Restricting Senior Executive Pay
In the past week, there have been numerous comments about overreaching by the Federal Government in placing caps upon the pay of the top twenty-five executives in companies that have received major government investment.
Government determining the pay of executives is clearly an overreach, but I find it hard to criticize the modest restrictions.
Consider the situation if these institutions were not banks, where bankruptcy was a legal option. Under such circumstances, every employee in the organization would likely be facing firing, salary and other reductions in remuneration.
Banks are difficult to put into bankruptcy because such events would trigger complex and cascading contract events, so the Fed, the Treasury and other regulators have been forced to take over these financial institutions in a "soft" bankruptcy.
When government involvement is looked at in this light, perhaps the complaint should be that more has not been done.
Tuesday, October 27, 2009
Monday, October 05, 2009
Commentary: Rules Matter and Foot Faulting is Cheating
On Sunday, I made a fuss on the tennis court. It's not something I like to do, but my opponent was so egregious in his cheating that I felt compelled to call him out. (By the way, I use the word cheating deliberately based on what the USTA states.)
Now, before I tell you my story, let me confess that I lose a lot of tennis games, but I love the sport -- the Zen of playing it. So winning is great, but it is not everything for me. So I am not motivated by gamesmanship. I enjoy the fun of tennis which is why I organize a regular game for two courts of players each weekend.
My opponent, let call him "S", started outside the base line, placed his right foot completely into the court (inside the line) and then pushed up from inside the court to hit his serve. He did this on every serve even when he had been called on a foot fault for the previous serve for the same fault.
He got angry, claimed I could not see his feet and insisted that he served way behind the base line. After four consecutive foot faults, he stormed off the court, very angry at me. All in all, it was not a pleasant experience for me. And probably not for him, either.
Coincidentally, I ended up watching S in a subsequent round from a position where I could see along the base line as if I were a line judge. Every serve repeated the pattern of stepping one foot completely into the court before rising up to serve the ball. What I realized is that S either does not understand the rules of faulting or he is not watching his own feet. A companion, a knowledgeable, long playing tennis player and long term organizer of tennis events, seated beside me agreed on my assessment. It was clear to both of us.
Now S has a strong serve and I like playing against people with strong serves. It gives me a chance to practice my service return. But, as Randy Cummings points out in his web site:
What does a foot-fault do? Think of it this way, it either lowers the net by a six inches or more or makes the guy serving equal in height to Ivo Karlovic. In either case, the server has a distinct advantage over the opponent who remains behind the baseline until after the ball has been struck. The cheater can hit harder, flatter balls, because with a lower net or higher physical stature he has more margin for error (see my articles Deceptively High Net and Window on the Serve for more explanation). If he is also serving and volleying, he is that much closer to the net before your return crosses into his half of the court, making his volleys easier to execute.
Why is this cheating tolerated? Probably because those facing the cheater don't realize how high the net really is and how much topspin needs to be hit on the ball in order for it to clear and land in the box. The net is deceptively low because you can see through it. If it were a solid piece of material, you would quickly perceive how much you have to arc the ball in order to have a safe serve. Failing to understand this, players allow the cheater to continue, not realizing how much advantage is really being taken by the foot-faulter. The foot-faulter has reduced the amount of arc he needs to have on the ball to get his serve in the box, giving him a distinct advantage.
http://vjtta.com/content/view/238/88/
This paragraph by the way describes the type of serve delivered by S.
To reinforce the point, the USTA states:
... And one of the most missed/ignored rules is the foot fault. Here’s a reminder from Sheila Banks, Director of Adult/Senior Recreation USTA/Pacific Northwest, reminding players of the foot fault rule and how to handle a team that is committing foot faults:
Please pass this on to your Captains as I have received concerns that many players are footfaulting during their matches.
Foot Faults are considered cheating and at no time to be allowed..
http://tenniscrowd.com/blog/2009/03/07/the-foot-fault-rule/
USTA Code p. 54/55
Footfaults: A player may warn an opponent that the opponent has committed a flagrant foot fault. If the foot faulting continues, the player may attempt to locate an official. If no official is available, the player may call flagrant foot faults. Compliance with the foot fault rule is very much a function of a player’s personal honor system. The plea that a Server should not be penalized because the server only just touched the line and did not rush the net is not acceptable. Habitual foot faulting, whether intentional or careless, is just as surely cheating as is making a deliberate bad call.
I have a pretty good serve some days. Some days not. Serving is difficult and we are all frustrated by days when our service is off. That same day of dealing with S, one lady came up to me and implied in a very gracious way she did not believe foot faults should be called. But there is very little point to tennis if we apply rules selectively. When should we bother calling a ball in or out? When it comes to foot faults, at what point do we call them, when the foot is on the line, inside the court, when the player is serving from three feet inside the court?
To be honest, I don't call most of the foot faults I see. There is a lot of social pressure not to. And there are a lot of them in weekend tennis. But if a player is a beginner or low rated player with a weak serve, I feel it's too much trouble to call.
But I am changing my view. I think we should call foot faults. In my research, the best conclusion I have come up with is to warn the person the first time and then call them on subsequent faults.
Not foot faulting is a good idea. It makes you less likely to foot fault in a tournament. It sets a better precedent for your kids. At the risk of being grandiose, in a world where large scale cheating has been occurring widely (Enron, Bernie Madoff and the whole financial melt down to mention only a few), perhaps not cheating has a larger value.
And if you are consistently hitting the net, maybe you should learn how to improve your serve rather than cheat. It's not that hard to learn how to put a little topspin on your serve which eliminates the need to foot fault.
I would like to offer a final mea culpa. In doing my research for this commentary and reading the rules of tennis, I have learned much more about foot faulting than I previously knew. I knew for example, from listening to commentators at tennis events, that your feet cannot intersect the center line of the court when you serve. I did not know you had to be inside the outside line when you serve. I also learned that you cannot be moving, either walking or running when you serve. I suspect I have been foot faulting when I served from too close to the outside of the doubles or tram lines. So, while I have never been called on a line foot fault, I suspect I should have been when I was serving from far too wide.
So, please, call foot faults. We can all benefit.
Friday, August 21, 2009
Chief Customer Officers and the Digital Living Room
The Digital Living Room still continues to fall between the cracks of the silos in organizations. Consider a recent experience with major vendors.
An evaluation HP Windows Media Server that I purchased recently for a project came with MacAfee for virus protection. The protection expired after the initial trial period of 7 months.
So, I decided to use Norton, which I use on my other machines. However, Symantec does not make it clear whether their products work on Windows Home Server. Nor did they reply to my support request. So, I decided to upgrade the existing MacAfee solution as the lazy man's approach.
After two support calls separated by three days, and after 50 minutes on hold, I determined on the second support call that the product currently has installation problems and also does not upgrade its data files. The conclusion was not shared with me on the first support call where a different answer had been suggested.
Now, as a past CEO of various software companies, I sympathize with the challenges of supporting continually changing software. And I am not particularly worried about this server, which is primarily used for file back up and music sharing.
But the whole experience of:
1. Having to determine whether a product works with a home server.
2. Inability to offer a clear and simple decision process on what to buy.
2. Confusing installation processes.
3. Difficult to use administrative software more appropriate for a small business than a home user.
4. Delivery of support via the small business support line causes unnecessary phone calls and downloads of support software.
reflects an inside-out silo'd view of the customer.
Persuading consumers to tackle the Digital Living Room will require a more customer centric perspective. A Chief Customer Officer would help a company transform the customer experience so that successful customers would become ambassadors on behalf of products and services.
The Digital Living Room still continues to fall between the cracks of the silos in organizations. Consider a recent experience with major vendors.
An evaluation HP Windows Media Server that I purchased recently for a project came with MacAfee for virus protection. The protection expired after the initial trial period of 7 months.
So, I decided to use Norton, which I use on my other machines. However, Symantec does not make it clear whether their products work on Windows Home Server. Nor did they reply to my support request. So, I decided to upgrade the existing MacAfee solution as the lazy man's approach.
After two support calls separated by three days, and after 50 minutes on hold, I determined on the second support call that the product currently has installation problems and also does not upgrade its data files. The conclusion was not shared with me on the first support call where a different answer had been suggested.
Now, as a past CEO of various software companies, I sympathize with the challenges of supporting continually changing software. And I am not particularly worried about this server, which is primarily used for file back up and music sharing.
But the whole experience of:
1. Having to determine whether a product works with a home server.
2. Inability to offer a clear and simple decision process on what to buy.
2. Confusing installation processes.
3. Difficult to use administrative software more appropriate for a small business than a home user.
4. Delivery of support via the small business support line causes unnecessary phone calls and downloads of support software.
reflects an inside-out silo'd view of the customer.
