Saturday, August 03, 2013

Does commoditisation lead to centralisation?

tl;dr Maybe. 

This question came up again recently, so it's probably worth covering this very old ground. 

All activities commoditise to good enough components providing interfaces that allow higher order systems to be rapidly created - nuts and bolts, electricity, you name it. The process of how things evolve to become commodity is driven by competition (supply and demand) between all actors in the market. Evolution towards a commodity is inevitable if competition exists.

Do we end up with one interface or many? Generally, we tend towards very few for a single act though there can be constraints (e.g. geographical, political) along with specific forms of provision for specific (more niche) markets. 

Does this inhibit innovation? It's always worth separating out the interface (which represents the commodity or utility) from innovation above the interface (i.e. building  electronic goods which consume standard electricity supply) and innovation below the interface (i.e. operational improvements in power generation). It's worth noting that whilst the interface becomes standard, innovation occurs above and below the interface and the rate of innovation above the interface accelerates as the interface becomes more standard (componentisation effects).

Does that mean we end up with centralisation? Not at all. The question of central vs decentralised depends upon an entirely different set of economic characteristics and we can often yo-yo between both. Take for example, electricity provision for which behind the "interface" a wealth of change is allowing decentralisation of some of the supply. The reasons for centralisation vs decentralisation often have a lot to do with strategic game play i.e. when a market evolves from product to utility then if a few players perform well and the rest of the competitors run around like headless chickens then it tends to centralise around the few players. It doesn't have to be this way.

So, take cloud for example and in particular IaaS. Amazon has played a good game so far and built a powerful ecosystem which it exploits. The competitors (with the exception of Google and to a lesser extent Microsoft) appear to have been fairly clueless so far. Hence, we're likely to see centralisation around Amazon, Google and MSFT. It didn't have to be this way.

How could it not be this way? Well, the shift from product to utility was highly predictable and not an unexpected change. By 2004 it was crystal clear the change was about to happen but we had plenty of warnings as far back as 1966. So, this isn't the usual case of "disruptive innovation" where a combination of inertia and unexpected market change (i.e. product substitution due to some change in characteristic such as cable vs hydraulic excavators) disrupts a firm.  In this case, it's a highly predictable and expected market change which disrupts. This only occurs because of executive failure to prepare for this.

When Amazon launched EC2, the competitors had multiple options. For example, in '07 / '08 :-

1). They could have flooded the market with AWS clones and created a price war.  This would have increased demand (IT demand is elastic) beyond the ability of one competitor to supply (Data Centres are capital and time intensive) causing a fragmentation of the market. You would have created a federated market of clones and as the "clone" market grew to exceed the AWS ecosystem then it would in effect capture, dominate and own the AWS APIs.

2). They could have flooded the market with their own individual systems, creating a price war. Again a fragmentation play but also a more aggressive (and dangerous) ecosystem play. Ecosystems if properly used can enable a company to simultaneously increase innovation, efficiency, customer focus, stable revenue and wealth generation opportunities at a rate in proportion to the ecosystem. By flooding a market with your own systems, you're basically going for a sink or swim - either you'll build the bigger ecosystem and runaway with a chunk of the market or you won't and then its often niche land for you. Chances are we would end up with a few big providers and Amazon might not have been one of them.

3) They could have flooded the market with their own systems based upon a common system, creating a price war to fragment the market. In this case you're likely to end up with a federated market around the common system and assuming they quickly built a larger ecosystem (certainly possible in 2007) and didn't go off on some collective prisoner dilemma then it would have easily won creating a federated market without Amazon.

However, this didn't happen. The executives of the competitors did nothing and sat and watched AMZN steal the show. Today, AMZN ecosystem is so large that your moves are limited by its effect but it's still possible to build a federated market around AMZN or to co-opt GCE. Anything else is likely to end up niche pretty quickly. Though, niche isn't all bad as you can eek out some form of existence just not a very big one.

The point is don't confuse how things evolve to commodity and utility with the question of centralisation or de-centralisation. These are entirely different.

The process of evolution simply requires competition by all actors. The question of centralisation or decentralisation when a shift from product to commodity or utility occurs is usually a question of whether the competition is on the ball or clueless. 

Oh, and don't blame the engineers, culture or trot out the old "innovation dilemma" excuse - this is purely an executive responsibility. If centralisation occurs (which is likely) and you're not one of these big players then if you were a former giants, you've simply been outplayed. Strategic gameplay is critically important when it comes to change. 

It's like Canonical (Ubuntu) vs RedHat (RHEL). RedHat dominated the field and let Canonical steal the future. I'm sure, as we shall see over this decade, RedHat has hardly been the smartest player. Even OpenShift versus CloudFoundry doesn't appear to be going that well for them. They should have bought Novell, at least it would have forced IBM to acquire them.  Oh well, it does look like one of those ignominious endings awaits. Buy-out by Oracle or CA? I suspect it'll be something pretty miserable.

-- Update 21st August 2013

According to this recent article by @mjasay based upon Gartner's new research then "AWS Now Five Times The Size Of Other Cloud Vendors Combined". If I was a shareholder in any of those dominant hardware players of recent years, I'd be spitting fury by now. It's not like there wasn't oodles and oodles of warning.