CHAPTER 6

The Two Market Competition Rules for the Digital Economy

In 2007 IBM acquired Cognos, a Canadian business intelligence software company, in an all-cash transaction for $5 billion. With this acquisition, IBM firmly established itself in the growing market for enterprise analytics. At that time, companies were starting to collect even more data and building strong analytics teams to extract insights from the data to improve all aspects of their business operations. Thus, the Cognos analytics capabilities were the perfect complement for IBM’s database and integration technologies that collected, processed, and stored data. The acquisition seemed like a perfect match. Cognos offered complimentary capabilities, with strong market growth potential and opportunity to amplify sales in the other product lines too. But a perfect match does not always make a perfect fit.

A few months after the acquisition IBM approached Information Builders Inc., where I was working at the time, and started to negotiate to OEM its WebFOCUS business intelligence platform. WebFOCUS was a direct competitor to Cognos, but IBM considered it a better fit for its DB2 platform. Why OEM a competing product just a few months after a costly acquisition? Why not fix the issue?

The reason is “coopetition”—a term coined to describe a situation of cooperative competition. In 1996 Adam Bradenburger and Barry Nalebuff published a book “Co-opetition: A Revolution Mindset that Combines Competition and Cooperation” that changed the business game. It sold more than 40,000 copies and influenced the thinking of many business executives about partnerships.1

The concept is not new. It is rooted in the fundamental questions of game theory about competition and cooperation. As the most popular game in game theory—the prisoner’s dilemma—shows, cooperation may be desirable but is hard to attain. In the prisoner’s dilemma game, two suspects are each independently offered by the prosecutor the choice to confess and betray the other and walk out free. If both suspects do not confess, they get the minimum sentence and spend a little time in prison. If both confess, they must spend a significant time in jail. Given this offer, the suspect who stays loyal to the other has the most to lose, as he will spend the maximum time in jail while the other will walk out free. If the two suspects have no means to assure each other of their silence, their rational strategy is to confess, which results in a worse sentence for both. It is one of those “damned if you do; damned if you don’t” situations.

The business environment is abundant with prisoner’s dilemma types of situations. You may be bidding on a contract with a partner. Suddenly the buyer reveals a much lower budget and wants both of you to cut your proposals. Who is going to take the biggest cut? What if your partner knows that you need this contract badly for your cash flow? Since you need it more than your partner, they may decline to lower their bid. Depending on how badly you need the cash, you may absorb the entire cost cut. For many years game theory scholars have studied and devised strategies of how rational people may attain and sustain cooperation in situations like this. Bradenburger and Nalebuff’s book introduced the business executives to a different way of thinking about how to secure cooperation even in situations where conventional thinking would have favored direct competition.

In a big and growing market, IBM’s decision to sell competing products seems completely rational. Since every competitor has enough room to expand its market share on its own, a company can maximize its profits by selling both products. Furthermore, by selling more business intelligence software, IBM can sell even more databases and more services, thus growing its other business lines too. So, did it matter to IBM that they sold competing products? No, as long as the margins were good, and the products did not cannibalize each other’s growth and market share. The rationale behind coopetition is that no company or product is big enough or grows fast enough to take over the entire market.

Coopetition is neither possible nor a viable strategy in the data-driven economy. This is so because the first movers become the winners take it all companies, that is, they become the digital giants. The only two rules that govern competition in the digital economy are:

• • First mover advantage, and
• • The winner takes it all

These two rules are the essence of the prisoner’s dilemma, except that
in the new world the first suspect to confess walks out free regardless of what the second one does; that is, the first mover in the digital economy is the winner-take-it-all regardless of what its competitors do. These are the only two rules that data-driven companies use to plan their market development strategies. Traditional asset-driven companies do not understand nor take seriously these two rules as they do not fit into the aggregation, accumulation, and concentration models that are the foundation of their businesses.

First Mover Advantage

The first mover advantage concept also originated in game theory. There are special types of games in which the players move sequentially.2 There are games in which it is advantageous to move late, as this allows you to have more information to plan your next move. The first mover advantage describes the opposite situation in which the player who moves first determines the outcome of the game.