Persuading consumers to tackle the Digital Living Room will require a more customer centric perspective. A Chief Customer Officer would help a company transform the customer experience so that successful customers would become ambassadors on behalf of products and services.
Wednesday, August 12, 2009
Getting Sued
I recently had an off the records conversation with a former CEO of major firm who had spent much of his CEO tenure dealing with more legal suits than any business should have to deal with.
The take away from our discussion was that with the full benefit of hindsight, the company's problem was that (1) it was small, (2) its patented technology was really valuable to very large customers, (3) the company priced licensing of its technology based upon the value of the technology to licensors and their customers.
What the company forgot -- and this is a common mistake of small companies in the United States -- is that a large company looking at a small company always has the choice of litigating and use the law as a weapon to beat the small company to death.
So, when I work with small high tech companies and their business plans talk about barriers to entry including a patent, I will often grimace.
If the technology is unsuccessfully, nobody will care.
If the technology is successful, then the chances of being sued go up.
If the technology is exceptionally successful or useful, it's pretty much a sure thing that you are going to get sued.
Without major reform to patent law in the US - which is clearly needed -- there are no simple legal answers to this problem, except to using pricing as a tool.
Pricing can encourage licensing and make it more attractive than suing. What people forget is that there are many ways of pricing a product. Pricing creativity can reduce legal risk, accelerate revenues and in some cases increase total revenues.
It's worth thinking about before you get sued.
I recently had an off the records conversation with a former CEO of major firm who had spent much of his CEO tenure dealing with more legal suits than any business should have to deal with.
The take away from our discussion was that with the full benefit of hindsight, the company's problem was that (1) it was small, (2) its patented technology was really valuable to very large customers, (3) the company priced licensing of its technology based upon the value of the technology to licensors and their customers.
What the company forgot -- and this is a common mistake of small companies in the United States -- is that a large company looking at a small company always has the choice of litigating and use the law as a weapon to beat the small company to death.
So, when I work with small high tech companies and their business plans talk about barriers to entry including a patent, I will often grimace.
If the technology is unsuccessfully, nobody will care.
If the technology is successful, then the chances of being sued go up.
If the technology is exceptionally successful or useful, it's pretty much a sure thing that you are going to get sued.
Without major reform to patent law in the US - which is clearly needed -- there are no simple legal answers to this problem, except to using pricing as a tool.
Pricing can encourage licensing and make it more attractive than suing. What people forget is that there are many ways of pricing a product. Pricing creativity can reduce legal risk, accelerate revenues and in some cases increase total revenues.
It's worth thinking about before you get sued.
Thursday, August 06, 2009
The Digital Living Room - Miles to Go Before You Can Sleep
Yesterday, I attempted to watch a Blu-ray movie obtained from Netflix, produced by Sony studios, on a six month old Sony Vaio multi-media laptop, hooked up to a 25.5 inch Samsung monitor as a secondary monitor. Blu-ray of course is a wonderful standard for high def movies developed by Sony.
It took me two hours and two support calls to get the movie started.
Now it's pretty hard to argue that compatibility should have been an issue with Sony controlling all the technology. If I were not doing consulting to firms in the digital living room area, I would have broken something in frustration. I rarely get so annoyed by technology that I curse out loud, but it was one of those evenings.
So, you may ask, what happened?
The problem began with the InterVideo software shipped with the notebook. When I stuck in the Blu-ray disk, it told me that I need to renew a key in the Blu-ray viewing software. I was sent to a confusing page with the software vendor Corel, a relationship I was unaware I had. My immediate thought: is this some kind of virus problem? The key transaction then failed twice. So far ten minutes wasted.
The courteous and knowledgeable support person in Costa Rica talked me through disabling user account control on my notebook and obtaining a key upgrade. I was fuming by this stage. Not only do I object to an unnecessary key renewal, the software does not even work well. So far, 60 minutes wasted.
But the problems did not stop there. I could not escape the previews on the DVD. Now, I would like to think I am a pretty knowledgeable about the digital living room. People hire me to look at their products and do competitive comparisons. But it was practically impossible to get to the movie. I think I saw the previews seven times. Unlike most people I have two media computers with Bluray from different vendors. Same problem on both my desktop and my notebook. Total time wasted now at around 70 minutes.
On the second support call, we determined that a second Netflix Blu-ray disk, immediately went to a main menu from which you could play your movie easily. Admittedly, the second disk did reveal I had a bad setting on my desktop, causing the colors to be wrong, which I eventually fixed by letting the video app control color settings. The conclusion from the second support call was that the Blu-ray disk was defective.
Now, I am not a typical user. I am way more persistent. I eventually figured out a way of getting to the movie with some additional experimentation. Total time invested over the entire evening ended up at over two hours. But I would have to say that the experience was ridiculous. A media notebook that can't play media. A Blu-ray disk that won't let you get to the movie on it. Disappearing menus. Software that won't let you play your movie on your external monitor. Multimedia computers that have non working registration software that prevent usage.
Yesterday, I attempted to watch a Blu-ray movie obtained from Netflix, produced by Sony studios, on a six month old Sony Vaio multi-media laptop, hooked up to a 25.5 inch Samsung monitor as a secondary monitor. Blu-ray of course is a wonderful standard for high def movies developed by Sony.
It took me two hours and two support calls to get the movie started.
Now it's pretty hard to argue that compatibility should have been an issue with Sony controlling all the technology. If I were not doing consulting to firms in the digital living room area, I would have broken something in frustration. I rarely get so annoyed by technology that I curse out loud, but it was one of those evenings.
So, you may ask, what happened?
The problem began with the InterVideo software shipped with the notebook. When I stuck in the Blu-ray disk, it told me that I need to renew a key in the Blu-ray viewing software. I was sent to a confusing page with the software vendor Corel, a relationship I was unaware I had. My immediate thought: is this some kind of virus problem? The key transaction then failed twice. So far ten minutes wasted.
The courteous and knowledgeable support person in Costa Rica talked me through disabling user account control on my notebook and obtaining a key upgrade. I was fuming by this stage. Not only do I object to an unnecessary key renewal, the software does not even work well. So far, 60 minutes wasted.
But the problems did not stop there. I could not escape the previews on the DVD. Now, I would like to think I am a pretty knowledgeable about the digital living room. People hire me to look at their products and do competitive comparisons. But it was practically impossible to get to the movie. I think I saw the previews seven times. Unlike most people I have two media computers with Bluray from different vendors. Same problem on both my desktop and my notebook. Total time wasted now at around 70 minutes.
On the second support call, we determined that a second Netflix Blu-ray disk, immediately went to a main menu from which you could play your movie easily. Admittedly, the second disk did reveal I had a bad setting on my desktop, causing the colors to be wrong, which I eventually fixed by letting the video app control color settings. The conclusion from the second support call was that the Blu-ray disk was defective.
Now, I am not a typical user. I am way more persistent. I eventually figured out a way of getting to the movie with some additional experimentation. Total time invested over the entire evening ended up at over two hours. But I would have to say that the experience was ridiculous. A media notebook that can't play media. A Blu-ray disk that won't let you get to the movie on it. Disappearing menus. Software that won't let you play your movie on your external monitor. Multimedia computers that have non working registration software that prevent usage.
Is Amazon the Most Interesting Media Company in the World Today?
The move to digital content has to a large extent was initially spearheaded by Apple. It's initial focus on its business system was on simplicity. Pricing per track was set at 99 cents. Simple and understandable. A good pricing model for a new and complex technology.
But today, the world looks quite different. Digital music is now mainstream. And with mainstream businesses, traditional retail issues and innovation start to become more important.
Amazon is at the forefront of this new trend. It is a result, possibly the most interesting media company in the world.
Consider the following:
Amazon sells traditional books, electronic books on Kindle or iPhone/iTouch, traditional physically delivered music, downloadable MP3s, new and second hand DVDs, downloadable movie purchases and downloadable rentable movie viewing. Other than a subscription model, Amazon has most of the purchase options covered.
Even more interestingly, unlike Apple, Amazon is behaving like a smart retailer. It uses free songs, free Kindle copies of the first book in a series to create traffic, in a way analogous to the supermarket offering cheap milk to bring in customers or samples to get customers to try a new brand.
And Amazon is testing pricing. It offers daily specials pricing anywhere from 99 cents to $2.99, with $1.99 as the most common price point to encourage traffic, obtain sampling and give customers a reason to keep coming back every day to their web site. It's better than advertising, because revenues are produced by the hook that pulls in the customer. And of course, the big problem with an ecommerce site is getting traffic. If they visit, you have a chance of selling them something.
