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The most obvious answer to the above question — “What do Amazon, Apple, eBay, Facebook and SaleForce have in common?” — is that these companies all conduct their business exclusively, or extensively, over the Internet. That answer is technically correct but it misses a key element for understanding the information economy. The true success of these companies lies in their ability to leverage increasing returns to their competitive advantage.
Take Amazon as an example. Amazon’s decision to let other retailers, from large retail chains (e.g., Macy and Target) to mom-and-pop resellers to sell their merchandise on its Website, often in direct competition with its own retail offerings, had many skeptics at first; but no more. By transforming itself from simply a retailer into a retail platform (more on the platform concept in a later post), it is able to expand its lead as “Earth’s Largest Selection” (not just Earth’s Largest Retailer originally). With so many resellers offering a vast range of merchandise on its Website, Amazon has fortified its position as a one-stop retail destination for millions of online shoppers; if shoppers can find everything at Amazon, why would they waste time going to many other places. Thus, the more retailers Amazon can attract to its Website, the more attractive it becomes to online shoppers; as more people shop at Amazon, the more attractive its Website becomes to other retailers. The network effect is at work.
Consider Apple. Its iPhone and iPod Touch are marvelously designed. By themselves, they offer little value to their users. But the thousands and thousands of applications, available via Apple AppStore, let users add a wide range of selected functionality to these products. The more apps are available, the more attractive the iPhone and iTouch become; the more people owning them, the stronger is the incentive for developers to build applications for the iPhone and iTouch. Billions of downloads from the AppStore tell the story. Once again, the network effect is at work.
How about eBay? There are other consumer auction sites out there; but none comes close to eBay. Why goes anywhere else. As more sellers list their merchandise on eBay, more buyers find eBay an attractive place to buy; and as more buyers look for merchandise on eBay, more sellers become interested. Should I keep on saying the network effect is at work?
Look at Facebook. It was trailing far behind MySpace until it decided in May 2007 to let independent software developers to build applications for Facebook (and earn a share of advertising revenues). As more such applications become available, users can do more things (e.g., sharing shopping info with friends) on Facebook, they spend more time there instead of searching on Google or going somewhere else. As users spend more time on Facebook, advertisers become attracted. As more advertisers spend their ad dollars on Facebook, more app developers become interested; as more apps become available, users spend more time on Facebook… The virtuous circle spirals upward. Look at where Facebook is now, relatively to MySpace.
Also look at SalesForce.com. It is a pioneer of Web-based CRM software applications. Competing with software giants such as Oracle and SAP, which can spend massive amounts of money on software development, is certainly not easy. So, SalesForce creates AppExchange that lets independent developers, and users as well, to develop and market complementary applications…. [You can fill in the rest of the story].
There are more than just the network effect being at work. Amazon could have expanded its offering from books into other lines of merchandise on its own; but that would be very costly, slow and perhaps ineffective (after all, each line of merchandise requires unique “domain” expertise that takes years to build). By mobilizing other retailers to sell through its website, Amazon can accomplish the “Earths’ Largest Selection” mission very expeditiously. Furthermore, a major hurdle for online retailers is “order fulfillment” — once a customer places an online order, the merchandise has to be picked, packed, shipped and, if needed, traced. Amazon has spent around a billion dollar to build such a system. That system cannot be economically justified without the massive volume of sales to utilize it; yet, the massive volume cannot be generated without having such a system in place. Here is a chicken-and-egg problem — which one, sales volume or fulfillment system, should Amazon have first? By mobilizing resellers to Amazon site, the company can quickly build up the sales volume to justify the investments in building its fulfillment system. Scalability has been at work thanks to this. Likewise, it would be cost prohibitive and take foreever for Apple, Facebook and Salesforce to develop the massive volume of applications on their own. By mobilizing independent application developers, they can scale up very economically and expeditiously.
In the video clip above, the presenter suggests that the future lies with companies like Apple and Facebook (but not Google). That means these companies will be able to maintain their market leadership (while Google cannot, at least not so effectively). My question for you is: can they? That depends on their ability to lock-in their customers/users. In the case of Amazon, it would be very costly and time-consuming for someone else to develop an order fulfillment system of that scale and even more to replicate Amazon’s website operation capabilities (search, merchandise rating and recommendation functionality, payment processing, etc.). So, it should be difficult for resellers on Amazon to migrate elsewhere. But how about Apple, Facebook and Salesforce? As for Google, where can it finds and exploits the network effects?