The classical example of a first mover advantage game is “The First to 100” game. In this game two players take turns and choose numbers between 1 and 10 and add them to a cumulative total. Whoever takes the cumulative total to 100 wins the game. It is easy to see that if one player makes the cumulative total 90 or higher, the other player will win. It is also easy to see that if any of the players brings the cumulative total to 89, this will force the other player to bring the cumulative total over 90 and lose the game. We can apply backward induction to find all the numbers like 89 that will force a player on the losing path. Backward induction is another game theoretic term that describes the process of reasoning that starts from the effect and goes backwards to identify the cause. In “The First to 100” game the winning path numbers are:

100, 89, 78, 64, 56, 45, 34, 23, 12, 1

If a player wants a sure win, all they have to do is to ensure that they play first and choose the number one. After such a move the other player has zero chance to win. Naturally, experienced players never play one and then the sequence of “trap” numbers that secure the win. They play other numbers but watch carefully to be the first to claim 89. As the other player realizes the importance of 89, experienced players start securing lower “trap” numbers. All players figure out the game quickly and lose interest in it.3

Ironically, this is the case in the digital economy too. Once a digital giant emerges, they embark on a predictable path to capture most of the market share quickly leaving the other players without practical short-term strategies. Thus, many competitors simply disengage and fade away. Of the 20 or so search engines that were in business in the 1990s practically all faded away and today, Google has roughly 90 percent of the market share, Yahoo 4.2 percent, and Bing 3.5 percent.4 Google was not the first company to invent and launch search. It had many predecessors. Google was the innovator that made search indispensable to consumers and who figured a viable monetization model on how to sell words. The first mover advantage is rarely secured by the first inventor; it goes to the innovator who drives the mass adoption with a complete business model, as Google did with its data-driven business model.

The first mover advantages exist in the physical world too. Xerox had a 15-year first mover advantage and market leadership as a result of the invention of the photocopier. Coca-Cola also had a first mover advantage secured by its highly secretive beverage recipe. In fact, patents and trade secrets exist to ensure that the first mover advantage is sustained over time being protected by a temporary legal monopoly granted by the government as a reward for ingenuity and invention of useful products.

The first mover advantage is not always sustainable in the long run. Pandora invented and launched the first digital streaming radio in 2000. The company went through its initial hurdles but started to rapidly take off in 2009. In five years, it attracted 80 million listeners5 and became the digital radio giant. Then in 2015 it lost its leadership to a late comer Spotify. In 2018 Pandora had 100 million less active listeners than Spotify.6 Some analysts attribute Spotify’s outmaneuvering of Pandora to its curated playlists and weekly suggestions about new music for its listeners to check out.7 Curated lists and recommendations are technology- and analytics-enabled strategies for disaggregation of the demand for music to meet very specific personal preferences. Spotify has created a long tail data-driven model on top of the digital streaming technology and service.

In the long term, neither a traditional assets-driven company nor a digital data-driven company is immune against market leadership takeover because of its initial first mover advantage. Myspace, the first and hugely popular social network, was overtaken by Facebook. Ford dominated the market with its Model T initially but by 1927 GM surpassed it in sales and market share. Can Tesla maintain its first mover advantage in the electric car market segment—this is yet to be seen. Whether a company can maintain leadership depends on many factors, but a head start is an undisputed advantage especially in the digital economy where assets-based barriers to entry for rapid scale do not exist.

In the physical assets-driven economy, the first mover advantage derives primarily from two sources: (1) market learning and (2) economies of scale. Innovation, know-how, marketing strategies, customer knowledge, and so on, all pertain to market learning, while economies of scale are realized through investments in business assets. In the digital economy the first mover advantage is associated with network effects and the formation of consumer habits. The more people who join Facebook or LinkedIn the less incentive people have to join other competing social networks, as one can find pretty much everyone in one of those social or professional networks. Because one can find everything on Amazon, everyone buys and sells on Amazon. At some point the network effect transforms into a personal habit and habits hardwire the loyalty of consumers to digital businesses.

Hardwired habits make it very difficult for consumers to switch from their preferred digital products. Look at how hard it is for iOS users to switch to Android. It is not the physical phone that consumers become so used to as all smartphones are very much the same today. It is the interaction with the software, the habits that people formed about how to recognize and find things on the screen. Even though the same apps with the same look and feel and functionality exist on both operating systems, it is the little differences that irritate people and cause them to hate switching phones. On the other hand, people switch cars, hotel rooms, and other purely physical goods easily. Consumers do not care what brand the rental car is. They will gladly take the cheapest model in their preferred category. But try to swap their phones or tablets! Hardwired habits to digital products last long.