But the really interesting capability that Amazon is building is deep understand of individual customer tastes and price elasticity, something that Apple has spurned. Amazon is learning about the tradeoffs that individual customers make on different types of purchase, lease or download of content. When will a customer own or rent? What do you need to do to create trial? When does it make sense to discount to trigger additional purchases of content from a writer or artist, or to addict a reader to a book series?
Great businesses don't freeze their strategy. They continually improve them. Amazon seems to be aggressively learning faster than other players. Kudos to them.
The move to digital content has to a large extent was initially spearheaded by Apple. It's initial focus on its business system was on simplicity. Pricing per track was set at 99 cents. Simple and understandable. A good pricing model for a new and complex technology.
But today, the world looks quite different. Digital music is now mainstream. And with mainstream businesses, traditional retail issues and innovation start to become more important.
Amazon is at the forefront of this new trend. It is a result, possibly the most interesting media company in the world.
Consider the following:
Amazon sells traditional books, electronic books on Kindle or iPhone/iTouch, traditional physically delivered music, downloadable MP3s, new and second hand DVDs, downloadable movie purchases and downloadable rentable movie viewing. Other than a subscription model, Amazon has most of the purchase options covered.
Even more interestingly, unlike Apple, Amazon is behaving like a smart retailer. It uses free songs, free Kindle copies of the first book in a series to create traffic, in a way analogous to the supermarket offering cheap milk to bring in customers or samples to get customers to try a new brand.
And Amazon is testing pricing. It offers daily specials pricing anywhere from 99 cents to $2.99, with $1.99 as the most common price point to encourage traffic, obtain sampling and give customers a reason to keep coming back every day to their web site. It's better than advertising, because revenues are produced by the hook that pulls in the customer. And of course, the big problem with an ecommerce site is getting traffic. If they visit, you have a chance of selling them something.
But the really interesting capability that Amazon is building is deep understand of individual customer tastes and price elasticity, something that Apple has spurned. Amazon is learning about the tradeoffs that individual customers make on different types of purchase, lease or download of content. When will a customer own or rent? What do you need to do to create trial? When does it make sense to discount to trigger additional purchases of content from a writer or artist, or to addict a reader to a book series?
Great businesses don't freeze their strategy. They continually improve them. Amazon seems to be aggressively learning faster than other players. Kudos to them.
Monday, August 03, 2009
To Pareto or Not To: Changing the Profitability of Your Business
Copyright Alistair Davidson, August 2009 as an unpublished work. Alistair Davidson is a strategic consultant with turnaround experience who has been CEO of several companies and helped companies improved their revenues and business development activities.
Contact: alistair@eclicktick.com Phone: +1-650-450-9011
Certain key insights in strategy seem to be continually important. Flanking a competitor is often a better strategy than attacking them head on is one example.
In many business and economic analysis, 20% or so of a market, customer group or products seems to account for a disproportionate result, often characterized as 80% of the results sought (revenues, profits, etc.). This Pareto or 20:80 rule became very popular in the 80s when activity based costing exercises revealed that for many companies profitability was driven by a small number of customers. The less intuitive conclusion, one that frequently has to be explained to first time readers is that if 20% of your customers account for in excess of 100% (say 150-200%) of your profits, then the you are losing money on the other customers.
What is challenging about the Pareto insight is that it offers a universal rule of thumb, frequently and consistently important, but the prescription from the insight is often less obvious. And sometimes it is wrong. The Pareto insight leads to one of two conclusions:
Business Model Revision
The Pareto rule is often difficult to apply is where a new business model is introduced. It is never 100% clear whether a potentially disruptive technology at the low end of a market will change market requirements or provide a platform for an initial insignificant competitor to build upon. In a parallel way, migration of high end features from premium products and services to the mass market is also difficult to predict in some markets.
The concept of Track and Trace (making parcels and envelopes trackable though out the logistics process), offered by FedEx and UPS was extremely threatening to the Canadian Post Office. They could see no way of matching the capability given the volume of mail and packages they delivered.
The internal debate revolved around whether they should take a Pareto approach and focus a Track and Trace capability only on parcels and high value added packages, or whether this would be a long term capability for all logistic operations. Their eventual conclusion was they needed to have more presence in the premium package and envelope business and Track and Trace would largely be restricted to the high end of the market. To this end, they bought a courier company, Purolator.
Dropping Customers
One potential prescription from learning that 20% of your customers account for 150% or more of profits is to slim down the business and focus upon the profitable customers. However this strategy is often emotionally very difficult for many managers and often pursued too late. Managers have spent so much time investing in acquiring customers that given up the customers is distressing.
Raising Prices
Raising prices for the less profitable customers seems like an obvious solution to a 20:80 insight, but resistance from the sales force, inadequate systems for tracking discounting behavior and negative feedback from customers are likely barriers that will need to be overcome. Slightly more clever approaches change the basis of pricing in ways that are more palatable to customers. Leasing and usage based pricing are particularly attractive to capital constrained customers and change the nature of the evaluation process.
Reducing the Cost of Delivery for Unprofitable Customers
Financial services organization frequently have used self service with ATMs and online banking to reduce the cost of less profitable services and less profitable customers. In contrast, wealth management services offer higher levels of service and advice.
Reducing Marketing Costs
A less obvious approach to making many customers profitable is to delight customers so that they become your sales agents. Strong word of mouth can significantly reduce a required marketing budget. Amazon uses daily specials in e.g. the MP3 download market to encourage daily visits to their site, a low cost way of generating traffic. Heavy users may tell their friends about hot music they have found a deal on.
Life Cycle Management
As with most costing decisions, it turns out that pricing is often a strategic decision. As a result, the time frame over which you measure customer profitability is critical as are the implications for organizational capacity.
Increasing Value Propositions
Bundling is one example of changing value propositions. Companies like Hyperion (now Oracle) and Microsoft have used bundling to reduce the cost of individual applications, but create more value for customers. In telecom, triple and quad plays (combination of voice services, broadband, TV services and mobile services) are a common marketing approach.
In some ways, bundling can be slightly unintuitive. Most purchasers of e.g. MS-Office probably don't use most of the features they purchase, but the incremental cost of having compatible features available has value. Most fixed rate pricing programs e.g. Netflix make this same tradeoff. Netflix may lose money on some customers who are heavy users of the service, but the reality is that most people are at or close to the limits of time they can devote to viewing videos. Value perceived is not necessarily usage.
Changing the Basis of Competition and Cost of Delivery
The Pareto insight is one that many companies are facing in the current recession. When demand for a product category drops dramatically, downsizing assumptions are often affected by assumptions about demand and profitability distributions.
In the automobile industry, the politically unspoken "elephant in the room" is that gasoline prices will in the future be maintained at a far higher level than previously for reasons of balance of trade, security and global warming. This increase in the total cost of ownership of a car will make likely make small cars more popular and more expensive than they have been historically. It will also make driving more expensive reducing total demand for cars. Auto companies are faced, as a result, with downsizing, a cyclical downturn of unusual size and a longer term secular shift in purchase patterns.
As with many markets, the automobile market is likely to become far less homogenous. The market may evolve towards predominantly electric powered microcars for in city driving, hybrids for trips requiring greater range, and larger hybrid capacity vehicles for transporting larger groups of people.
For automobile companies, their cost structure, traditional assumptions about profitability, scale and scope economies are all open to question.
In the same way, telecom service providers faced with demand for low priced unlimited data plans are having to rethink their network architecture to divert home and office data traffic away from cell towers to home fixed broadband connections.
Summary
The key take-away from any Pareto analysis is that it is a useful rule of thumb that inspires important questions about making money in your business. Making the right decision means not only looking at product and customer profitability, but also your delivery process and value chain from the perspective of both current and emerging usage patterns.
Copyright Alistair Davidson, August 2009 as an unpublished work. Alistair Davidson is a strategic consultant with turnaround experience who has been CEO of several companies and helped companies improved their revenues and business development activities.
Contact: alistair@eclicktick.com Phone: +1-650-450-9011
Certain key insights in strategy seem to be continually important. Flanking a competitor is often a better strategy than attacking them head on is one example.
In many business and economic analysis, 20% or so of a market, customer group or products seems to account for a disproportionate result, often characterized as 80% of the results sought (revenues, profits, etc.). This Pareto or 20:80 rule became very popular in the 80s when activity based costing exercises revealed that for many companies profitability was driven by a small number of customers. The less intuitive conclusion, one that frequently has to be explained to first time readers is that if 20% of your customers account for in excess of 100% (say 150-200%) of your profits, then the you are losing money on the other customers.
