Mass Customization and The Paradox of Choice

Does the paradox of choice doom mass customization? A search on the above phrase shows that a lot of marketers believe mass customization is a doomed concept with the headlines: Mass Customization Maybe Offers Too Many Choices, Spoiled for Choice: Consumer Confusion in Internet Based Mass Customization, The Mass Customization Paradox, and When Less is More in Consumer Choice. I disagree.

The Paradox of Choice by Barry Schwartz

is a worthwhile, albeit slightly depressing book. Schwartz does an excellent job of demonstrating that today we (especially Americans) have infinite choices before us. We can choose from a variety of career paths, we can live in different cities, we can eat various foods, we can buy different products, we can date different people… on and on, you get the idea. Schwartz also presents various statistics (suicide rates, diagnosed depressions, medications) suggesting that, we are (in general) less happy. He suggests causation with the following rationale:

Making good choices is just plain hard (imperfect, constantly changing information).
We spend so much time researching choices that we’re too busy for our families and things that matter.
We are constantly stressed out about choices because we don’t want to miss opportunities (we want them all).
After making a choice we fantasize about how much better life would have been if we had chosen the alternative (regret).
After doing all the research to select the best option our expectations of the result become so high that reality can not deliver (disappointment).
Once we’ve made our choice, we constantly compare our choices to others and try to analyze who made a better choice.

Throughout the book is the theme that there are two types of people: maximizers and satisfiers.

Maximizers always try to make the “best” decisions and satisficers try to make decisions that are “good enough”. The ironic result is that maximizers tend to be more successful and satisficers tend to be more happy.

Most of us are somewhere in the middle, or behave as one or the other depending on the choice being considered. I think the book is a worthwhile read for this point. You might find some personal insight into your own quality of life!

If more choice = less happiness and mass-customization = lots more choice, it follows logically that mass-customization = lots less happiness.

And there are plenty of failed mass-customization efforts to cite. Just see Proctor and Gamble’s “Reflect”, Cannondale, or Levi’s Personal Pair. However, a little research will show is that many of these “failures” or “discontinuations” weren’t because consumers didn’t like the choice. For example, Levi’s ended the Personal Pair effort because it caused sales channel conflicts – other efforts had trouble manufacturing custom products and staying competitive.

Points from PoC that support the case for mass-customization

We are naturally drawn to choice

The fact is, most of us want more choices – even if they make us less happy. As Schwartz says, “65% of people not diagnosed with cancer say they would want to choose the treatment if they were diagnosed”. We crave freedom and individuality whether it is good for us or not. Mass-customization offerings are thus a natural draw to potential customers and should be able to easily get customer attention.

Whether we like it or not, we are already faced with infinite choices

Suppose you are an ecommerce company selling coffee makers. According to Schwartz’s advice, offering fewer coffee makers on your website would increase your sales. This might have worked 10 years ago in department stores, but today, when customers are looking at your coffee maker website, you can bet they have multiple browser tabs open to your competitors websites as well. Putting less products on your digital store shelves only decreases the likelihood you will be offering what the customer is looking for (for more analysis on this point refer to Chris Anderson’s “Long Tail” discussion of Amazon.com).

PoC ideas to improve a mass-customization strategy

Provide salient information that help users make the right choices

The flip side of the above cancer treatment statistic is that “88% of people actually diagnosed with cancer did not want to choose their treatment”. The unhappiness of choice comes when the stakes are high and the correct choice isn’t clear. To help mitigate this, provide either a live person or a digital wizard to (1) provide an “experts” recommendation for the customers needs and (2) ease the customer’s mind that the stakes are not as high as they think (which is true for most buying choices). When personal attention is not feasible (most ecommerce), it is critical to integrate easy to navigate and relevant information. User interface designs such as Zafu that make recommendations after a customer answers several intuitive questions seem to work especially well. MyShape, HisCatalog and Yelp also offer user interfaces that work well for helping customers make buying decisions. These strategies should be applied to mass-customization offerings as well.