Because of the network effects and the emotional attachment to digital products, the winners can not only take it all but can also sustain their leadership and market dominance for very long periods of time.

The Winner Takes It All

The ABBA hit song “The Winner Takes It All” has the following lyrics:

I’ve played all my cards

And that’s what you’ve done too

Nothing more to say

No more ace to play

The winner takes it all

The loser standing small.8

ABBA’s song is about a relationship breakup, but it sums it brilliantly that when the winner takes it all the loser is left without any options and with diminished importance.

Mark Andreesen described the emergence of the winner takes it all effect in the digital economy in 2013:

In normal markets, you can have Pepsi and Coke. In technology markets, in the long run, you tend to only have one …The big companies, though, in technology tend to have 90 percent of the market share. So, we think that generally these are winner-take-all markets. Generally, number one is going to get 90 percent of the profits. Number two is going to get like 10 percent of the profits, and number three through ten are going to get nothing.9

The winner-take-all describes a market where the winner captures a large percentage of the market share. But what is surprising is how extreme the level of market share that the winner-takes-all captures in the digital economy. The traditional hospitality market used to be dominated by a few big hotel chains—Hilton, Marriott, Radisson, NH Hotels, and many more. Many other hotel chains were national—operating just within the boundaries of one country or region. Airbnb has become the dominant player in the short-term rental market and there is no other digital short-term rental company that has a market share even close to Airbnb’s market share. There are also no notable regional, country-specific competitors or challengers to Airbnb’s model and dominance.

This extreme market share and demand concentration is explained by Taleb in his book “The Black Swan”:

The web produces acute concentration. A large number of users visit just a few sites such as Google, which at the time of this writing has a total dominance. At no time in history has a company grown so dominant so quickly—Google can service people from Nicaragua to Southwestern Mongolia to the American West Coast without having to worry about phone operators, shipping, delivery, and manufacturing!10

And so do Airbnb and Uber. There are no constraints to their growth because there are no physical resources involved in their business models.

In the digital economy the winner-take-all correlates with staying power. The larger the market share, the harder for anyone to challenge the digital giant. Microsoft Bing, Ask, and other search engines have been trying to challenge Google’s dominance and chip away market share unsuccessfully for many years. In the traditional economy GM overtook the dominating Ford with its Model T in just a few years, and Pepsi split the market with Coca-Cola. But why is it so difficult then to challenge the winners in the digital economy?

As the accumulation of physical assets provided market protection to companies in the traditional economy, so does the accumulation of data in the digital economy. The more data and data processing power a company has, the more it can disaggregate services and products and offer a more personalized experience to win and retain satisfied customers. The more people enjoy the personalized experience, the more likely they are to form a hardwired habit and a large network. Convenience leads to habit formation and once habits are formed behaviors become automatic. Once behaviors become automatic, it is very hard for a competitor to even convince a user to try an alternative product. Only a very differentiated competitor offering even more personalized service can penetrate the stronghold of the incumbent market leader. Spotify grabbed the leadership position from Pandora because it offered a habit-forming convenience to explore and learn new music. Pandora on the other hand offered a great and easily accessible service, but there was not a habit-forming hook besides the ability to start and choose a radio station with a few taps on your phone. In the world of data and data products one can only compete with better data and better analytics directly embedded in the products and the business models.

Disrupting and Winning With Data

In today’s business environment data creates the foundation for scale and scope expansion without the limitations of assets accumulation. Because of this it can disrupt any business and any market as it takes an important component of the business equation valid for the traditional asset-driven economy. The basic accounting formula that has been used since the 14th century stipulates that the company assets must equal the company liabilities plus the owners’ equity. But what happens when assets are taken out of the equation? We do not know yet how to factor the value of data as an asset into this equation, but we know that data creates tremendous shareholder value and market power with less investment in physical assets.

Data is beginning to permeate every business and every physical product. Data flows in phones, watches, cars, and industrial and medical equipment, thus is becoming the most essential component that defines the usefulness of all products. But more importantly, it contains the individual DNA of the operations of each individually used product. Data makes every smart watch unique. It is not any more this or that brand, it is the watch of this individual because the data reveals how it is used, how it benefits its owner, and how it can be improved to deliver even more value.

The rest of this book will describe how data can be used to create different data-driven business models. Each model provides a conceptual framework to help companies ideate and create their own transition strategies to the digital economy and infuse their products and services with data.

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