Economics as Networks - application to business analysis

My friend Robert Scoble has sparked a great discussion on his blog about the “froth” in the current Web 2.0 market. While reading his post and many of the 90+ comments on it his readers have generated, I started to compose the rest of this post below as a comment. I have decided to post it here and link back to his post. This reflects an application of my thinking on Economics AS Networks, namely the value that this type of analysis can offer a startup firm in thinking through where to position themselves and where (perhaps) to capture value.

This is a comment/reaction to Getting Outside the Frothy Bubble by Robert Scoble

One immediate thought is to stop focusing on the tech (as many of us do all too easily) and start thinking about what people do/need to do.

and from that, what, where and how they might pay for it (or if not them directly, who would pay for them - i.e. advertisers of some form)

A simple thought exercise to help:

take your firm. Think about what value you generate (where it flows from - and yes investors are a source here, as are founders, customers, advertisers, sales channels etc). For a startup, once it “enters” your company it probably doesn’t have too many places to move around (i.e. perhaps paypal then to a bank account for example). And where do you “spend” this value - i.e. where does it go (employee’s salaries, benefits, bandwidth, hosting, software, physical products, shipping costs etc)

Now focus on the “value in” part of the network. What ROLE do you play for those parties?

Is it a “critical path” (for your investors, for example, are you their mad money or a vital and key part of their investment strategy?) For your non-investment sources of value, are you a discressionary cost OR can you move from “optional” towards “necessary”?

In either case what then are you competing with? Are you set up to continue to gain value from existing sources? Or must you continually generate and discover NEW sources of value? (i.e. are you Gillette who will make money from my purchases of razor blades for many many years to come? Or are you a restaurant I stopped at the one time I was visiting a given city?)

Now also map this process to your business’s normal thinking about your “customers”. Are they, in fact, your sources of value? Or, as in many cases, are your “customers” part of the value you provide to your actual sources of value? i.e. Advertisers or other partners who rely on your relationships with readers to in turn deliver value for them, value that you assume is greater than the amount of value you charge them (or else they are unlikely to sustain the relationship with you for very long).

If you apply this type of analysis to most Web 2.0 companies I suspect that you will find that they have structured themselves as part of a fairly unsustainable network. They are, mostly, an optional expense on the part of their sources of value (other than investors and founders) and while the costs they have/will incur also relatively low, they may for quite some time be greater than the new value they are creating.

On the otherhand, I think this analysis does offer some suggestions for many of the current Web 2.0 firms (or anyone starting a new firm) for how to build something more sustainable in the long term.

1. Think deeply about what “advertisers” are seeking to achieve and design your products to even more directly than Google adwords to deliver that value for your advertisers. For example, the move of a site such as MySpace.com to offer fulfillment services for independent labels and bands to sell their DRM free mp3s directly seems to me a very good approach. I wouldn’t be surprised if a possible additional step (or steps) would be to partner with event demand services such as Eventful Demand and/or ticket fullfilment services to offer a competition for ticketmaster. Done well both myspace and 1000’s of bands and venues could directly grow real value - at the same time being directly aligned to the interests of the users/fans on MySpace. Keeping in mind, however, that all of the sources of value here (the fans) are spending their entertainment dollars - so this is in some competition for their other entertainment options (other bands, ticketmaster handled venues, movies, games etc)

2. Look to align your generation of value with how your sources of value look at their costs - and in most cases strive to achieve an ongoing relationship, not a one time sale relationship. Microsoft, for example, while they do sell individual copies of Office and even Windows, generates the vast majority of their revenue from ongoing relationships with large corporations and other organizations. These relationships achieve an ongoing revenue stream for Microsoft and periodic bumps, generally aligned with when the organizations enter into an upgrade cycle for their computing needs. In essense these firms (and governments or other organizations) pay a “Microsoft tax” per employee, one they factor into their costs of hiring and firing. There are, of course, many serious debates about the ‘value’ of this tax for a given company, but by for the most part thinking in terms of “per employee” Microsoft has set itself up to fit into the existing costs model for most businesses.

3. Don’t get too greedy or try to capture too high a percentage of the system’s value. IF your business is not working in the “discressionary” side of things. That is, if you are an “input” into your sources of value’s network, then they MUST be able to take your goods or services and in turn add value on top of them. If they can’t, you will not be able to sustain the relationships over time for very long. Think of any wholesaler - if you tried to sell your products to retailers at 100% of what they could sell them for, it is unlikely you would have a strong retain channel for very long (unless you found a way for them to make a lot of money somewhere else as a result of distributing your product and collecting funds etc on your behalf). On the otherhand, if your goods/services are part of a discresionary spending, then the parties purchasing from you are not, in turn, expecting to use what you provide to directly make themselves greater value. In this case you can charge more (perhaps) but have to watch out for a new issue. (see below)

4. It is better to charge a price at which people’s reaction is “I’d be silly not to buy this” than a price that generates a lot of questions and long decision cycles. This is not, however, an argument for always selling at the lowest price. Rather it is an argument of aligning your price with the scope of your sources - you want to be high enough priced that they consider you - i.e. not so low that they ignore you entirely. A large corporation won’t invest much time thinking about a purchase that is a few hundred dollars, nor will most want to spend tens of millions. But there is some price that is high enough to be serious but low enough that their reaction is “it would be silly of us not to spend this money”. For individuals, likewise, there is a price where it makes more sense to buy than to think about it for very long. Recently I had to decide between two swimming suits that were for sale, I didn’t know which size would fit me, the fitting room was unavailable, and I had little time to meet up with a friend to go swimming, but when I learned that the cost for BOTH swimsuits would be a combined $14, it was priced such that it would have been silly of me not to buy both suits - to costs of not buying one or both was higher than of buying both.

For entertainment purchases many people, myself included, think somewhat (though not entirely) in terms of my hours of entertainment. i.e. a new book is a couple of hours, a movie a couple of hours, a new game perhaps 10’s of hours. A magazine subscription a few hours each month etc. I also think in terms of who and what I want to support - so I’ll buy books (lots of friends who are writers and I’m trying to sell a book myself), I’ll go to independent movie theaters when possible and watch independent films.

So much more to think about, I’ll be following up with more posts on this and related topics in the months to come and if you seach through my archives you will find many more posts, both here and on my personal blog Searching For the Moon

This entry was posted on Wednesday, September 6th, 2006 at 8:56 am and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

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