Focus on offerings that provide real utility – not just aesthetics

Frank Piller once mentioned that this is the key success driver in mass-customization companies. The paradox of choice psychology provides a good explanation why. If your mass customization provides a product with a superior fit (such as custom orthopedic shoes), the choice becomes easier to make because you just choose “perfect fit”. Real utility implies that there is a correct answer, not a subjective opinion. It might be complicated and it might require domain expertise or a better understanding of your personal situation, but with the right information it will be an easy choice. Conversely, aesthetic choices can be unclear. For example, choosing between 100 shades of pink could be a subjective choice – thus a very hard decision to make.

If you find the topic interesting (and don’t mind a $2000 conference price tag) come to the First Annual MIT Smart Customization Seminar November 10th and 11th, where I will be discussing my mass-customization start up Proper Cloth.

Tagged: , mass-customization, Paradox of Choice

Published:: October 1, 2008 – 8:57 pm
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The #1 Concern for an Internet Startup Should be Customer Acquisition Cost

I’ve been talking with several people working on internet businesses recently, and it’s always the same story: If we build a website that does (insert whatever perceived problem they are solving), then we can make (X dollars) every time a customer uses our wonderful service.

What they fail to think through is the cost of getting those potential customers to their website. (To give credit, I was first introduced to this way of thinking about internet businesses by Nick Beim while I was studying at MIT) Customers don’t just show up by themselves, and even if you’re really popular, telling your friends won’t bring you the thousands of customers you probably need.

Customer Acquisition Cost is the amount of money you have to spend to get someone to take the action on your website that gets you paid. You can acquire customers through many different marketing strategies, some may be better suited to your particular niche. Some people will pass out flyers around their school, or send emails to their colleagues. Others may try to engineer their website to be “viral“, or to stimulate “word of mouth marketing“.

I like all these strategies, but I would hesitate to base a complete business plan on any of them. They are not always predictable, nor are they necessarily scalable to a large audience. Don’t ignore them, but consider them as a bonus: if you get them right they will only add to your success.

Perhaps unsurprisingly, I think pay-per-click advertising is where the most analysis should be placed. Pay-per-click advertising is both predictable (you can calculate how much it will cost to get a potential customer to your site), and it is scalable (you can choose to bring 10, 100, or even 1000 potential customers to your site per day). Great places to setup ppc advertising are Google Adwords and Yahoo Search Marketing.

Knowing how much it costs to get a potential customer to your website is the first step. The next step is to estimate what percentage of those potential customers you can turn into actual customers – also known as the conversion rate. This number is hard to predict, but here are some things to think about:

How many competitors do you have? – If you are the only one offering your product, you could expect a higher conversion rate (this never happens though).
How much better is your offering versus your competitors? – It’s likely that the potential customer will browse through your site as well as a few of your competitor’s sites. If your product is cheaper or more featured this could boost your conversion rate.
How easy is it for someone to understand your website quickly? -Your potential customers generally have short attention spans. If you have a great offering but the site is confusing, your potential customers may never appreciate what you have to offer.
How closely aligned is your product with what the customer was searching for? If you are building a social network for plumbers, and you buy the keyword “social network”, it’s likely that a lot of the people that come to your site are looking for something else, thus your conversion rate could be very low.
Analysis on your competitors is also a good idea.
Try to run some low cost experiments to test your theory.

Once you’ve convinced yourself that you have a good idea what your conversion rate will be, the rest is easy: Simply divide your cost of getting a potential customer to your website by the conversion rate, and you have your estimated customer acquisition cost.

From here it is simple- if you make more money per customer than it costs to get that customer (and there are lots of potential customers) you are in business! Best of luck!

Tagged: Conversion Rate, Customer Acquisition Cost, Pay per click

Published:: August 18, 2008 – 10:44 am
Comments:: 2 Comments

Super Targeted Advertising: Tailoring Messages to an Audience’s Cognitive Style

There is some interesting research coming out of MIT (professor Glen Urban) that I think will eventually be relevant to behavioral ad targeting. The research recognizes that different people, in different contexts have different cognitive styles.

