Platform Creation and the Outsourcing Dilemma in Web Services
July 7th, 2008 seph250 Posted in Internet, Social Networks |
It seems that every web 2.0 start up today is striving to become a “platform”. Obvious examples are Facebook and Twitter. By building a product that othercompanies will build their businesses on top of, a company could become an irreplaceable part of the internet’s architecture. Microsoft Windows is a great example of this working out really well for a company. However, I wouldn’t take it as a hard rule. A company needs to be very careful when deciding what will be it’s core competency, and what will be left for other businesses to innovate on. Yet again, I will draw some parrallels to Clayton Christensen’s “Innovators Dillema”.
Outsourcing in Brick and Mortar Business
When a new product first becomes available its performance does not usually fulfill the needs of its customers. For example, when the first personal computer became available, it was slow, lacked memory, and had a poor user interface. In short, it was not good-enough for most users. Any improvement in performance was highly valued. When performance is so critical, Christensen demonstrates that proprietary, interdependent system architectures dominate. However, as these proprietary systems move from being not-good-enough, to good-enough, to more-than-good-enough, advantages begin to shift to systems with modular, open architectures.
Personal computers in the 1980’s were produced by vertically integrated companies like IBM, Digital Equipment and Apple, but during the 1990’s, more modular architectures began to emerge. This shift was accompanied by a shift in the industry from vertically integrated firms to horizontally integrated firms. IBM, the original market leader in personal computers supported this shift as it outsourced component development to emerging companies.
Particularly when a company is managed to optimize short-term financial performance, outsourcing certain functions makes a lot of sense. Outsourcing decreases the company’s asset base (improving ROA) and lets management focus on only the most profitable operations. In the PC industry, operating systems were sourced from Microsoft, micro-processors from Intel and hard-discs from Seagate. This shift to a modular architecture and horizontally alligned industry allowed narrow expertise to be developed for each component, and the overall performance of the PC to continue to improve, but it also caused market power to shift from the systems integrator to the component manufacturer. As the performance of the individual components begins to define the performance of the overall product, the system integrator became commoditized by the component manufacturer. IBM suddenly found itself competing with HP, Dell, and Compaq in the systems integrator role and unable to capture much value.
It’s not always clear, when something is outsourced, which side of the equation will end up becoming commoditized. Often this is determined by the strength of the relationship between the systems integrator and the end customer. When the relationship is strong and end customers have few alternatives, or high switching costs, the suppliers become commoditized. However, if relationships between the systems integrator and customer are weak, it is likely that the systems integrator will either completely liquidate their company through outsourcing, or become a commodity service themselves.
Outsourcing in Consumer Internet Web Service
As consumer internet web services improve in performance, and become good-enough for their users, will a similar outsourcing phenomenon occur? In many cases, it seems that the leading web services are wise to this game and will try to stay vertically integrated as long as possible. However, some companies seem more open to outsourcing certain functions and may provide an opportunity for a new company to disrupt them.
In the initial stock offering, Google boldly declared that it would do things differently and not make decisions for short term financial benefit. Its founder’s unique, powerful stock privileges, and Google’s outstanding financial performance to date have given it the flexibility to focus on a long term strategy. As a result, Google keeps almost all of its functions in house. It’s interesting to consider that Google takes a very broad view in what it considers its “core-competency”. Everything from mapping software to electronic mail to mobile applications to advertising networks, even huge server farm management are developed and managed in-house.
Yahoo
Yahoo, while similar to Google in its product offerings, does seems in jeopardy of outsourcing important functions. With weak financial performance the last few years and recent pressure by Microsoft to justify its share price, Yahoo is feeling the pressure to outsource certain functions to boost profitability. A recent Wall Street Journal article “slams Jerry Yang’s strategy to remake Yahoo into the front page of the Internet. The column calls for activist investors to shake up discredited management, outsource search, and spin off Asian investments in Alibaba and Yahoo Japan”. Thus, it seems that short-term financial pressure could force Yahoo to outsource a critical part of its offering, beginning the outsourcing business liquidation evolution described by Christensen.
Facebook showed huge confidence in its customer relationships when it announced the Facebook Platform. By allowing third parties to develop and profit from applications, Facebook has essentially outsourced its application development and several successful companies specialized in producing Facebook applications have emerged including Slide, Rockyou, and Fotoflexer. At the time of the announcement it seemed these companies would only be able to prosper with the consent of Facebook. Facebook was the destination that consumers went to, and had tight control over the environment. Thus, Facebook was in a safe position to capture most of the value created by third party applications. Thousands of web developers began to compete to develop Facebook applications to try and profit from this new opportunity. As a result, these applications themselves became commoditized, with several different applications having essentially the same function.
In response to this announcement, Google organized the commitment of several other social networks, and created the Open Social Platform. Open Social provides a standardized interface between social network and application. With this new development, power has shifted from the social network to the application developers. Application developers now only need to write their application once, and can offer it on several different social networks. Whereas at first it seemed that there would be many applications competing for attention on one social network, it is now possible that many social networks will be competing to get the best applications on their platform. If the outsourcing trend continues and a social networks performance becomes defined by the performance of its third party applications, value capture will begin to shift from the social networks (Facebook and MySpace) to social network application companies such as Slide and Rockyou.
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