Tuesday, February 19, 2013

Differentials, Barriers and Constraints

We now need to turn to those maps and identify specific roles and constraints for the various components before we start to attempt manipulate the environment through some form a strategy.

The first role we need to identify are those visible top-level components that act as differentials i.e. they provide to the consumer a qualitative difference between our offerings and most of our competitors. Such components will be in the genesis or custom built stage and in the case of the Fotango service, this was image manipulation.

You also need to identify those components that act as a barrier to entry into your value chain through high levels of capital (either physical, financial, knowledge or social). These tend to be hidden further down the value chain and are mainly invisible to the consumer. In the case of the Fotango service, our engineering skill and knowledge in building large-scale distributed systems capable of coping with millions of registered users was such a barrier.

Finally, you need to identify constraints and in particular the balance of power between consumers and suppliers. I tend to use Porter’s five forces here. For those unfamiliar with five forces, these are:-

Rivalry within industry: this can be assumed to be a given though the type of competition changes e.g. from relative competition in the peace phase to a fight for survival during the war phase.

Threat of New Entrants: increases as an activity evolves from the peace stage of competition to the war stage.

Threat of Substitution: often the most difficult to spot and manage, tends to occur in the peace phase of competition e.g. replacement of cable excavators with hydraulic.

Bargaining Power of Suppliers Vs Consumers: the balance of power between the groups affects a range of areas from pricing to dependency to strategic control. For example, in a value chain if one supplier provides one component, then that supplier can exert considerable pricing pressures on your entire value chain.

The balance between these forces tends to change as anything evolves. It also isn’t static within a stage of evolution. For example, when an activity becomes more of a commodity or provided as a utility we will often experience a yo-yo between centralization and decentralization (with a corresponding yo-yo between Supplier and Consumer bargaining power).

With commoditization (i.e. evolution for activities), it is often assumed that the shift towards utility provision means centralization but this is not the case. Whilst the interaction of ALL consumers (demand competition) and ALL suppliers (supply competition) drives the process of evolution, the question of whether a specific activity or data set centralizes or decentralizes depends upon the actions of individual actors (suppliers and consumers) in this market. 

Hence for example, with Cloud Computing and specifically Infrastructure as a Service (IaaS), the shift from product to utility is simply a process of evolution driven by market competition (ALL Supplier and ALL Consumers). 

On the question of centralization, it would have been relatively trivial for the hardware manufacturers to create a price war in the IaaS space around 2008-2010 in order to fragment the market by increasing demand beyond the capability of one vendor to supply.  The fact they didn't is their own fault and also one of the major factors why we might see centralization in the IaaS space. Hence centralization depends upon the actions of specific actors (in this case the inaction of hardware suppliers and hosting companies).

In the future, this may in fact yo-yo from centralized to decentralized or find a balance between the two (as with electricity provision and self generation). Of course this is a change in the means of production and the interfaces themselves are unlikely to change i.e. a shift from central to self-generation does not mean a change in voltage / frequency for domestic power provision.

The interface can often hide a complex market. For the average home consumer of electricity you have sockets and a power supplier. You could be forgiven for thinking your home electricity supplier actually generates the power. However their value chain includes components such as the National Grid where they consume and purchase power from multiple power generators (their suppliers) through a complex market including spot and derivatives. There is no reason your actual home electricity supplier has to own any actual power generation capabilities themselves and they can instead act more like a broker. In the UK, such distinctions are licensed through OfGem with suppliers, generators and non physical traders.

Hence, you should always be careful about assuming that as an activity evolves to more of a utility it will centralize into the hands of a few suppliers. There is a danger that this will happen but it all depends upon the individual actions of specific players in the market. In figure 50, I provided an example of some general changes in the five forces.

Figure 50 – General changes in the five forces

During the Peace phase of competition then substitution tends to be something to watch for but new entrants are relatively rare, competition is often relative between big suppliers and a yo-yo between supplier vs consumer bargaining power can exist but is often relatively minor.

