New Patterns of Power and Profit

This book is for everyone who wants to understand our information age. This book is written for CEOs, entrepreneurs considering online start-ups, and undergraduates still trying to pick a career. This book is for regulators, lobbyists, and lawmakers. This book is for anyone who wants to understand how information changes consumer behavior, corporate strategy, competition, and law. This book describes the digital transformation of everything. It describes the new patterns of power in this transformed world. We start by learning about the changes produced by information. These are the individual pieces that, when taken together, create the digital transformation of everything. We’re going to see how information changes the behavior of individuals, the strategy of firms, and the structure of organizations. We’re going to learn to see new patterns as they start to emerge, before their impact on behavior, strategy, or structure is readily visible. This will enable us to understand the changes that have occurred, early, before others see them. It will also enable us to predict the changes that are going to occur, even before it is possible to see them. It will give us competitive advantage. This chapter introduces the book’s first pattern, Newly Vulnerable Markets.

This chapter is about information and the power of information. We need to understand the power that comes from having more information, or more accurate or more recent information, than your competitors and knowing how to use it. Our interest here is in what information to obtain and how to use it, not on the underlying technology. Information asymmetry occurs when one party in a relationship, in business, military conflict, or elsewhere, knows more than the other party. When you buy a used car, or accept an invitation to join as the fourth on a blind double date, you can assume that the others know more than you do. Should you buy the car, have it inspected, or just walk away? Dealing with information asymmetry is so important that animals have found mechanisms to deal with it when choosing mates, insurance companies have found ways to deal with it when pricing policies, and we all have developed mechanisms to cope with information asymmetry in our social and professional interactions. This chapter describes the principal mechanisms that have been developed to deal with information asymmetry and the conditions under which to use each to learn about the people you’re dealing with.

Some problems are much easier to solve than they initially appear, and a simple restatement of the problem can simplify it and make the solution obvious. In this chapter, we explore how Reframing and transforming a problem can convert it from a form that is intractable and impossible to solve into one that is easier to solve and may be solved by inspection. This is really important when trying to answer questions that no one has ever answered before, and understanding the digital transformation of everything involves asking questions that no one has ever asked before. This chapter introduces our second pattern, newly vulnerable online markets, or Newly Vulnerable eMarkets. This is the start of understanding the transformation of sales and distribution channels. Online channels transform competition between manufacturers and service providers and their traditional retailers and resellers, allowing them to take over the roles previously held by retailers and resellers. We introduce five concepts for reframing. We start with a problem outside of business, to establish the power of the concept, and then move on to a business problem to demonstrate the concept’s value. We use the technique to generate our second pattern, Channel Competition and Newly Vulnerable eMarkets.

Resonance marketing has transformed what we buy and the delight we take in our purchases. Resonance marketing has also transformed what companies sell and increased the margins they earn on their sales. Resonance marketing is the move away from the original goal of the industrial revolution, which was mass production of uniform, interchangeable products, to achieve the highest volume at the lowest cost. This resulted in a small number of high-volume market fat spots, with identical beers and identical white breads and a small number of candies and blue jeans competing for consumer attention through advertising. When nearly identical products compete, in the presence of complete information, competition drives margins down. Consumers wanted more choice, while companies wanted higher margins. Online community content—reviews from experts and from other shoppers—provides far better information than traditional advertising. With perfect information, consumers can accurately evaluate everything in the market and buy whatever delights them the most. When consumers can find and buy exactly what they want, then corporations change their strategy and start producing to occupy a wide range of high-margin, niche-focused market sweet spots, selling unique offerings where margins are not depressed by head-to-head competition with nearly identical offerings.

Resonance marketing (see Chapter 4) is critically dependent upon user-generated content to enable consumers to locate and evaluate unfamiliar products. This allows companies to offer niche-focused sweet spot offerings that delight their target market consumers. These markets are too small to justify the expense of traditional advertising or traditional promotions, and yet the higher prices of these resonance products discourage casual trial. Adoption is largely by consumers who know what to expect. Managing community content is vitally important to the launch of resonance products. Delighted customers serve as Online Brand Ambassadors, posting reviews that create additional demand. Strongly dissatisfied customers become Online Brand Assassins, writing reviews that deter future customers from trying the product and can destroy the perception of a product’s quality. The newly emerging role of the Chief Perception Officer (CPO) is to coordinate all aspects of a product’s quality and manage customers’ perception of the brand. While the CPO cannot control what the customer writes, the CPO can strongly influence what the customer wants to write. When the CPO reduces the operational breakdowns that cause dissatisfaction and designs procedures to fix problems immediately when they occur, the CPO ensures that few customers want to write negative reviews.

When competing in any area, it’s helpful to have valuable stuff that opponents don’t have. If you want to fight a war, it helps to have better fighter aircraft and better tanks. This pattern is called resource-based sustainable competitive advantage. Resource-based sustainable competitive advantage is surprisingly difficult to achieve in an information-based business because software can be copied. However, sometimes the resources the firm owns or its skill base cannot be fully duplicated. These resources and skills can be sources of sustainable competitive advantage when leveraged through software, even if the software itself can be copied. Platform envelopment is a form of resource-based sustainable competitive advantage. In platform envelopment, the firm creates the resources that it later combines and uses to protect and defend its sustainable competitive advantage. Each app that’s included in the platform creates super-additive value; the value of the platform is far greater than sum of the values of each part. To compete with a complete platform, it is usually necessary to have an equally attractive complete platform of your own. Google has a platform envelopment strategy. Amazon, Apple, Facebook, and Uber pursue their own. Platform envelopment strategies create monopoly power, delighting consumers but virtually destroying competition.

