combined with the ability to simultaneously serve millions of customers at once are driving prices to zero. Some of the free services that will be examined include Google, Yahoo, Hotmail, Flickr, Facebook, MySpace, Twitter, Wordpress, Pandora, Monster, and Skype.
But hold on, if these companies don’t charge for their products, how do they make money? Two of the most popular business model’s applied to these types of businesses (as coined by Chris Anderson), are Freemium, and Advertising.
Freemium
In the freemium business model, the basic service is free, however, a premium version of the product costs money. An example of this is Skype. Calls between two computers running Skype are free, however, to call from a computer to a landline or mobile phone the user must pay a charge. By offering the basic version of Skype for free, Skype has been able to garner a large number of users, develop initial relationships of trust, and later up-sell customers to the premium product. Low bandwidth and low data storage costs mean that even if only a small percentage of people pay for the premium version of a freemium service a web-service can still be profitable. Other web services that use this business model include Flickr, which offers increased storage space for $25/year and Pandora which lets customers stream music on their mobile phone for $36/year. Both of these companies provide a free service as well which the majority of customers rely on.
Advertising
With the advertising business model, a website offers its service for free to consumers, but charges a third party the right to advertise on the website. As illustrated, the web service attracts the attention of the consumer, and effectively sells a portion of this attention to advertisers. Advertising is the most popular strategy for monetizing a web site and can easily be used in combination with other monetization strategies. Examples of web services using this business model are Facebook, Google, and YouTube.
Disruptive Innovation
Disruptive innovation is described by Clayton Christensen as the “Innovator’s Solution” because it seems to provide a unique opportunity for new companies to replace market leaders. Other types of innovation include sustaining innovation and revolutionary innovation. Sustaining innovations are the incremental improvements in products over time. Sustaining innovations are generally predictable and it is rare for a startup to disrupt a market leader with a sustaining innovation. Revolutionary innovations are innovations that suddenly offer huge improvements in performance. Today, these types of technology improvements seem to require huge investments in research and are difficult for startups to achieve, although in the situations where this has occurred, great companies have been created very quickly.
Disruptive innovation is a highly desirable strategy for entrepreneurs to follow because it allows a startup to compete with established players in a way that tends to cause the leader to abandon the less profitable customers and move up market. Disruptive innovation can be divided into two categories, low-end disruptive innovation and new-market disruptive innovation.
Low-End Disruptive Innovation
Low-end disruptive innovation is shown in. This type of disruption relies on the pattern that sustaining innovations improve a products performance faster than consumers can utilize this performance improvement.
An example of a low-end disruption is flash drives disrupting rotational hard discs. Early on, consumers were underserved by the storage capacity available and placed a high value on the larger hard drives. As the size of operating systems and software applications increased, consumers demand for storage capacity (which varied depending on the consumer) generally continued to increase. However, with sustaining innovations, rotational hard disc capacity increased at a faster rate than most consumers could utilize. Today, with loads of digital pictures, movies, music, and applications, the typical consumer can utilize a very large hard disk. Even with all these demands, however, we are finding that we don’t need the super large capacity hard drives that are available. Since we don’t need them, we refuse to pay a premium for them, and instead opt for the midsized hard drives that are available. Lack of differentiation forces the price of these discs down, and they become less profitable.
Meanwhile, another technology for data storage, flash drives has been being developed. Initially, flash drives had much lower capacities than rotational hard disks, however through sustaining innovations, they also increased their performance. As rotational hard disks exceeded typical user’s needs, flash drives began to meet consumers minimal storage requirements. Thus, flash drive storage is beginning to disrupt rotational hard disc storage. The recently launched MacBook Air is one of the first mainstream laptops to be offered with a flash drive instead of a rotational hard disc. As Flash prices continue to decrease, we can expect rotational hard disks to become an obsolete technology.
Low-End Strategies to Disrupt a Free Web Service
Traditional low-end strategies require undercutting the competition on price. With prices of consumer internet services at zero, it seems this is not possible. In this section, I will explore two variations of low-end strategies that a startup can consider: less than free and low-time disruption.
Less than Free
One approach is to actually pay your customers to use your service. This approach was attempted by All Advantage in 2000 and is currently being employed by several video sites.
AllAdvantage.com
In 1999, AllAdvantage offered to pay customers to use their service. AllAdvantage’s slogan “Get paid to surf the web” was an extremely effective marketing message and drove the site to be one of the top-twenty trafficked web properties. The service required users to view advertisements targeted to them. AllAdvantage split the advertising revenue with its users. As you probably guessed, AllAdvantage is no longer around today. Unfortunately, it’s hard to know exactly why AllAdvantage failed. It was definitely caught in the internet bubble having raised over $200 million in venture capital, and was hit hard by the sharp downturn in 2002.
Online Video
Other companies employing the less-than-free strategy include video sites Revver.com, Shareaflick.com, Metacafe.com, and Blip.tv. With these video sharing sites, not only can users post video’s for others to see for free, they can profit if the video generates a significant audience. Similar to AlAdvantage, these sites offer revenue sharing such that the advertising revenue that their site generates is shared with the producers of the content.
Does Less than Free Work?