As the activity evolves to more of a utility, hence the shift from peace to war, then competition becomes more of a fight for survival as new entrants appear. The balance of power can shift towards suppliers (centralization) if other potential suppliers such as past product vendors fail to act appropriately. Beyond peace and war, the state of wonder also tends to be an aggressive fight for those new activities but in this case it is more a case of a fight to become established, to prevail over other equivalent attempts to provide the new activity by many new entrants. 

All competition is a fight but it’s worth emphasising (and repeating) the different economic states for any component.

Wonder: New activities appear and a fight to become established occurs in an uncertain and un-established market. Consumers hold the balance of power and you’re competing against other entrants with no idea of whether any will be successful. Everything is a gamble and a huge risk with rapid change.

Peace: Activities are provided in a relatively well-defined, widespread and established market. Large competitors jostle for relative positions and to maintain profitability. Inertia to change builds due to pass success. There is often a balance between consumer and supplier bargaining power. New entrants see an almost impossible mountain to climb and must look to substitute and disrupt existing suppliers often by changing the value chain. Whilst difficult, this can be achieved by adding to or altering the visible components associated with a product (e.g. smaller hard drives, more energy efficient) and then establishing these components in an alternative market. The occasions were the giants are disrupted are relatively few as sustaining change tends to exceed disruptive, however disruption can occur due to changes in the value chain. This is hard to predict and hence defend against and is compounded by inertia.

War: Activities evolve to more of a commodity (or utility), new entrants take up the charge into the space with past giants having inertia to the change. For these giants a fight for survival for their massive established business occurs, many will be disrupted by what is entirely predictable and could be defended against. Due to the speed of change and depending upon how well the game is played, the balance of power can shift to large centralized suppliers. 

At this point, I tend to mark up the map with the following legend (see figure 51) covering differentiators, barriers to entry and five forces. I also include future changes i.e. what happens as activities (or data or practices) evolve and add inertia barriers to change (i.e. caused by past success).

Figure 51 – Legend

Using the above legend, I’ve updated the Fotango Map (see figure 52). From the map, the reader should by now be able to read that Fotango had a value chain of many components at different stages of evolution. The Fotango service itself was building an ecosystem of end users and was in a maturing field that was moving from a fight to become established towards more relative competition. Consumers currently held the power and substitution was a threat.

The provision of image manipulation was a differentiator though we had no idea whether it would be successful. Consumers again held the bargaining power and new entrants providing image manipulation services were common.

Figure 52 – Map of Fotango, 2005

Platforms, which were used to build the Fotango site, were in a relatively peaceful state of competition with well-established platform players and the only main threats being substitution. This activity (like all) was evolving and becoming suitable for utility provision (PaaS). New entrants were likely to take up the charge and establish broad ecosystems that also led to a danger of centralization. Past players were likely to suffer inertia barriers to the change.

Infrastructure was even more of a commodity and was also suitable for provision as a utility (IaaS). It currently existed in a relatively peaceful market of large players with the only main threat being substitution. Those players would have inertia to the change and the new entrants could build broad ecosystems and potentially centralize if the existing giants failed to act.

The future IaaS world could power the PaaS world.

One of the barriers to entry in Fotango’s space was the ability to build large-scale architectures dealing with large volumes of users. This was a highly skilled engineering task and such knowledge could be considered a barrier to entry into the business. 

Writing these maps is a big undertaking. A fully-fledged map for a value chain can take up to two hours of efforts and it's not strictly necessary to go into the detail of mapping out forces, value can be gained just by doing a simple map of value chain vs evolution and just thinking about the above when reading the map is enough. However, I thought I'd at least show you this for completeness sake.

Given 40 or so value chains in an organization, you could be looking at two weeks effort to get a really clear understanding of the environment. But it’s worth it because now that we can write and read maps then we’re finally getting ready to start playing the strategy game.


Post 21 on the Management and Strategy series.

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