When a market or industry is stable and predictable, the incumbent players can have what appear to be unassailable structural advantages – solid revenues, top talent, access to capital, and economies of scale just to name a few. But those advantages can end up being the catalyst for their undoing during times of disruptive change.
For a timely case study, consider what’s happened in the print news industry.
A decade ago, newspapers were high-margin businesses. Because entry costs were high and distribution was physical, they could effectively operate as localized monopolies with little competitive pressure. Outside of a few nationally recognized publications, most newspapers served a particular city or region, and local businesses saw them as the most effective way to advertise to the regional demographic they wanted to reach. When they combined this with the classified advertising component of their business, newspapers enjoyed an operating model that was both predictable and highly profitable. That, in turn, attracted larger media conglomerates who started buying up these local newspapers, often at incredible valuations.
It was a great time to be in the newspaper business.
Fast forward to today. The newspaper business is on the brink of collapse. The industry has spent the last several years struggling unsuccessfully to recreate itself into something that is both relevant and financially viable. The key factor in this reversal of fortune has been – no surprise – the accelerating adoption of the internet. It isn’t that everyone in the news industry missed what was happening here or simply chose to ignore it. Most understood the corrosive effect the internet was having on their traditional business model and created their own web properties to try and offset it. What they quickly found out, however, was that the revenue they can produce from online advertising is no where close to what they are used to getting from print advertising. This has left them in a ‘no win’ position. They are sitting at a significant tipping point in the business being asked to choose between a new revenue model that can’t sustain the business they’ve built, and a current revenue model is just plain unsustainable.
And that’s the dilemma all incumbents ultimately face.
During periods of disruptive change, the only solutions that are rational for an incumbent to consider are ones that contain some recognizable form of themselves at the new “end state”. They don’t have the luxury of being able to envision optimal future states, and working backwards to reconstitute the assets they have into a form that can be successful there. They need to work from where they are and find a way to move forward.
But their obligations to the present can be overwhelming…
The additional irony here is that the options they can realistically pursue are likely limited by the very elements that made them successful businesses in the first place. This is the point where the advantages they had as incumbent’s can come back to punish and even paralyze them.
- Solid Revenues – Revenue is something that may be pried from a company’s hands, but is almost impossible for them to let go of it on their own. They’ve typically developed an operational cost structure that depends on it – one that’s optimized for the current business model and could be difficult and disruptive to change. If a company is publicly traded, they have shareholder expectations that they are obliged to consider, and that puts pressure on them to optimize for the near term even at the expense of the long term. Before making any significant changes to their business/revenue model, a company will need a reasonable understanding of the current market dynamic. Unfortunately, while it may be possible to predict that a tipping point is coming, timing when it will arrive is really just guesswork. And that means most companies won’t make any significant changes until after a tipping point has been crossed. By then, it may be too late.
- Top Talent – The ‘Top Talent’ at most firms is the driving force that effectively runs the business. They provide both the strategic vision and tactical execution a company depends on to succeed, and they are typically well paid for doing so. The challenge here is that these individuals have a vested interest in maintaining the model that rewards them so well. They will instinctively direct their considerable talents toward optimizing and preserving the status quo, and not risk taking effective action until failure seems imminent. During periods of disruption, “Top Talent” can move rapidly from being an major asset to an expensive liability.
- Access To Capital – Any firm that tapped into the debt markets or accessed credit lines or private equity has taken on an obligation to service that debt. Debt is an anchor that ties a company to the past. It requires a level of cash flow beyond immediate operational expenses. It is normally tied up in longer term projects, some of which may no longer be relevant or economically viable. It may have operational triggers attached to it that may force early payment or changes in rates. In times of change and realignment, debt is a liability that can destroy an otherwise viable business.
- Economies Of Scale – When a company points to their “Economies Of Scale”, what they usually mean is that they have optimized their processes and relationships to cost effectively deliver very specific services the market is looking for. Almost without exception, optimization comes at the expense of flexibility and adaptability. So when a marketplace is in transition, optimized organizations can find themselves at a loss for how to respond, and become extremely vulnerable to more nimble rivals.
While I used what’s happening in the newspaper industry as an example of struggling incumbents, this isn’t a situation that is unique to traditional industries. In fact, many technology companies find themselves in very similar situations.
Sun Microsystems, the company that powered the first push to the internet, never recovered from the market crash of 2000. After building a reputation and business model based on proprietary hardware and software, they were never able to adapt when the industry shifted to high performance commodity systems running open source software. Even though they have remained technically innovative with developments in areas like JAVA and the NFS file system, they never regained commercial viability. The rumor circulating now is that they will likely be acquired by IBM. If that doesn’t happen, I could easily see them shuttering the business.
Even the massive, technology savvy firm Microsoft is struggling with changes that are happening in the marketplace. Each of their key business franchises is under pressure from significant long term shifts that are taking place. Many corporations are starting to view the internet & browser as their real operating platform – not the desktop operating system and office suite. They have shown little interesting in doing costly upgrades to Microsoft’s Vista or Office 2007, while their investment in web delivered platforms and services remains reasonably healthy. Microsoft’s server business is being threatened by open source technologies, specifically, Linux, MySQL, and Lucene, that offer exceptional performance with no licensing fees. And the big macro trend – cloud computing – is maturing rapidly. It has the potential to overtake the traditional software industry and reshape it significantly. Microsoft has jumped into this space with their own Cloud-based platform called Azure, but it isn’t clear that this could become a viable replacement for their existing business models. What essence of what Microsoft is struggling to respond to is a an irreversible move to low cost or free software and services. This shift is starting to erode their pricing power, and is commoditizing any proprietary value that may have delivered in the past. This hasn’t reached the tipping point quite yet, but it is coming. When it arrives, it will likely undermine their entire business model and threaten their survival in any form that resembles the Microsoft of today.
Change like this is a constant. It ruthlessly prunes anything that lacks value, and provides an opportunity for the new and innovative to grow and flourish. There’s a quote from American social writer and philosopher Eric Hoffer that speaks to this so eloquently:
In a time of drastic change it is the learners who inherit the future. The learned usually find themselves beautifully equipped to live in a world that no longer exists.
The disruptive change he observed in this quote isn’t something new. It’s the force that has shaped our history while bringing the promise of opportunity to our future.
And its happening faster than ever.