Cognitive styles can be measured across several different dimensions. Some examples include: impulsive (makes decisions quickly) vs. deliberative (explores options in depth before making a decision), visual (prefers images) vs. verbal (prefers text and numbers), or analytic (wants all details) vs. holistic (just the bottom line).

As we are better able to determine what sort of customer is viewing an advertisement, we will not only be able to show them an ad of something they may be interested in (geographic, demographic, contextual), but we can present the advertisement in a way they are most receptive to it.

For example, if it is determined that a customer has a verbal cognitive style, they will be more interested in an advertisement listing impressive specifications of a product than they would be to a picture of the product. This will ultimately lead to higher click through rates.

Additionally, we’ll see these ad’s take users to the advertisers website in more intelligent ways. For example, take an impulsive buyer to a purchase page, and a deliberate buyer to a product details page. This will ultimately lead to higher conversion rates.

Tagged: Cognitive Style, Conversion Rate, Glan Urban, Internet Marketing, Targeted Advertising, Website design

Published:: July 16, 2008 – 10:39 am
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584 Pixels

I’ve been doing a lot of user interface design lately, and Sam Decker pointed me to a great presentation on Web 2.0 Product Management by Dan Olsen. There is a section in the slide show on UI design that is definitely worth taking a look at. One of the points that I found really useful is this:

When most people are casually internet browsing, they don’t scroll down to see what else is on the page, just below their initial field of view.

Thus, if there’s any critical content “below the fold”, it’s likely your users won’t find it. Confusion and frustration will set in, and they’ll end up on your competitors site.

Now, to get technical: according to the presentation, 92% of the population has a screen height of 768 pixels or greater, while only 38% of the population has a screen height of 772 pixels or greater. I’m not sure where the information comes from, and how recent it is, but this does serve as a pretty convincing argument to optimize your site for a 768 pixel screen height (or at least make sure it provides a great experience at this resolution).

In my Firefox 3 browser, with two toolbars shown, and multiple windows open, a 768 pixel screen height leaves about 584 pixels of web page height viewable in the browser without scrolling down. Basically – it’s not much. Fitting all critical content into this 584 pixels puts a lot of pressure on a UI designer to be as efficient as possible, but ultimately shuld pay off with more satisfied users and a higher conversion to sales rate.

Tagged: Design, User Interface Design, Web Page Design

Published:: July 10, 2008 – 1:07 pm
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Platform Creation and the Outsourcing Dilemma in Web Services

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.

Google

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

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.

Tagged: Facebook, Google, Internet, Outsourcing, Platform, Twitter, Web Services

Published:: July 7, 2008 – 1:27 pm
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Vertical Product Search Engines Diminish Importance of Brand in Consumer Products

I’m convinced that the emergence of product search engines is having an affect on the value of brands, and thus creating opportunities for smaller players to succeed.

Consider air travel. Eight years ago, when I wanted to fly from San Diego to Boston, I was pretty internet savvy, and would go online to buy my ticket. The online travel agencies (Orbitz, Travelocity, etc.) were an option, but they were not perfect for two reasons. First of all, there was a lack of transparency in the pricing. If you booked an American flight through Orbitz it could cost more than if you booked it through American Airlines website directly. Second of all, there were a few airlines that were not included in the search -most notably Jet Blue, that had reasonable prices and (at the time) great service.

As a result, when I went shopping for a plane ticket, brand mattered a lot. It was the brands that I could remember off the top of my head that I was drawn to first.

I’d check American Airlines website, check Jet Blue’s website, and then make a decision.