What is challenging about the Pareto insight is that it offers a universal rule of thumb, frequently and consistently important, but the prescription from the insight is often less obvious. And sometimes it is wrong. The Pareto insight leads to one of two conclusions:
1. The 20% of customers represent a unique group and lessons learned from them are not directly applicable to the rest of the market.
2. The 20% of customer represent a model for my future business.
Business Model Revision
The Pareto rule is often difficult to apply is where a new business model is introduced. It is never 100% clear whether a potentially disruptive technology at the low end of a market will change market requirements or provide a platform for an initial insignificant competitor to build upon. In a parallel way, migration of high end features from premium products and services to the mass market is also difficult to predict in some markets.
The concept of Track and Trace (making parcels and envelopes trackable though out the logistics process), offered by FedEx and UPS was extremely threatening to the Canadian Post Office. They could see no way of matching the capability given the volume of mail and packages they delivered.
The internal debate revolved around whether they should take a Pareto approach and focus a Track and Trace capability only on parcels and high value added packages, or whether this would be a long term capability for all logistic operations. Their eventual conclusion was they needed to have more presence in the premium package and envelope business and Track and Trace would largely be restricted to the high end of the market. To this end, they bought a courier company, Purolator.
Dropping Customers
One potential prescription from learning that 20% of your customers account for 150% or more of profits is to slim down the business and focus upon the profitable customers. However this strategy is often emotionally very difficult for many managers and often pursued too late. Managers have spent so much time investing in acquiring customers that given up the customers is distressing.
Raising Prices
Raising prices for the less profitable customers seems like an obvious solution to a 20:80 insight, but resistance from the sales force, inadequate systems for tracking discounting behavior and negative feedback from customers are likely barriers that will need to be overcome. Slightly more clever approaches change the basis of pricing in ways that are more palatable to customers. Leasing and usage based pricing are particularly attractive to capital constrained customers and change the nature of the evaluation process.
Reducing the Cost of Delivery for Unprofitable Customers
Financial services organization frequently have used self service with ATMs and online banking to reduce the cost of less profitable services and less profitable customers. In contrast, wealth management services offer higher levels of service and advice.
Reducing Marketing Costs
A less obvious approach to making many customers profitable is to delight customers so that they become your sales agents. Strong word of mouth can significantly reduce a required marketing budget. Amazon uses daily specials in e.g. the MP3 download market to encourage daily visits to their site, a low cost way of generating traffic. Heavy users may tell their friends about hot music they have found a deal on.
Life Cycle Management
As with most costing decisions, it turns out that pricing is often a strategic decision. As a result, the time frame over which you measure customer profitability is critical as are the implications for organizational capacity.
- Mature software companies like Oracle will often discount their software significantly to obtain sales (with the largest discounts occurring at quarter and year end when sales reps are under pressure to meet their goals). Part of their willingness to do so, is their knowledge that software is actually more a service than a capital expenditure with maintenance revenues a critical part of the annuity relationship with a customer.
- The success of the Apple iPhone is based in part upon the fact that that a $600 cost of purchase by AT&T is resold to a subscriber for $200 in return for a two year contract that might add up to $2400 of revenues and a strong probability of retention at the end of the contract. These high ARPU (average revenue per user) clients are likely some of AT&Ts most profitable.
- The challenge for AT&T is to how to grow their business. Are these customers atypical, i.e. a 20% that is atypical or do they represent a different business. Research suggests that there is a large gap between the number of subscribers that would like an iPhone-like service (i.e. with easy to use Internet access) and the actual number of data subscribers. One interpretation is that subscription rates would increase with lower data plan prices. A move in this direction would have significant implications on network architecture for AT&T mobile network capacity by reducing the revenue per user from data plans and lowering revenues per byte transmitted.
Increasing Value Propositions
Bundling is one example of changing value propositions. Companies like Hyperion (now Oracle) and Microsoft have used bundling to reduce the cost of individual applications, but create more value for customers. In telecom, triple and quad plays (combination of voice services, broadband, TV services and mobile services) are a common marketing approach.
In some ways, bundling can be slightly unintuitive. Most purchasers of e.g. MS-Office probably don't use most of the features they purchase, but the incremental cost of having compatible features available has value. Most fixed rate pricing programs e.g. Netflix make this same tradeoff. Netflix may lose money on some customers who are heavy users of the service, but the reality is that most people are at or close to the limits of time they can devote to viewing videos. Value perceived is not necessarily usage.
Changing the Basis of Competition and Cost of Delivery
The Pareto insight is one that many companies are facing in the current recession. When demand for a product category drops dramatically, downsizing assumptions are often affected by assumptions about demand and profitability distributions.
In the automobile industry, the politically unspoken "elephant in the room" is that gasoline prices will in the future be maintained at a far higher level than previously for reasons of balance of trade, security and global warming. This increase in the total cost of ownership of a car will make likely make small cars more popular and more expensive than they have been historically. It will also make driving more expensive reducing total demand for cars. Auto companies are faced, as a result, with downsizing, a cyclical downturn of unusual size and a longer term secular shift in purchase patterns.
As with many markets, the automobile market is likely to become far less homogenous. The market may evolve towards predominantly electric powered microcars for in city driving, hybrids for trips requiring greater range, and larger hybrid capacity vehicles for transporting larger groups of people.
For automobile companies, their cost structure, traditional assumptions about profitability, scale and scope economies are all open to question.
In the same way, telecom service providers faced with demand for low priced unlimited data plans are having to rethink their network architecture to divert home and office data traffic away from cell towers to home fixed broadband connections.
Summary
The key take-away from any Pareto analysis is that it is a useful rule of thumb that inspires important questions about making money in your business. Making the right decision means not only looking at product and customer profitability, but also your delivery process and value chain from the perspective of both current and emerging usage patterns.
Friday, June 12, 2009
Could your sales drop suddenly and surprise you?
Multiple-technology substitution (MTS) provides a new way of losing or growing revenues
Alistair Davidson is a strategy marketing and technology consultant, former CEO of several high tech startups, and author of three books and numerous articles on technology and strategy. He has worked with telecom service providers, communications equipment vendors, software and media companies.
Copyright Alistair Davidson, 2009 as an unpublished work.
E-mail: alistair@eclicktick.com,
Phone: +1-650-450-9011
Executive Summary
Having your strategy be disrupted by a single inexpensive lesser performing product represents one type of disruption risk that has been frequently written about in the past decade. [1] A second type of disruption, Multiple Technology Substitution (MTS) is based on a collection of products or services that, in combination, compensate for individual weaknesses of the complementary technologies. The complementary nature of the collection of offerings – a “synthetic” product offering -- can compensate for individual low levels of performance, surprising established competitors which sell more capable product offerings.
During a period of initial customer experimentation, market growth due to the disruptive products/services maybe misinterpreted as a long term trend towards an increase in category use and/or spending. Marketers may overestimate market growth and fail to anticipate a sudden drop in users’ category spending. A 3-stage cycle of (1) increased spending due to experimentation, (2) learning how to use the inexpensive products, and (3) consolidation of usage is likely as users gain experience in assembling and optimizing solutions.
Adding to the impact of MTS is the idea of MTS amplification, or products/services that amplify the effectiveness of the MTS combination. MTS Amplifiers may present ways of changing customer relationships and represent opportunities both for competitors competing on a different basis than traditional competitors and for existing players defending their markets.
Introduction
There is nothing worse for a career than a nasty sales surprise. In the case of a small business case, the resulting cash flow problems can kill the business. In a larger business, it can kill your career.
For some industries, multiple technological substitution (MTS) presents an unperceived and hence unmanaged risk -- one that may be invisible to managers without new kinds of user research. Many markets demonstrate MTS – software companies facing open source solutions; hardware vendors facing open source software replacement; cable companies facing Internet-based video competition; to name just a few.
For a more detailed look at the phenomena, consider the specific situation of fixed line voice service providers (recognizing that telcos exist in various formats: fixed line, mobile only, integrated with both fixed and mobile, and virtual operators leasing capacity from companies with actual networks). [2]
Globally, there were 4 billion mobile cell phone contracts as of the end of 2008 [3]. As mobile phones have become more popular, fixed line telephone company executives in developed economies have worried about the substitution of mobile phone for the combination of mobile plus fixed services (FMS), Such replacement would cause them to lose highly profitable fixed line voice customers. And the data for telcos suggests that FMS has been occurring on a large scale as consumers cancel their traditional fixed phone lines.
