In today’s technology industry, having a better product is not enough to win. Ten years ago, you could produce a component that was better, faster or cheaper than the competition and you could be reasonably certain that, as long as you executed properly, sales would go up and profits would increase. Things are not so simple any more.
One of the reasons is that, as the industry moves beyond the PC, it is quickly moving from a horizontal, modular structure to a more integrated vertical structure with competing ecosystems – something we had not had for quite some time.
In the beginning: vertical integration
Every industry goes through integration/disintegration cycles. When a technological advance leads to the birth of a new cycle, it is because a single vendor combines a set of existing capabilities with proprietary components to provide an innovative solution that delivers value to customers in a way far superior to the previous model. Think about IBM in the mainframe era, Digital in the minicomputer era, the first PCs like the Tandy TRS-80 and the Commodore 64 or for a more recent example, Apple’s iPod. During this stage, the innovator captures the lion’s share of the profits.
Towards a horizontal structure
Gradually the industry grows and the installed customer base becomes large enough that niche markets become attractive. Standards appear and specialized providers with better components win by virtue of their narrow focus. Vendors like Seagate and Quantum who focused on hard drives provided faster, cheaper drives than IBM or DEC. Disk drive vendors fight other disk drive vendors; software providers fight other software providers. At the systemic level, copycats appear with very similar (but cheaper) solutions.
A war of efficiency
Competition heats up and the focus of the industry shifts away from the new product’s value proposition (which is now standard and understood by everyone) towards the optimization of distribution and supply chain models, driving lower prices, better quality and increased performance. This is the horizontal stage of the industry.
Great examples are Compaq and Dell, with their meteoric rise to dominate the PC industry. Both used standard components, Compaq grew thanks to the channel distribution model and later Dell due to its direct model.
Back to vertical structure: the next big thing
As the industry grows and continues to drive prices down, conditions become ripe for the next major wave of breakthroughs. These breakthroughs come from companies that leverage the platforms and economies of scale created by previous stages (the Internet, cheap storage, digital content) to enable compelling new ways of using technology. Just like PC’s vs. minicomputers, the iPod vs. MP3 players or smartphones vs. cell phones.
The value provided by the innovation is significant and the innovator takes the lion’s share of the profits (compare the profit Apple makes off an iPhone vs. the profits made by its suppliers). This drives the industry again towards a vertical structure and companies participating in the new, winning “ecosystem” thrive.
Companies who previously led the horizontal stage now find themselves in unfamiliar territory as they find a need to innovate and redesign their products, partnerships and go-to-market models. This is extremely difficult to do, because of the massive internal inertia built over the years towards driving efficiencies and evolutionary products. Creating value through innovation and creating value through efficiency are very different mindsets and require very different skills. By the time change becomes urgent enough to spark true revolution, it is normally too late and in the vast majority of cases leaders miss the next cycle.
The industry is in this stage today. There is stark contrast between players with the momentum of this giant pendulum working for them versus against them. Consider: as of this writing, the market capitalization of Apple ($333B) exceeds that of HP ($76B), Nokia ($23B), and Microsoft ($227B) combined.
As you consider creating a startup, or think about its strategic direction, define what “ecosystem” you want to become part of – and identify the trends and forces that will shape it into the future. It is always easier to grow when you work with, rather than against, the industry’s strategic momentum.
I look forward to your comments and opinions – remember to add yourself to the mailing list if you wish to receive the next blogs automatically!