Enter Kayak. Kayak was the first vertical search engine for flights that I became aware of. It covered all the different carriers, and its pricing was transparent because you purchased your ticket from the airline directly. My new process for buying a ticket is simple. Go to Kayak, enter the desired dates of travel, and see what the options are. Being price conscious, I often just go for the best deal. If two flights are virtually the same in terms of travel time and cost brand might by the tie-breaker, but generally speaking I don’t consider brand as much. Kayak organizes all the information in such a comparable way that i can pick the product best suited to my needs.

Fine. What’s so interesting about this? Analogous to Orbitz are sites like Zappos and Endless, and analogous to Kayak are sites like Shopping and Pricegrabber. Shopping.com and Pricegrabber are true vertical product search engines that send a shopper to the suppliers website to make a purchase, providing pricing transparency, while Zappos and Endless sell you the product directly.

I predict that Product Search Engines will improve over the next few years. They will cover a broader range of sources and they will present the specification of their products in improved ways such that it is easy to compare products and make the best purchase decision.

For example, in the future, if someone is searching for a leather bag, they will be able to go to a Product Search Engine focused on bags, and know with confidence that 99% of bags for sale on the internet are included in their search results. Furthermore, an improved interface will allow a customer to filter based on the specification of bags. If you only want black, you can filter out everything else. If you want a briefcase style, you can look only at those as well. Only gold plated zippers, no problem. Vintage finish to the leather, done. In the end, we will have narrowed our options to a few products that meet our exact criteria, and ultimately be able to make an informed buying decision. As before, if you end up with two bags that are equal in every way, with the exception that one has a brand you like and the other does not, the brand may still win out. The brand is ultimately less important though, because you were not looking at the product because of its brand, you were looking at it because it met your product criteria

This will be a major shift from how things are today. If someone wants a product today, they go directly to the brick and mortar store of the brand they know for producing that product. In the store, they are captive to see only products from that brand. For the online shoppers, they do effectively the same thing, going directly to the websites of the brands they know.

Bottom line: I’m excited about this, because I think it will open the door for new product companies without a lot of brand cache to compete against the major brands simply by offering quality products that meet consumers expectations and needs for a reasonable price.

Tagged: Brand, Kayak.com, Pricegrabber.com, Product Search, Vertical Search

Published:: July 5, 2008 – 1:59 pm
Comments:: None

New Market Disruptive Innovation for Web 2.0

New Market Strategies for Disruption

New market strategies for disruption are different than low-end disruptive strategies. Instead of simply entering the market with a lower cost, lower performance product, new market strategies involve “coming off the backplane” into a new market.
An example of a new market disruptive innovation is Sony’s portable transistor radio. When originally released, the transistor radios sound quality was completely inferior to that of existing radios on the market. However, existing radios were so large they were often built into furniture and thus not remotely portable, and prohibitively expensive for most customers. When Sony’s low cost portable music player came on the market, it was not really a direct competitor to the existing radio businesses. If someone was in the market for a high end radio, they would balk at the poor sound quality of the transistor radio. Likewise, most customers interested in the transistor radio could never have afforded an expensive home radio. By positioning the product for a new market, Sony was (according to Christensen) “competing against non-consumption”. Customers were either going to get a Sony radio, or not get anything at all.

New Market Strategies to Disrupt a Web-Service

In most of the examples Christensen describes, new market disruptive strategies seem similar to low-end disruptive strategies because price is the factor that separates different markets. In free consumer internet services, markets are not defined by pricing categories because the prices are already zero, a price that anyone can afford. However, there are other factors that separate markets in consumer internet and thus still ways to position a service such that it “competes against non-consumption”.

New Market Disruption

Foreign Language Applications

One proven strategy is to offer a consumer internet service in a certain foreign language. Many consumer internet sites target the US market and ignore the rest of the world. If you don’t speak English, you can’t use these services.

Xiaonei Disrupting Facebook

An example of a company employing this strategy is Xiaonei, dubbed by many as the “Chinese Facebook Clone”. In April 2008, Xiaonei reportedly raised $430 million in venture capital, and had built a community of over 8.8 million active users. As in all disruptive innovations, it currently seems that the two social networks do not compete with each other. As globalization continues it’s possible these companies will become direct competitors. If Xiaonei is able to focus on the unique needs of their Chinese customer base and to develop real innovations in their own right rather than just mimicking what Facebook does, it may be able to build enough momentum to compete with and even disrupt Facebook in the English market.