If you are student, living at home in summers and on-campus during the school year, a mobile phone makes perfect sense for a transient live. Demographically, one would expect to see younger telephone users more likely to be mobile-only customers but the trend towards increased mobile usage is actually quite broad. Research on phone use shows that people will use their mobile phones in the workplace and at home for reasons of convenience and in order to always be reachable. Roughly 50% of mobile usage occurs in situations where a fixed line is likely to be also available.
But there is a more insidious danger for telephone companies, one that is less obvious. It comes in the form of a collection of voice communication services delivered over the Internet. Voice services like Gizmo, Yahoo Messenger with Voice, Microsoft Live Messenger with Voice MagicJack or Skype cost nothing or next to nothing to purchase. Skype accounts for 8% of world international call minutes according to the company fact sheet [4]. Like many disruptive technologies, the services can have unpredictable or lesser quality. MagicJack works well on a fast machine, and not very well on a slow machine. Skype works better with a Skype “box” attached to the router than it does on a personal computer. VoIP (Internet based voice calling) over WiFi on a WiFi enabled unlocked cell phone is sometimes difficult to set up and can be unreliable.
Sidebar: Internet Based Telephony Data Show That Low Cost Services Are Significant
Number of Magic Jack customers: > 2 million as of January, 2009. [5]
Number of Skype user accounts: 405 million as of Q4, 2008 [6]
Skype was reported as delivering 20.5 billion Skype to Skype minutes in Q4 of 2008 and 65.3 billion minutes for the full year. Skype calls to regular phones cost money: $2.6B of paid calls for SkypeOut minutes were used for calls to regular phone numbers. 33.4 million users were active in Q3.
To date, the unpredictable and lower quality of these Internet-based services (relative to the gold standards of the traditional fixed line or the higher quality of cable VoIP voice services) has been a disadvantage for these Internet IP-based voice providers. Voice quality is an important service attribute. It has represented a barrier to further market expansion by these free or low cost services. The need for some technology knowledge to figure out the best way of using the services makes them a poor choice for those unwilling to experiment. As a result, usage is often low and adoption has been limited to the tech-savvy.
The Risk of Synergistic Substitutes
But synergy between a mobile phone and an Internet IP-based phone service changes the value proposition significantly. If the IP-service does not work, you can always use your cell phone. If the mobile carrier is charging a higher rate for roaming or international long distance, the cost conscious user can use the Internet IP-based services. Skype additionally permits allows cell phone users to dial a local number in order to access Skype’s international rates, which are typically lower than cell phone international rates. One CEO of my acquaintance came back from S. Korea with a $500 roaming bill. The next day, he put in place a policy of using Skype when travelling internationally and calling home.
There is a general pattern here. When you have an established product/service category (e.g. fixed line phone service), and you are competing with multiple disruptive services (e.g. the available but slightly less reliable mobile service as well as a more unreliable Internet-based voice services), user behavior may become harder to predict. Users will initially try substitutable services; as they gain experience with the substitutable services, they may become decide that they have sufficient redundancy in their two or more new services; this insight means that they can drop their less used and now perceived to be redundant traditional (fixed line) service.
As validation for this insight, consider the following question: “How many people would give up their cell phone to retain their fixed line?” One could only imagine this choice occurring if the customer were using the fixed line for both dial-up Internet access and voice, a decreasingly common usage pattern. For most users, if they have to choose, a broadband connection ranks higher in importance than a fixed voice line. And of course, if you have a broadband connection, you can use it for voice calling so it acts as a strategic amplifier.
In the early stages of a new disruptive technology, reliability and ease of use may be poor, but over time, failed experiences may be replaced by more successful experiences as the technologies improve.
When consumers are financially flush, they are likely to try out new and potentially substitutable services in addition to “trusted” services or products. Total spending in the category goes up until the consumer becomes so comfortable with the cheaper technologies that they decide to drop the traditional service. Consumer cutback due to job loss or income reduction may trigger the decision even faster.
The implications for managers facing substitution is that past market spending and trends are likely to be misleading. The 3-stage cycle of trial, learning, and product/services consolidation means revenue growth can be followed by a sudden drop to a new and lower revenue level. This process of overestimation parallels the problem of pipeline fill in distribution organizations where initial demand for product inventory in the pipeline causes overestimation of end-user demand. The difference here is that the disruptive products are inexpensive so they don’t increase revenues proportionately as much as they increase usage, but when the traditional product or service is dropped, the revenue effect is dramatic. Free or low cost replaces traditionally priced products.
Amplifying MTS Disruption
For the example of fixed line telephone companies, the challenges don’t stop with the double substitution of mobile and Internet voice services for fixed lines. There exist “amplifying” products and services that make the substitution more effective. They improve benefits, lower risk and cost. These amplifying services may sometimes move the locus of account control to third parties which are using the benefit of the amplifying service as a novel way of building relationships with customers often by deploying different business models.
The combination of on-line advertising-supported video programming at sites such as Hulu.com or Joost.com offers another amplification example. TV and movie video content has only recently become legitimately available on the Internet. Here the amplifier is called “media extenders” or technologies for connecting the Internet-sourced video to the TV. Media extenders – typically a WiFi-based specialized set top box -- are a new phenomenon, so retail availability and consumer understanding have both been limited, and adoption has not yet been large. As the availability of devices for linking the Internet to TVs is adopted, the acceptability of the Internet for sourcing video content improves dramatically. Netflix’s download services which are free if you subscribe to the core product of unlimited TV rental also amplify any decision to eliminate cable subscriptions.
In the telecom sphere, Google’s GrandCentral service is a strategic amplifier. It is a free unified communications (UC) services with the feature of single number ring. UC single ring is actually simple in concept. You give out a new phone number to your contacts. The new phone number is controlled by the user via a web page and automatically rings all the phone numbers the user has specified. So, if a user doesn’t trust the reliability of his Internet based phone services, he can introduce redundancy by having more than one service and having his cell phone also ring. With a close to zero-cost Internet telephone service, users can rethink the nature of their communications services. And each time they chose to pick up their Internet phone (instead of their mobile phone), they avoid using their ‘basket’ of mobile minutes.
Many telephone companies have not picked up on unified communications with single ring for consumers -- perhaps for fear of loss of revenues to Internet services. Google’s service forces consumers to have yet another phone number. Mobile telephone companies already have assigned the consumer a telephone number so less work is required for the consumer if single number ring is accessed through a call to the mobile number. A wireless provider launching this product as first mover is likely to gain advantage and reinforce the primacy of its relationship with consumers who dislike changing phone numbers.
The results of these three overlapping technologies (mobile, Internet-voice and unified communications) is that a US consumer now has the opportunity of reducing his communications cost by $700-1000 per person per year. In other international markets where the cost of mobile minutes is higher than in the US, the savings might be even greater. From the carrier perspective, customers switching to an MTS solution represent a significant drop in market size. For the consumer, such a savings is significant in a normal economy and more so in a recession. It represents a savings in excess of that being claimed by online insurance companies for switching automobile insurance and therefore, is likely to be adopted. These technologies can also spread easily via word of mouth, corporate policy changes, and marketing to mavens and experts. [7]
Technology Amplifiers take a substitution problem and increase the effectiveness and perceived usefulness of the new substitute technologies. Just as importantly, Amplifiers can trigger permanently reduced spending on the product category. When Amplifiers are owned by different competitors, a non-amplifying company may be perceived as offering less value than previously.
Implications
The implications of Multiple Technology Substitution and Amplifiers is that competitive risks can, in some markets, become more complex to analyze, more difficult to anticipate. While some disruptive competitors may have a deliberate installed base strategy of pursuing users of the higher performing product, other may not. MTS introduces new accidental groupings of competitors, that pursuing their own narrow objectives, constitute a functional or virtual competitor. Traditional competitive analysis and extrapolation is insufficient to predict such emerging coalitions of use. Scenarios and forecasts need to be considered for these synthesized virtual competitors that could emerge and accidentally combine in almost biological way. For vendors launching a disruptive product, a failure to consider how complementary disruptive product can assist in a launch will lead to missed opportunities.
Understanding why customers are not buying is important in a downturn. MTS implies that it is just as important to investigate consumer patterns of usage and experimentation. Attitudinal research and the rate of change of attitudes towards potential substitute products should be tracked. If you understand where customers are experimenting with products and services, you may be able to anticipate the consolidation risk. In some cases, you can forestall consolidation through pricing and product changes. In other cases, the reasons for the exit may force you to change your business strategy and operations.
