One of the greatest — or, depending on you perspective, nastiest — effects of the Internet is that it tends to drive prices to zero in almost every market it touches. This effect has been extensively described in books and countless blog posts, so there’s little need to reiterate all the many well-known industry cases (in news, music, movies, software, etc.).
However, almost every week brings a new example of dramatic price erosion through the power of the Internet. The latest case: Google now offers a free turn-by-turn GPS navigation application on Android smartphones (and, subject to negotiations, probably soon on other platforms). Until now, the established vendors charged more than $100 for applications with the same functionality. Poof, there goes another profit pool.
Why can Google do this? It now owns all the necessary map data thanks to its Street View project, and reusing this wealth of data for another application is very cheap. Giving away the navigation software probably won’t cost Google much in incremental costs, since it’s already giving away the entire smartphone OS anyway. Of course Google hopes to make money in the only way it really excels at: Through advertising, in this case built-in ads in the GPS application.
Tough luck for TomTom, Garmin, Navigon and all the other vendors of GPS products, right? They will just need to adapt and match Google’s business model. Well, unfortunately, they will have a hard time doing that. Only TomTom owns a maker of map data, but probably can’t easily afford to just give this data away, because it doesn’t have an unrelated source of profits the way Google does. Things look really bad for the other vendors, because they have to buy their map data from external providers. The only company that could match Google’s free offer is Nokia, which bought map data provider Navteq a couple of years ago. But Nokia has no experience selling advertising, and it’s increasingly losing momentum in the smartphone market.
This case shows very nicely how whole industries can be turned upside down without warning by a new player who leverages the Internet to completely change the economics of a market.
Let’s recap: Google takes advantage of
- free distribution of its software (the app will simply come pre-installed on smartphones or can be downloaded)
- free marketing (no need to convince people to use a free, pre-installed app)
- free support and maintenance infrastructure (software and data updates will be distributed through the wireless data plans that smartphone users already pay for — at no cost to Google)
The missing link that prevented anybody from offering a free GPS app so far was the map data. And Google is in the unique position to have collected the necessary data (at least for the United States) for its Google Maps service. This huge effort has probably already been paid for by the local ads that Google shows in Maps.
Of course there are still years of life left in the traditional GPS device market, since not everybody owns a smartphone and Google still has to overcome obstacles with data availability. But the writing is on the wall: Another fundamentally disrupted market, with incumbent players that soon will fight for survival.
History shows that no business is ever really safe from disruption. But the Internet with its particular economic characteristics speeds up disruptive processes and makes them much more dramatic. The classic case studies of disruption show how disruptive competitors enter a market with products that are less sophisticated than the “state of the art”, at much lower price points. This over time forces the incumbents to offer simpler, cheaper products (if it’s not too late by then). But having somebody come into your market who simply gives away a sophisticated, in some aspects even superior product for free is an entirely different matter.
Sure, Google cross-subsidizes its new GPS service heavily from its traditional business. It will probably not make money from this product for years, if ever. It’s a long-term bet and an investment into a whole ecosystem. The fundamentally important point is that this kind of extreme strategic move is only possible in the digital world, and only thanks to the ubiquity of the Internet, which provides nearly free distribution. The marginal costs of digital goods are very close to zero, and this enables an entirely new set of deeply disruptive strategies that most managers (and academics) have probably not even begun to understand.
If you sell a product or service that can be replaced by an entirely digital product or service, all that is needed for a fundamental disruption is somebody who is willing to invest some money into the initial development of such a product. The money can come from an existing profit pool (as in the case of Google) or from investors who believe that there could be profits in the future. The barriers to entry are extremely low in almost all digital markets, and the speed of disruption can be breathtaking. Just ask a newspaper executive.
The characteristics of digital markets attract competitors who behave irrationally in the short term (by putting money into a free, profitless product) in the hope of somehow winning control of a market in the long run. The low barriers to entry (thanks largely to free digital distribution) make many digital markets look very disruptible and hence attractive to potential disruptors.
Unfortunately, once a player gains significant market share and starts to make profits, it will attract other competitors with similarly aggressive strategies. The result is almost constant disruption, which makes it hard to ever build a consistently profitable business. Commoditization is of course nothing new and happens in the physical world too. But the clock-speed of Internet-based disruption is much, much higher. Remember, just two years ago, MySpace looked like the unassailable king of social networks. Then it got replaced by Facebook, which burned through $716 million in capital to build its current position and is still not profitable. It’s safe to assume that somebody with even deeper pockets and/or better ideas could eat Facebook’s lunch in the near future.
This increasingly frequent pattern will have pretty profound consequences. For instance, the traditional venture capital model is built on the assumption that a tech startup can achieve a strong market position and profitability within 4-7 years and is then ready for a major exit, preferably an IPO. The attractive past returns of venture funds were fully based on this model, not the profitless “Please, Google, buy us” model of most Web 2.0 startups. But when even very well capitalized, market-leading startups have trouble reaching profitability before yet another disruptor attacks them, the whole system of tech investments as we know it breaks down.
Are there any strategies that protect a company against this kind of disruption? There are probably only two: One is to have extremely strong platform-based lock-in effects, as in the case of Microsoft Windows. For most businesses, switching from Windows to even a free OS like Linux would be so costly that it’s almost impossible to justify. However, this is not the same as having just some superficial network effects, which are often weaker than expected. Facebook is not safe from disruption just because a lot of people have built their friend lists on it. Yes, that is a network effect, but the decline of MySpace shows that it’s not a very strong protection against a better competitor. Building a deep lock-in is very difficult. Apple and Amazon are trying to do this for digital media, but their lock-in doesn’t look nearly as strong as Microsoft’s.
The other strategy is to consistently be at least as good as all competitors and invest heavily into a protective ecosystem. Google is of course the poster child for this strategy. No company so far has come up with a search engine that is really significantly better than Google’s. And through services like Maps, Gmail, Google Docs, Wave etc., Google is slowly building a network of small lock-in effects that collectively can build a pretty strong wall against attackers. The free GPS app is of course part of this plan, because Google wants to play in most parts of the mobile Internet market in order to defend its core business against competitors.
But it is clear from many recent examples that the Internet will change how we think about competition, strategy and business plans. And this change will probably be more fundamental than we think.
(Picture: Erik Charlton, CC license)