Baidu Disrupting Google

Similarly, Baidu is a search engine that targets the Chinese market. The interface, while resembling Google’s search page, is in Chinese, but the differences go much deeper. For a search engine to adequately address the Chinese market, it needs to be able to index and search through pages that use Chinese characters. This provides unique challenges that companies focused on the US market are not well positioned to address. In 2006, Baidu was “the first choice of 62 percent of Chinese users, up 15 points over 2005”, according to a study released in September by the China Internet Network Information Center. As globalization continues, Baidu may one day expand into offering a US search engine that can disrupt Google at home in the US.

Provide Mobile Access

Another new-market disruptive strategy is to initially focus on mobile. Around the world, many people have access to a mobile phone, but no access to a computer. Mobile services are generally lower performing products than their personal computer browser counterparts limited by the smaller screen, user interface and slower data rates. Some mobile services work by simply sending text messages to the service, which responds with a text message, others work in the mobile phones browser, and others work as a Java application installed on the phone. Mobile services with value propositions similar to desktop browser internet applications could provide a foothold to disrupt the leading internet application. Some companies that seem to be employing this strategy include 4Info and Babajob.

4Info Disrupting Google

4Info was one of the early local/mobile search companies that functioned via text messages. In order to submit a search a user only has to send a text message to short code 44636 (4info), of what they want to search. Sending the message “Starbucks Boston” will return the address and phone numbers of Starbucks locations in Boston. Sending “SWA 436” will return the details of Southwest Airlines flight 436. By using text messages as the interface to the service, 4info is available to anyone with a text message capable mobile phone. People without a broadband internet connection on their PC are able to use the service. Unfortunately for 4Info the leading search engines have recognized this service as a potential disruption, and launched similar services, making it seem unlikely that 4Info will be able to disrupt Google or Yahoo.

Babajob Disrupting Monster

Another startup that is using mobile access as a new-market disruptive strategy is the India based startup Babajob.com. Babajob is a service to connect employees with employers. The business takes advantage of the fact that although most workers in India do not have personal computers with internet access, they have text message capable mobile phones. Once signed up, job seekers get text message notifications of job opportunities they might be interested in, and can respond with their availability. As the Indian job market grows and more Indians begin to use personal computers with internet connections, Babajob may be able to move up market and find itself in a position as the Monster.com of India, and a disruptor of the US market leader.

Tagged: , 4info, Babajob, Baidu, Christensen, Disruption, Google, New Market, Web

Published:: July 2, 2008 – 10:51 am
Comments:: 1 Comment

Low-End Disruptive Innovation in Web 2.0

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.

Tagged: Advertising, All Advantage, Anderson, Christensen, Disruption, Flickr, Freemium, Innovators Dillema, Pandora, Skype

Published:: June 30, 2008 – 9:12 am
Comments:: 1 Comment

Value Capture, Complementary Assets and Uniqueness in Social Networks

There’s no doubt that with the fast rise of social networks, immense value has been created. Myspace now ranks as the fifth most popular website globally and Facebook ranks seventh. It’s unclear, however, if these services will be able to capture this value in the future.

Friendster

As one of the first social networks to enjoy success, Friendster is an awesome example of failing to capture value. Today, Friendster sees considerable traffic, ranked the 17th most popular website globally. However, in December 2007, Friendster saw revenues of $700,000, with a loss of $400,000. Why, with so many users is Friendster still not being profitable? The answer is in Friendster’s user base. Today, 70% of Friendster’s traffic comes from the Philippines, Malaysia, or Indonesia . Only 4% of traffic comes from the United States. With such little traffic coming from wealthy countries, online advertising (key to social networks revenue) is ineffective and Friendster is unable to capture value.