Telephone companies are being forced to face these new technologies. Not surprisingly, their reaction depends upon whether they see these new services as threats or opportunities. For mobile operator T-Mobile USA these disruptive technologies allow them to expand their service beyond their narrow product offering of cell phone services. T-Mobile USA now offers three kinds of phone service: (1) cell phone service, (2) WiFi-based phone services if you have a dual mode WiFi capable cell phone, where you trade off a fixed monthly fee for unlimited voice over WiFi services, and (3) a $10 a month fixed line service that runs over the home fixed broadband connection.
T-Mobile is attempting to displace the traditional phone company relationship for both fixed and mobile voice services without having to build an expensive fixed line network. It is changing the rules of the game by dramatically reducing the cost of a fixed line to reflect its dramatically lower cost of providing an Internet-based phone services.
As a side benefit, T-Mobile’s strategies also reduce the cost of delivering mobile services by converting regulated bandwidth-consuming cell phone calls to unregulated free WiFi which is then, in turn, transmitted over the consumer’s fixed broadband connection back to the operator’s backbone.
For marketers, understanding how different buyers see and are using your and MTS products may allow new segmentation, pricing, delivery and value propositions. Strategic costing studies often suggest that a small portion of customers are particularly profitable. Rules of thumb in activity based modeling suggest that roughly 10-30% of customers account for more than 100% of the profits of the organization in any given year. Understanding who is profitable is important. Losing the most profitable customers can be devastating. Equally as importantly, making explicit decisions about the life cycle profitability of customers may salvage a business in trouble or provide new growth opportunities than can grow sales and higher profit relationships. Some telephone companies are attempting to use femtocells, or small cellular base stations located within the home or office to improve their value propositions and capture a higher share of customer telecom spending.
The Amazon Kindle electronic book reader provides another example of an amplifying technology that preserves and grows market share for Amazon, but also offers significant opportunities for content that were previously uneconomic. The obvious benefit to Amazon is that Kindle owners are often frequent book buyers who have decided that they buy enough books that the breakeven on the Kindle will be achieved quickly. Travelers and readers with two homes will appreciate not having to carry piles of books. But non-Amazon entities such as authors and publishers can now can skip the traditional printing and distribution process. Perhaps more importantly they avoid the pervasive and costly problem that books are a returnable product, additionally lowering the cost of distribution.
Example Reconfiguring of Products for a New MTS Environments
Digital content is an example of a market where product reconfiguration is required in response to MTS. In digital environments there is often more opportunity for product reconfiguration that managers realize. Content companies will have to manage a more complex portfolio of business models and develop more sophisticated ways of integrating their view of individual consumers and their usage.. There are five basic forms of revenue models that will emerge or which can be bundled together:
1. Traditional advertising based models. (Examples: classic network or cable TV)
2. Fee-based models for one time viewing or viewing for a period of time, unbundled from subscriptions. (Examples: video on demand, Pay-TV, single viewing downloads, downloads valid for a narrow viewing time slot.)
3. Subscription models analogous to current cable or satellite tiered services. (Examples: premium cable subscriptions, satellite subscriptions, Netflix, music subscription services)
4. Product placement, sponsorship and brand integration models sometimes combined with other economic models. (Examples: various soap operas or drams financed by e.g. Procter and Gamble or Hallmark, combination network TV shows financed by product placement and advertising.)
5. Purchase models which include a variety of portability, versioning and resale rights. (DVD purchase, download purchases.)
These revenues models can more broadly be thought as a collection of pricing models, rights granted to consumers and services around the purchase, use, storage and management of the rights. Rights represent a new frontier in content marketing and can include:
1. Right to view on one or more devices
2. Right to save
3. Right to redownload to one or more devices
4. Right to transfer ownership
5. Right to share with a designated group e.g. a family
6. Right to upgrade to a new technology or quality
7. Right to resell
8. Right to receive a commission on referral leading to resale
The marketing of content with attached rights management is likely to be controversial among consumers accustomed to the current simpler legal environment.
It’s likely that as users become educated about the rights bundles attached to different ways of acquiring media, different consumers will evolve different buying patterns. For example, less technologically sophisticated users and audiophiles both still prefer to buy music and video on optical data media such as CDs and DVDs. Slightly more sophisticated technology users may find the integration of a music/video downloading service and device more attractive until they get annoyed at the difficulty of moving content or the lower quality of many digital media. More sophisticated digital downloaders will discriminate on the basis of absence of rights restrictions and higher quality. For example, Amazon’s MP3 music offering initially offered both a DRM and a price advantage over the brand leader, the iTunes Store. Apple finally responded by offering unrestricted music files, but at a higher cost.
Confusingly, while consumers may evolve their preferences over time, they will likely to continue to trade off rights against price inconsistently, based upon their involvement or interest in specific content.
Multiple-technology substitution (MTS) provides a new way of losing or growing revenues
Alistair Davidson is a strategy marketing and technology consultant, former CEO of several high tech startups, and author of three books and numerous articles on technology and strategy. He has worked with telecom service providers, communications equipment vendors, software and media companies.
Copyright Alistair Davidson, 2009 as an unpublished work.
E-mail: alistair@eclicktick.com,
Phone: +1-650-450-9011
Executive Summary
Having your strategy be disrupted by a single inexpensive lesser performing product represents one type of disruption risk that has been frequently written about in the past decade. [1] A second type of disruption, Multiple Technology Substitution (MTS) is based on a collection of products or services that, in combination, compensate for individual weaknesses of the complementary technologies. The complementary nature of the collection of offerings – a “synthetic” product offering -- can compensate for individual low levels of performance, surprising established competitors which sell more capable product offerings.
During a period of initial customer experimentation, market growth due to the disruptive products/services maybe misinterpreted as a long term trend towards an increase in category use and/or spending. Marketers may overestimate market growth and fail to anticipate a sudden drop in users’ category spending. A 3-stage cycle of (1) increased spending due to experimentation, (2) learning how to use the inexpensive products, and (3) consolidation of usage is likely as users gain experience in assembling and optimizing solutions.
Adding to the impact of MTS is the idea of MTS amplification, or products/services that amplify the effectiveness of the MTS combination. MTS Amplifiers may present ways of changing customer relationships and represent opportunities both for competitors competing on a different basis than traditional competitors and for existing players defending their markets.
Introduction
There is nothing worse for a career than a nasty sales surprise. In the case of a small business case, the resulting cash flow problems can kill the business. In a larger business, it can kill your career.
For some industries, multiple technological substitution (MTS) presents an unperceived and hence unmanaged risk -- one that may be invisible to managers without new kinds of user research. Many markets demonstrate MTS – software companies facing open source solutions; hardware vendors facing open source software replacement; cable companies facing Internet-based video competition; to name just a few.
For a more detailed look at the phenomena, consider the specific situation of fixed line voice service providers (recognizing that telcos exist in various formats: fixed line, mobile only, integrated with both fixed and mobile, and virtual operators leasing capacity from companies with actual networks). [2]
Globally, there were 4 billion mobile cell phone contracts as of the end of 2008 [3]. As mobile phones have become more popular, fixed line telephone company executives in developed economies have worried about the substitution of mobile phone for the combination of mobile plus fixed services (FMS), Such replacement would cause them to lose highly profitable fixed line voice customers. And the data for telcos suggests that FMS has been occurring on a large scale as consumers cancel their traditional fixed phone lines.
If you are student, living at home in summers and on-campus during the school year, a mobile phone makes perfect sense for a transient live. Demographically, one would expect to see younger telephone users more likely to be mobile-only customers but the trend towards increased mobile usage is actually quite broad. Research on phone use shows that people will use their mobile phones in the workplace and at home for reasons of convenience and in order to always be reachable. Roughly 50% of mobile usage occurs in situations where a fixed line is likely to be also available.
But there is a more insidious danger for telephone companies, one that is less obvious. It comes in the form of a collection of voice communication services delivered over the Internet. Voice services like Gizmo, Yahoo Messenger with Voice, Microsoft Live Messenger with Voice MagicJack or Skype cost nothing or next to nothing to purchase. Skype accounts for 8% of world international call minutes according to the company fact sheet [4]. Like many disruptive technologies, the services can have unpredictable or lesser quality. MagicJack works well on a fast machine, and not very well on a slow machine. Skype works better with a Skype “box” attached to the router than it does on a personal computer. VoIP (Internet based voice calling) over WiFi on a WiFi enabled unlocked cell phone is sometimes difficult to set up and can be unreliable.
Sidebar: Internet Based Telephony Data Show That Low Cost Services Are Significant
Number of Magic Jack customers: > 2 million as of January, 2009. [5]
Number of Skype user accounts: 405 million as of Q4, 2008 [6]
Skype was reported as delivering 20.5 billion Skype to Skype minutes in Q4 of 2008 and 65.3 billion minutes for the full year. Skype calls to regular phones cost money: $2.6B of paid calls for SkypeOut minutes were used for calls to regular phone numbers. 33.4 million users were active in Q3.
