Competing With Monopolies
“What does true differentiation mean? True differentiation can never be based on features…because someone will come along and copy the features…if [Snap does] build a viable business over the long run, it comes from the fact that the role Snapchat fills in its users’ lives is fundamentally different than the one Facebook does,…and Facebook, by virtue of…what makes Facebook valuable, can never go there.” — Ben Thompson, Exponent Podcast
Demand-side and Supply-side Disruption
In Christensen’s classic demand-side “disruptive innovation” entrants disrupt incumbents by either consuming their customer base from the bottom up or by siphoning it to a newly created market. In both cases, the incumbent’s capabilities remain intact. They should, in theory, be able to respond through either their own product development or through acquisition. These disruptions turn more dangerous when they creep into the supply-side of things. Supply-side disruptions more frequently result in the sudden, massive, firm-ending events we generally label as the byproduct of entrepreneurial genius. In supply-side disruption, incumbents are:
“unable to transfer the new technologies into their mainstream operations because doing so requires them to fundamentally change the way they manufacture and distribute their products. In essence, the basic architecture of the product — how it is put together — changes along with customer expectations and preferences, creating “supply side” disruption.”
With a good example of this theory found in RIM:
“BlackBerry and its peers moved quickly to include iPhone-like features — such as a touch screen and a better web browser — but they were unable to compete effectively because the innovation required them to redesign the process for making phones from the ground up.”
In an era dominated by software, these types of massive disruptions are more difficult to pull off. Consumer internet companies are structurally less vulnerable to supply side disruption because they possess fluid capabilities and sizeable balance sheets created by owning winner-take-most markets (i.e. they’re often natural monopolies).
When Disruption Fails
The ways in which which software companies “manufacture and distribute their products” are inherently more adaptable. Unlike RIM, which had to “fundamentally redesign the process for making phones”, today’s tech companies can shift product development resources and objectives with greater fluidity. As a result, these companies possess “mainstream operations” that can address nearly any new technology. For instance, in addressing Snap, it took Facebook fewer than two years and no major changes to its capabilities to transition from post-based sharing to story and video-based sharing across all its products.
In instances where acquiring new capabilities requires specific expertise, large balance sheets and an absence of non-competes make it easy for tech incumbents to simply purchase new capabilities. For instance, when Apple fell behind on machine learning and artificial intelligence, it went on a hiring and acquisition “spree” to quickly catch up. Given the “fluid” nature of software, it’s easier for Apple to successfully incorporate its acquisitionsrelative to past companies. Though RIM had the means and successfully added both touch screen technology to it’s hardware and an app store to its OS, they never integrated well with the overall experience, resulting in a firm-ending event.
Herein lies the great challenge for entrepreneurs and competitors today. How do you compete with an opponent who is technically capable of copying any of your innovations? The only type of strategy left for companies is “true differentiation”, which leverages the outsized value of the monopolist’s own business model as a point of entry.
Product /Market / Principle Fit
Though monopolist incumbents can obtain nearly any capability, challengers can succeed by building differentiation on capabilities that incumbents won’t obtain because doing so would jeopardize the viability of the monopoly. This idea may be more relevant today, but it isn’t new. For instance:
Incumbent Western Union gave its telephone patents and local markets to upstart Bell to preserve the monopoly profits it enjoyed from its long distance telegram monopoly. Though Bell’s product began as a niche form of communication, it would eventually go on to put Western Union out of business.
Google created a preference for search and targeted advertising, which violated Yahoo’s portal and banner ad business model. Developing capabilities in search and targeted advertising would have eliminated the monopoly profits Yahoo enjoyed from selling portal banner ads to customers who didn’t realize their poor ROI.
By expanding the pool of drivers, ride-sharing platforms built capabilities that were incompatible with a taxi medallion model. Allowing more cars on the road would have eliminated the monopoly profits Taxis’ enjoy by restricted supply.
The strategy against monopolists is thus to create a preference for a differentiated feature that is fundamentally incompatible with the monopolist’s golden goose, or as Ben Thompson would call it, “true differentiation.” In this sense, it is not enough to establish product/market fit. The product must also fit a principled differentiation from your competitor. If you lack a fit on principle, you lack a product that will remain viable in the face of competition as it scales.
In Practice Today
The canonical example of this concept in action today is Facebook & Snap. As mentioned in a previous post, Snap’s original innovation was its “detachment from the foreverness” of Facebook. Facebook can never compete with Snap in this area because it’s business is built on a monopoly of indelible customer posts/data. Of course, this limits Snap’s addressable market to whatever niche prefers this differentiation, but any attempt to break out of this entrenchment with camera or sharing based innovations has and will elicit a response from Facebook. New ways to share expand Facebook’s data set and thus protect its existing business.
This concept isn’t limited to incumbent v. entrant relationships either. It can also be used as general strategy for competition. Apple is employing this strategy as it shifts from hardware to services. Recognizing its past failures in targeted advertising, Apple’s services over-index on privacy. Knowing that Google and Facebook won’t abandon their targeted advertising models, Apple is trying to create a consumer preference for data ownership and a level of privacy that actually diminishes the functionality of certain services.
The most interesting aspect of this strategy is that is should alway be viable because principle based disruption results in a Nash Equilibrium. So long the disruption is not existential and certain, the incumbent is made worse off by addressing the entrant, and the entrant is made worse of by attempting to grow outside its niche. In an age where companies are becoming increasingly large and difficult to compete with, having an evergreen framework for evaluating competitive strategy should hopefully result in better outcomes for new companies.