Myspace

Friendster’s founder Jonathan Abrahms is credited with developing the idea of an online social network, however, without any real intellectual property protection, or secrecy, the idea was not unique for very long. It would seem that Myspace took the same idea and built the first successful social networking business, thus creating and capturing value. MySpace’s web pages are crammed with advertisements and MySpace is profitable. According to News Corp, MySpace, turned a profit of $10 million on revenue of $550 million for the fiscal year ending June 30, 2007. MySpace revenue is projected to surpass $800 million in fiscal 2008.

Facebook

Facebook has also created value with its social network, however so far it has captured very little. In 2007, reported revenues were $150 million, with an EBITDA of $50 million. Projected revenues for 2008 are $300 to $350 million. Facebook has only recently begun to insert advertisements in its site, and it has been very judicious in how it goes about doing this. As opposed to MySpace, Facebook shows fewer advertisements per page and they are generally more subtle.

Complementary Assets in Social Networks

Complementary assets are critical to the success of social networks, which inherently rely on network externalities to be successful. The following complementary assets play a large role in the competition between social networks and will continue to do so in the future.

User Base

Social networks are all about the people that use them. A person is most likely to join a social network that his/her friends are already in and a positive feedback loop occurs. There are also switching costs (although small) of moving from one social network to another so a new customer for one social network often means one less potential customer for a competitor.

Servers

In 2008, Facebook plans to invest $200 million in new servers. Increasing its number of servers and having servers located across the country is an expensive upfront cost, but it will allow Facebook to deliver faster loading pages to a broader audience. If other social networking sites do not take action similar to this they may be at a disadvantage. As video and interactive content on social networking sites increases, these servers will allow Facebook’s pages to load faster and deliver an improved user experience.

Third Party Applications

Facebook was the first to announce the Facebook Developers Platform, allowing third party developers to build and launch their own applications within Facebook. Since this announcement, Myspace and Friendster have made similar announcements. By allowing third party applications, social networks hope to create another complementary asset of third party developers and rich applications for users to benefit from.

Interestingly creation of this asset is another example of a social networking site passing up an opportunity for value capture. Instead of developing these applications internally and capturing all the advertising dollars, Facebook allows third parties to profit. In the first six months of launching the platform, third parties are estimated to have earned $20 million in revenue.

Uniqueness in Social Networks

There is no defensible IP in social networks (that I know of anyways). Theoretically any social network could copy another. Many startups today have taken what seem to be the best features of Facebook, MySpace and others and launched (arguably) better social networks than either of the leaders. However, without the complementary assets these startups have gotten little traction.

But, uniqueness still plays a role in Social Networks. With such a large install base (so many users) it is not always possible for social networks to copy each other. For example, it is a fundamental feature of MySpace that users can customize the HTML of their page. So, suppose MySpace decides that they prefer the clean, organized look of Facebook. To make that change they would have to make major changes to the system and run the risk of angering and losing many of their current users. Thus, they are forced to stick to more evolutionary changes to the system as demonstrated when MySpace launched a news feed very similar to that on Facebook.

Uniqueness has and will continue to play a major role in completion between existing Social Networks. The subtle differences between Facebook and MySpace may cause one or the other to ultimately prevail.

Tagged: Complementary Assets, Facebook, Friendster, Internet, Myspace, Profit, Revenue, Social Networks, Value Capture

Published:: March 21, 2008 – 5:12 pm
Comments:: 4 Comments

Market Diffusion of Online Social Networks

Online Social Networks have seen huge success in the last five years, going from less than one million users in 2003, to an aggregate of over 100 million users today. This market diffusion has been fueled by broadband penetration, mobile access, international expansion, product improvements and the obvious network externalities. This recent diffusion has changed the entire industry, shifting power from traditional internet leaders (Microsoft, Google) to the social networking sites (Facebook, MySpace). In this chart here, I am simplifying data from Alexa and inferring the number of uniques users from comscore reports, and quantcast data. I’ll consider the number of unique visits as the number of “customers” these sites has.