To date, the unpredictable and lower quality of these Internet-based services (relative to the gold standards of the traditional fixed line or the higher quality of cable VoIP voice services) has been a disadvantage for these Internet IP-based voice providers. Voice quality is an important service attribute. It has represented a barrier to further market expansion by these free or low cost services. The need for some technology knowledge to figure out the best way of using the services makes them a poor choice for those unwilling to experiment. As a result, usage is often low and adoption has been limited to the tech-savvy.
The Risk of Synergistic Substitutes
But synergy between a mobile phone and an Internet IP-based phone service changes the value proposition significantly. If the IP-service does not work, you can always use your cell phone. If the mobile carrier is charging a higher rate for roaming or international long distance, the cost conscious user can use the Internet IP-based services. Skype additionally permits allows cell phone users to dial a local number in order to access Skype’s international rates, which are typically lower than cell phone international rates. One CEO of my acquaintance came back from S. Korea with a $500 roaming bill. The next day, he put in place a policy of using Skype when travelling internationally and calling home.
There is a general pattern here. When you have an established product/service category (e.g. fixed line phone service), and you are competing with multiple disruptive services (e.g. the available but slightly less reliable mobile service as well as a more unreliable Internet-based voice services), user behavior may become harder to predict. Users will initially try substitutable services; as they gain experience with the substitutable services, they may become decide that they have sufficient redundancy in their two or more new services; this insight means that they can drop their less used and now perceived to be redundant traditional (fixed line) service.
As validation for this insight, consider the following question: “How many people would give up their cell phone to retain their fixed line?” One could only imagine this choice occurring if the customer were using the fixed line for both dial-up Internet access and voice, a decreasingly common usage pattern. For most users, if they have to choose, a broadband connection ranks higher in importance than a fixed voice line. And of course, if you have a broadband connection, you can use it for voice calling so it acts as a strategic amplifier.
In the early stages of a new disruptive technology, reliability and ease of use may be poor, but over time, failed experiences may be replaced by more successful experiences as the technologies improve.
When consumers are financially flush, they are likely to try out new and potentially substitutable services in addition to “trusted” services or products. Total spending in the category goes up until the consumer becomes so comfortable with the cheaper technologies that they decide to drop the traditional service. Consumer cutback due to job loss or income reduction may trigger the decision even faster.
The implications for managers facing substitution is that past market spending and trends are likely to be misleading. The 3-stage cycle of trial, learning, and product/services consolidation means revenue growth can be followed by a sudden drop to a new and lower revenue level. This process of overestimation parallels the problem of pipeline fill in distribution organizations where initial demand for product inventory in the pipeline causes overestimation of end-user demand. The difference here is that the disruptive products are inexpensive so they don’t increase revenues proportionately as much as they increase usage, but when the traditional product or service is dropped, the revenue effect is dramatic. Free or low cost replaces traditionally priced products.
Amplifying MTS Disruption
For the example of fixed line telephone companies, the challenges don’t stop with the double substitution of mobile and Internet voice services for fixed lines. There exist “amplifying” products and services that make the substitution more effective. They improve benefits, lower risk and cost. These amplifying services may sometimes move the locus of account control to third parties which are using the benefit of the amplifying service as a novel way of building relationships with customers often by deploying different business models.
The combination of on-line advertising-supported video programming at sites such as Hulu.com or Joost.com offers another amplification example. TV and movie video content has only recently become legitimately available on the Internet. Here the amplifier is called “media extenders” or technologies for connecting the Internet-sourced video to the TV. Media extenders – typically a WiFi-based specialized set top box -- are a new phenomenon, so retail availability and consumer understanding have both been limited, and adoption has not yet been large. As the availability of devices for linking the Internet to TVs is adopted, the acceptability of the Internet for sourcing video content improves dramatically. Netflix’s download services which are free if you subscribe to the core product of unlimited TV rental also amplify any decision to eliminate cable subscriptions.
In the telecom sphere, Google’s GrandCentral service is a strategic amplifier. It is a free unified communications (UC) services with the feature of single number ring. UC single ring is actually simple in concept. You give out a new phone number to your contacts. The new phone number is controlled by the user via a web page and automatically rings all the phone numbers the user has specified. So, if a user doesn’t trust the reliability of his Internet based phone services, he can introduce redundancy by having more than one service and having his cell phone also ring. With a close to zero-cost Internet telephone service, users can rethink the nature of their communications services. And each time they chose to pick up their Internet phone (instead of their mobile phone), they avoid using their ‘basket’ of mobile minutes.
Many telephone companies have not picked up on unified communications with single ring for consumers -- perhaps for fear of loss of revenues to Internet services. Google’s service forces consumers to have yet another phone number. Mobile telephone companies already have assigned the consumer a telephone number so less work is required for the consumer if single number ring is accessed through a call to the mobile number. A wireless provider launching this product as first mover is likely to gain advantage and reinforce the primacy of its relationship with consumers who dislike changing phone numbers.
The results of these three overlapping technologies (mobile, Internet-voice and unified communications) is that a US consumer now has the opportunity of reducing his communications cost by $700-1000 per person per year. In other international markets where the cost of mobile minutes is higher than in the US, the savings might be even greater. From the carrier perspective, customers switching to an MTS solution represent a significant drop in market size. For the consumer, such a savings is significant in a normal economy and more so in a recession. It represents a savings in excess of that being claimed by online insurance companies for switching automobile insurance and therefore, is likely to be adopted. These technologies can also spread easily via word of mouth, corporate policy changes, and marketing to mavens and experts. [7]
Technology Amplifiers take a substitution problem and increase the effectiveness and perceived usefulness of the new substitute technologies. Just as importantly, Amplifiers can trigger permanently reduced spending on the product category. When Amplifiers are owned by different competitors, a non-amplifying company may be perceived as offering less value than previously.
Implications
The implications of Multiple Technology Substitution and Amplifiers is that competitive risks can, in some markets, become more complex to analyze, more difficult to anticipate. While some disruptive competitors may have a deliberate installed base strategy of pursuing users of the higher performing product, other may not. MTS introduces new accidental groupings of competitors, that pursuing their own narrow objectives, constitute a functional or virtual competitor. Traditional competitive analysis and extrapolation is insufficient to predict such emerging coalitions of use. Scenarios and forecasts need to be considered for these synthesized virtual competitors that could emerge and accidentally combine in almost biological way. For vendors launching a disruptive product, a failure to consider how complementary disruptive product can assist in a launch will lead to missed opportunities.
Understanding why customers are not buying is important in a downturn. MTS implies that it is just as important to investigate consumer patterns of usage and experimentation. Attitudinal research and the rate of change of attitudes towards potential substitute products should be tracked. If you understand where customers are experimenting with products and services, you may be able to anticipate the consolidation risk. In some cases, you can forestall consolidation through pricing and product changes. In other cases, the reasons for the exit may force you to change your business strategy and operations.
Telephone companies are being forced to face these new technologies. Not surprisingly, their reaction depends upon whether they see these new services as threats or opportunities. For mobile operator T-Mobile USA these disruptive technologies allow them to expand their service beyond their narrow product offering of cell phone services. T-Mobile USA now offers three kinds of phone service: (1) cell phone service, (2) WiFi-based phone services if you have a dual mode WiFi capable cell phone, where you trade off a fixed monthly fee for unlimited voice over WiFi services, and (3) a $10 a month fixed line service that runs over the home fixed broadband connection.
T-Mobile is attempting to displace the traditional phone company relationship for both fixed and mobile voice services without having to build an expensive fixed line network. It is changing the rules of the game by dramatically reducing the cost of a fixed line to reflect its dramatically lower cost of providing an Internet-based phone services.
As a side benefit, T-Mobile’s strategies also reduce the cost of delivering mobile services by converting regulated bandwidth-consuming cell phone calls to unregulated free WiFi which is then, in turn, transmitted over the consumer’s fixed broadband connection back to the operator’s backbone.
For marketers, understanding how different buyers see and are using your and MTS products may allow new segmentation, pricing, delivery and value propositions. Strategic costing studies often suggest that a small portion of customers are particularly profitable. Rules of thumb in activity based modeling suggest that roughly 10-30% of customers account for more than 100% of the profits of the organization in any given year. Understanding who is profitable is important. Losing the most profitable customers can be devastating. Equally as importantly, making explicit decisions about the life cycle profitability of customers may salvage a business in trouble or provide new growth opportunities than can grow sales and higher profit relationships. Some telephone companies are attempting to use femtocells, or small cellular base stations located within the home or office to improve their value propositions and capture a higher share of customer telecom spending.