Revenue sharing seems to have potential as a strategy for disrupting incumbents in the consumer web space, but it’s hard to point to any case where it has actually worked. One possible explanation is discussed in the book “Predictably Irrational” by Dan Ariely. Ariely’s research shows that there is often a huge, irrational increase in demand created by decreasing the price of something from $0.01 to $0.00. This may explain why so many web-services have generated huge audiences by giving their services away. However, Ariely also shows that paying people to do something can decrease the effort they put into doing it, especially if the amount they are being paid is relatively small. Why? When paid to do something, people tend to work as hard as they feel the payment justifies. When we do something because we are intrinsically motivated, we tend to put in our best effort.
Although it’s hard to point to an example of less than free being a successful disruptive strategy, I hesitate to totally count it out. Perhaps in the right context it could give one company the ability to surpass its rivals, particularly in situations where the performance difference between competing products is small. For example, if Yahoo held a promotion where it offered a daily $100,000 raffle to anyone using its search engine that day, it could probably win many of Google’s users.
Low-Time Disruption
Another strategy to disrupt a free-web service is to change how you think about the price of a service. Rather than trying to compete on the dollar cost (which is already zero), focus on the minute cost. For many consumers, time is of more value than money anyways.
As Figure 3 illustrates, a disruptive strategy could be to undercut competitors with a service that takes less of a consumer’s time to get something done. The disruptive service can have less flexibility or less features than the incumbents, but must still provide some value that the customer desires.
Facebook Disrupting MySpace
One example of a free web-service disrupting another with a “low-time” approach is Facebook’s rise over MySpace. As shown in Figure 4, while MySpace enjoyed a comfortable lead as the first social network to reach 20 million users, Facebook has continued to grow its user base and by some metrics surpass MySpace . Many differences between the two sites have been attributed to this disruption, but the “low-time” disruption model offers a compelling explanation.
In order to keep track of friends in MySpace, a user must browse their personal pages to see what they are up to. To keep track of who is dating who, where friends are travelling, or what someone did that day, users spend hours clicking through all their friends pages, reading the messages others have written, viewing pictures and generally staying in touch. The effort provides huge amounts of information, but can be an all day affair. In the disruptive framework, this is like paying a high price for a product that (may) exceed a customer’s needs. Consumers that find the process “too expensive”, end up not spending the necessary time to keep track of the majority of their friends, and thus receive little value from MySpace.
Facebook entered the social networking space later than MySpace and did not begin to see large customer base growth until 2007, when MySpace already claimed over 20 million users. Regardless, Facebook was able to surge past MySpace. To explain this disruption, consider Facebook’s “News Feed”. The News Feed is a core feature of Facebook, central to a user’s home page, and one of the first things seen when logging in. The News Feed displays, in reverse chronological order, recent events that have occurred in one’s Facebook network. With the News Feed, it’s no longer necessary to browse through all of one’s friend’s personal pages to see if anything new has happened in their Facebook life. Recent events such as posting new pictures, making new friends, updating a status, or commenting on others pages are consolidated and displayed right on the user’s home page.
In many ways, Facebook is less of a product than MySpace. It lacks the ability for a user to customize profile pages with music, videos, and stylized html that MySpace provides. Browsing around all your friends MySpace profiles definitely provides more information about one’s friend’s lives and personalities than simply glancing over one’s News Feed in Facebook. However, not everyone desires all the information that MySpace provides. Just as the extremely large capacities of rotational hard discs were not required by all computer users, the large amount of information provided by MySpace is not required by all social network users. Facebook provides us slightly less information than MySpace, but with a huge time discount, demonstrating the low-time disruption strategy.
Twitter Disrupting Blogs
According to Wikipedia, a blog is “a website, usually maintained by an individual, with regular entries of commentary, descriptions of events, or other material such as graphics or video”. Popular blogging platforms include Wordpress, Blogger and Movable Type. Blog platforms are much easier to setup than building a website from scratch, and have in many ways disrupted web development software such as Dreamweaver and Front Page. Today, there are reportedly over 100 million blogs.
Even Blogs may be disrupted with a low-time strategy. The blogging platforms described above give the blogger a significant amount of flexibility. Users are able to modify the source code of their site, manage comments, publish additional static web pages and embed an endless offering of widgets in the margins to provide added functionality. Blog posts are typically 200-600 words, with some being much more. Writing a good blog usually involves thinking carefully about the post, referencing sources with links, spell checking, fact checking, and even adding some insightful commentary to the facts being reported. This can be a very time consuming process.
Twitter, described as a “micro-blogging” service, uses a low-time approach to disrupt other blogging platforms. All Twitter posts are limited to 140 characters long. Given this strict limitation, it’s impossible to write well structured commentary the way one might with a blogging platform. However, this seems to be plenty of room for “Twitterers” to get their points across. With traditional blogging platforms, some customers were “over-served” with too much capability, and unable to afford the time necessary to manage a full blog. Twitter provides a less capable product that takes less time to use and thus also follows the low-time disruption strategy. With only 159,000 monthly unique visitors, Twitter still has significantly fewer users than blogging platforms such as Wordpress, which reports over 151 million monthly unique visitors. Twitter’s user base is growing quickly though.
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