Broadband Penetration Increasing

A major external factor limiting market diffusion of any product is distribution footprint. Since social networks are an Internet product, let’s consider internet access as a measure of a sites distribution potential. Broadband penetration in the US has increased from 33% in 2003 to 85% in 2008 , allowing increased distribution of online social networks. This growth has been a major fuel for social network diffusion.

Improvements in Mobile Access

Ease of access to online social networks via mobile devices has also improved dramatically in the last few years. In February 2006, Helio launched a phone featuring MySpace Mobile that allows users to perform the most popular MySpace functions. Another milestone was the launch of Apple’s iPhone in June 2006. The iPhone’s improved browser interface makes interacting with a social network much easier.

However, not everyone wants to access their social network on the go. According to Jupiter Research, only 2% of cell phone users use their mobile device to access an online social network while 12% of social network users are interested in accessing the sites on their phones. However, for some people without broadband, mobile access is their only way to participate. To capitalize on this, in September 2007, MySpace announced plans to launch a free ad-supported mobile phone. If they pull this off, it would open MySpace to users without broadband or mobile access today and grow their user base considerably.

Product Improvements

Another major factor influencing diffusion of social networks is the continuous improvement of the social networks themselves. Features such as content creation; flexible customization of pages and the ability to share media are adding greater utility for consumers and ultimately drawing more people to social networks. For example, at the time of launch of all three major social networks, there was no method for a user to upload and share videos. However, MySpace launched a video sharing functionality in January 2006 , and Facebook launched the feature in May 2007.

International Expansion

Major social networks are taking advantage of the scale of the Internet to diffuse their products and to create value beyond the US. In 2006, after being acquired by Fox Interactive,

MySpace expanded into 15 foreign countries, developing local versions of the site and marketing the site internationally. Currently, MySpace has developed local versions of its site for 24 different countries.

In fact, despite Friendster’s decreasing popularity in the US, it grew substantially in Asia in 2007, which now account for 89% of its unique monthly visitors.

Industry Evolution

Shift in Market Power

With the increased diffusion of social networks, the dynamics of the industry have changed dramatically. Just five years ago many people regarded social networks as a fad and waste of time. However, today with Myspace and Facebook producing so much traffic, they are regarded as extremely powerful companies. An indicator of this is when in October 2007 Microsoft paid $240 million for just a 1.6% stake in Facebook.

Transformation from IT Companies to Media Portal

When social networks first emerged, their primary focus was on communications and networking. However, in the last few years the sites have evolved to be more like media portals. For MySpace, this was driven partly by its acquisition by News Corp, a major media company, in 2005.

The result is that these social networks are now competing, not just with each other, but with more traditional portals like Yahoo, AOL and MSN, as well as media sites such as YouTube and Flickr.

Transformation from a Walled Garden to a Platform

Another important aspect of the industry evolution is that Social Networks are opening up their APIs and allowing other companies to develop and market applications that run on them. Facebook announced the Facebook platform in May 2007 and as a result over 5000 companies and independent developers are currently developing applications that run on Facebook.

This changes the industry, because now these developers no longer look at Facebook as competition but as a powerful ecosystem within which they can profit.

In November 2007, MySpace committed to the Open Social standard developed by Google allowing third parties to develop applications that run on MySpace and other social networks such as Bebo, Ning, Plaxo and Six Apart. Similar to Facebook, Myspace has also announced a developer platform.

Overall, the online social network industry is rapidly growing and dynamic. The factors driving market diffusion, such as broadband penetration, improving mobile access and product improvements are themselves continuing to evolve. The market structure and industry evolution indicate that social networks are poised for continued growth as the late majority begin to create their profiles.

Tagged: Diffusion, Facebook, Friendster, Market Diffusion, Media Portal, Myspace, Ning, Open Social, Social Networks, Web 2.0

Published:: March 5, 2008 – 10:03 am
Comments:: 1 Comment

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