The Amazon Kindle electronic book reader provides another example of an amplifying technology that preserves and grows market share for Amazon, but also offers significant opportunities for content that were previously uneconomic. The obvious benefit to Amazon is that Kindle owners are often frequent book buyers who have decided that they buy enough books that the breakeven on the Kindle will be achieved quickly. Travelers and readers with two homes will appreciate not having to carry piles of books. But non-Amazon entities such as authors and publishers can now can skip the traditional printing and distribution process. Perhaps more importantly they avoid the pervasive and costly problem that books are a returnable product, additionally lowering the cost of distribution.
Example Reconfiguring of Products for a New MTS Environments
Digital content is an example of a market where product reconfiguration is required in response to MTS. In digital environments there is often more opportunity for product reconfiguration that managers realize. Content companies will have to manage a more complex portfolio of business models and develop more sophisticated ways of integrating their view of individual consumers and their usage.. There are five basic forms of revenue models that will emerge or which can be bundled together:
1. Traditional advertising based models. (Examples: classic network or cable TV)
2. Fee-based models for one time viewing or viewing for a period of time, unbundled from subscriptions. (Examples: video on demand, Pay-TV, single viewing downloads, downloads valid for a narrow viewing time slot.)
3. Subscription models analogous to current cable or satellite tiered services. (Examples: premium cable subscriptions, satellite subscriptions, Netflix, music subscription services)
4. Product placement, sponsorship and brand integration models sometimes combined with other economic models. (Examples: various soap operas or drams financed by e.g. Procter and Gamble or Hallmark, combination network TV shows financed by product placement and advertising.)
5. Purchase models which include a variety of portability, versioning and resale rights. (DVD purchase, download purchases.)
These revenues models can more broadly be thought as a collection of pricing models, rights granted to consumers and services around the purchase, use, storage and management of the rights. Rights represent a new frontier in content marketing and can include:
1. Right to view on one or more devices
2. Right to save
3. Right to redownload to one or more devices
4. Right to transfer ownership
5. Right to share with a designated group e.g. a family
6. Right to upgrade to a new technology or quality
7. Right to resell
8. Right to receive a commission on referral leading to resale
The marketing of content with attached rights management is likely to be controversial among consumers accustomed to the current simpler legal environment.
It’s likely that as users become educated about the rights bundles attached to different ways of acquiring media, different consumers will evolve different buying patterns. For example, less technologically sophisticated users and audiophiles both still prefer to buy music and video on optical data media such as CDs and DVDs. Slightly more sophisticated technology users may find the integration of a music/video downloading service and device more attractive until they get annoyed at the difficulty of moving content or the lower quality of many digital media. More sophisticated digital downloaders will discriminate on the basis of absence of rights restrictions and higher quality. For example, Amazon’s MP3 music offering initially offered both a DRM and a price advantage over the brand leader, the iTunes Store. Apple finally responded by offering unrestricted music files, but at a higher cost.
Confusingly, while consumers may evolve their preferences over time, they will likely to continue to trade off rights against price inconsistently, based upon their involvement or interest in specific content.
Researching and Anticipating a Sudden Market Decline
Without research or deep interactions with customers, companies will have difficulty predicting customer exits or the extent to which they are progressing through the three stages of MTS model. As a result, they will find it difficult to figure out how best to reconfigure their offering.
These conclusions suggest three simple potential customer exit models. A step model (Type 1), a straight line decline (Type 2) and rapid initial decline with a long period of low usage (Type 3). Type 1 exits are the most dangerous because the drop in purchase rate is sudden and unpredicted and may be disguised by a period of higher spending before the sudden drop. Type 2 exits are predictable and therefore, easier to manage as long as you can distinguish between Type 2 and 3 exits. Type 3 exits may create a category of lingering but possibly unprofitable customers.
The most general prescription here is not to accept decline, but rather to actively manage the process. These steps should include the following elements:
Research and stratify your customers to determine to what degree they are at risk for exit. Understanding their testing and competence with the various disruptive technologies is crucial knowledge.
1. Estimate the potential revenue lost by customer profile.
2. Model the impact of customer loss using an activity based costing model.
3. Evaluate different pricing and business models targeted for different customers.
4. Identify the gateway products which maintain account control. In the telecom space, video services, fixed broadband and converged fixed/wireless services with unified communications all represent potential gateway products or bundles. In contrast, traditional fixed line services are essentially commoditized.
5. Reconfigure the marketing program. For some customers, ease of use will be a critical element in retaining customers. For other customers, launching disruptive collections of services, but making them easier to tie together will be a necessary strategy.
6. Reconfigure the value chain activities where required to be able to compete with the disruptive competitors, e.g. T-Mobile’s low cost fixed line service at $10 per month.
7. In many cases, integration and improved user interface design are required for the traditional offerings. Integrated telcos with WiFi hotspot, fixed and wireless operations are now introducing services that take advantage of their multiple networks. Less integrated operators are pursuing partnerships to enable the same capabilities.
Customer can be categorized into different groups. Examples might include:
Profitable customers, where the goal is increased usage.
Profitable customers, where the goal is retention.
Profitable customers where pricing, business model or value chain reconfiguration is required to preserve the relationship.
Marginal customers where different business models and value chains are required to make them profitable.
Marginal customers where cross selling is required to make the customer profitable, requiring e.g. bundled pricing.
Unprofitable customers that should be “fired”.
In actual practice, most enterprises have little ability to perform such analysis. Overstressed and matrixed product managers may be put under pressure to focus on existing and obvious competitors rather than emerging threats. And when the more difficult analysis of potential virtual competitor combinations is performed, it is done infrequently and often too late. The experience of the music industry demonstrates the cost of not adapting quickly to the disruptive effect of networking, peer to peer file exchange, software for ripping MP3s, digital music players and pervasive computer use.
In contrast, Adobe, which has increasingly been moving up-market with its successful suites of imaging products (containing well known products such Photoshop, Acrobat and Illustrator) is faced with an expanding and improving collection of free imaging products such as Google’s Picassa, the open source products, GIMP and Artweaver (to name just three of many) all which are increasing in capabilities. Adobe’s historical segmentation had been to provide lower cost versions of their software such as Photoshop Lightroom and Photoshop Elements for its consumer and hobbyist niches. Directly targeting the free software tools, Adobe has also set up a free online service, photoshop.com: it provides limited photography editing and 2 gigabyte of storage for storing and sharing photos and videos. Integration and ease of use provides some initial defense against MTS as does the additional value added of free storage.
Summary
The 2008 recession presents businesses with a significant challenge. The deflation of the speculative bubble in the US is likely to take many years to unwind. Consumer spending is no longer financed by increasing real estate prices. Many markets may not recover in ways that businesses and consumers hope for. The consequence will be permanent customer spending declines in many product categories.
Customers, seeking to reduce their spending, will increasingly use low cost MTS and amplifying products to save money. Companies that fail to research their users and markets may over-estimate the recovery of revenues due a failure to anticipate the permanence of the switch to collections of disruptive technologies as customers consolidate their spending and arbitrage their suppliers. Clever strategists can participate in and use MTS value chains to create new relationships with customers and win relationships at low costs.
References:
[1] Christensen, Clayton: The Innovator’s Dilemma, Collins, 2003
[2] Fixed Mobile Convergence for Integrated Service Providers, Cisco White Paper, 2008 https://www.cisco.com/en/US/solutions/collateral/ns341/ns523/ns519/white_paper_c11-480809.html
[3] Trends in Telecommunications, ITU, 2008, http://www.itu.int/itunews/manager/display.asp?lang=en&year=2008&issue=10&ipage=30&ext=html
[4] Preliminary data, TeleGeography Research, 2008. quoted in Skype corporate fact sheet, Feb. 12, 2009
[5] TelephonyOnline http://www.telephonyonline.com/residential_services/news/magicjack-two-million-customers-0106/index1.html
[6] Wikipedia, Feb. 12, 2008, http://en.wikipedia.org/wiki/Skype and corporate fact sheet.
[7] Davidson, Alistair, and Copulsky, Jonathan: “Managing Mavens: relationships with sophisticated customers via the Internet can transform marketing and speed innovation.” Strategy and Leadership, Vol. 34, No. 3. 2006 also available at http://www.deloitte.com/dtt/cda/doc/content/us_tmt_ManagingWebmavens_Article_022206.pdf
[8] Keith Nissen, Keith: “The Media Phone Has Arrived”, In-Stat, Document IN0904563RC
Trademarks referenced in the article are owned by the providing companies.
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