This chapter introduces our final two patterns, which represent powerful, even potentially dangerous, online business models. Individually, each can be very profitable. Together, they can result in almost unlimited harvesting of profits from the rest of the online ecosystem. The first pattern is Mandatory Participation Third Party Payer Systems (MP3PPs). Third Party Payer Systems are platforms where Party-1 (the customer) uses Party-2 (the platform) to interact with Party-3 (the merchant or service provider who needs to interact with the customer). The platform is free for Party-1 because Party-3 values it enough to subsidize it, or even to pay enough to make it available without charge to Party-1. A Mandatory Participation Third Party Payer System is one where the platform has become so essential to Party-3 that Party-3 must participate, almost without concern for the cost of participation. Online gateway systems are platforms that are used to link buyers and sellers. Sometimes there are effective competitors for a gateway, as when multiple markets can be used to trade securities, or when the eCommerce sites of multiple big box stores sell the same appliances. Sometimes a single online gateway becomes essential for sellers, such as Amazon in books or Google in search.

In Chapter 7, we saw the enormous power and profit that can be gathered when online gateways operate as Mandatory Participation Third Party Payer Systems. We’ve seen how difficult it is for companies that become dependent upon these MP3PP gateways to escape their grasp or to limit what they pay to the gateway operators. In this chapter, we see that even the perfect efficiency and perfect transparency promised by the Internet do not limit the power of these MP3PPs. MP3PPs are even more powerful than they were before the net, because they are even larger. They are potentially even more dangerous. We see that even MP3PPs that initially appear safe, moderate, and temperate in their demands have the ability to become exploitive. And we explore one of the greatest sources of danger, which occurs when MP3PP gateway operators expand into additional lines of business, and use their control of a critical gateway to destroy competitors and limit consumers’ ability to choose. Online gateways add value for users, Party-1, which is why they are able to attract users. As MP3PP gateways become more valuable to users, their ability to charge Party-3 (sellers) increases, and they switch from value creation to value harvesting.

In Chapter 6, we introduced the pattern associated with platforms and platform envelopment. Chapter 7 introduced two additional patterns, Mandatory Participation Third Party Payer Systems (MP3PPs) and online gateways, and showed how they combined for a unique form of power that was among the most important and most profitable innovations enabled by the Internet. Chapter 8 showed how these three patterns become intertwined online. We argued that the net has not reduced the power of online gateways that function as MP3PPs, but has actually increased their power. In this Chapter, we explore how dominant MP3PPs protect and extend their power, and how they make the transition from value creation to value harvesting. We explore the harm that this causes, and the inability of traditional forms of competition to correct this harm. When competition and the discipline of the market cannot limit abuses, regulation becomes necessary. Regulation of online activities must balance limiting harm from abuse of power against harm from premature or excessive regulation. We explore the conditions under which harm occurs, and under which regulation may be necessary. Historical precedents explain when regulation has been necessary in the past, and offer guidance for the form it should take now.

Scenario analysis deals with strategic uncertainty. It introduces a new way of thinking about problems. We use scenario analysis when we don’t know what will happen next, and when we are facing such strategic ambiguity that we don’t even know what game we are playing. Digital transformations are like that. We don’t know what the rules are. If we’re executives, we don’t know what’s possible, what our customers will want, or what our regulators will permit. We don’t know what our opponents’ strategies will be, or what strategies we should adopt in response. If we’re consumers, we don’t know what to buy, or how to choose, or what the sharing economy of Uber and Airbnb will do for us, or to our neighborhoods. We need a way to figure out what the new rules will be, and what the new strategic choices will be. We need to know what game we are playing. Then, we can develop our strategies, for our businesses and for our lives. Scenario analysis doesn’t start by gathering data. The process starts by identifying questions that will be important and then seeks to determine the data that you will wish you could have to answer those questions.

The net has facilitated the digital transformation of everything. Not surprisingly, since most human needs have not changed dramatically over the past twenty-five years, most of the activities transformed by the net have been the activities that humans have pursued since the beginning of time. We still eat, protect our families, seek shelter, make purchases, travel, read, and need entertainment. Our desire for these activities has not changed much in the few short years since the development of information technology. To a large extent, we use the net to facilitate the same things we always did. The digital transformation of everything has not resulted in the digital elimination or even the digital replacement of everything. Still, there are entirely new online businesses with entirely new online products and services. The net does allow us to do things we couldn’t do previously, rather than simply making it easier for us to do what we always did before. This chapter discusses Digitally Transformed Business Models and Fully Digital Business Models. It introduces eleven proven online business models, from the traditional (selling real stuff), through the virtual (selling virtual experiences, from games to higher education), and ends with those that monetize private information.

This chapter explores the social implications of the patterns introduced earlier in the book. Efficiency in pricing and in the allocation of goods means more of us get what we really want, more of the time. That’s good. However, this efficiency comes with a price. It dramatically reduces what we traditionally call fairness, and this will become worse. We are not all viewed as equal by companies, and they will increasingly be able to treat us differently. They will have the information needed to dramatically reduce fairness. Should we accept this? Should we change our definition of fairness? Or do we need new social policies? In our new online world, every text you send, every search you make, every step you take, they’ll be watching you. But where do we draw the line? Big data aggregators note everything we do, and we can’t be certain that their use of the information helps us. Should we care? Should we protect ourselves from the integration, reuse, and sale of personal information? This chapter and the next one end the book with some suggestions for privacy regulation and proposes a few simple measures we can take to protect our own privacy and the privacy of our families.