The Future of Semiconductor Business & Innovation

Abstract: The Life Cycle theory on industry evolution suggests that the rate of knowledge obsolescence tends to diminish over time. In effect it deters new entrants from entering the industry; the ensuing shakeout forces industry consolidation and concentration. The fallout; operational efficiency, product proliferation and price discipline take center stage.

In the semiconductor industry the very presence of technological knowledge obsolescence has prevented industry shakeout and consolidation up until now. However, with escalating costs and the fundamental limits on device physics reaching a climax are the curtains descending on the semiconductor industry. If so, what are the ramifications for the industry and its ecosystem?


Downloads:

  1. Future of Semiconductor Business & Innovation
  2. Fabless Semiconductor Chip Startup Business Plan
  3. Semiconductor SOC Design Cost Model

Updates:

April 24th, 2012 WSJ – Intel Makes $140 Million Deal With Cray, Intel will be buying interconnect technology and related intellectual property used in high-performing computers.

April 30th, 2012 EE TimesIDT buying PLX Tech for $330 million and Fox Electronics for about $30 million in cash. Enabling IDT to extend its horizontal product line reach and serve complementary customer base .

May 2nd, 2012 WSJ – Microchip buying Standard Microsystems for $828.8M in a move to expand its product offerings. SMSC acquisition will enable Microchip to get a foothold in the Automotive and Wireless audio markets.

May 15th, 2012 MorningstarNot So Golden Years: How an Aging Society Can Impact the Markets. The graying of the developed world is hitting an inflection point and is forecast to accelerate —an unprecedented shift in demographics is likely to impact everything from economic growth to equity multiples.

June 5th, 2012 EE Times – New Business Model taking hold in China  “We are seeing Chinese system guys pump out a new product every three months with just five to 10 people. That’s very disruptive.”

June 22nd, 2012 EE TimesTurnkey solutions the key to Mediatek’s emergence as the leader in global consumer electronics. Mediatek with its ability to integrate software and hardware as a genuine turnkey solution for system OEMs, has steadily risen, to the point where the company is getting the global digital consumer electronics market pretty much wrapped up.

July 2nd, 2012 WSJ – Sony to pay $380 million to buy U.S.-based Gaikai. Gaikai’s technological backbone allows software titles, even sophisticated games developed for powerful game consoles, to be played without delay on any browser. The strategy is a shift from a decades-old model of playing games on disks or cartridges in dedicated machines toward playing games on any Internet-connected device.


First a brief look at the semiconductor industry dynamics:

1. Semiconductor fabrication plants exhibit exponential cost dynamics. Rock’s Law, named after the visionary venture capitalist Arthur Rock, predicts that the cost of a semiconductor fab will double every four years.

2. Semiconductor Industry is characterized as having very high fixed cost, and low variable costs.

3. A cutting edge semiconductor fab has an active life cycle that lasts anywhere between three and five years. The cyclical nature of the industry results in periods of high capital expenditure interspersed with bursts of revenue streams.

4. Moore’s Law, named after the visionary cofounder Gordon More of Intel, predicts that the size of a semiconductor chip will shrink by half every two years (everything else remaining the same).

5. Semiconductor chips although very design intensive benefit heavily from division of labor.

6. Semiconductor design exhibits compelling scope economies due to cumulative experience and design knowledge.

7. Semiconductor design is susceptible to significant knowledge obsolescence within domains.

8. Process and Product Innovation both happen at the same time. Firms either acting alone or together orchestrate process innovations that the entire industry draws upon. Product innovations on the other hand are firm specific.

9. The industry is highly competitive with low barriers to entry. However tacit knowledge and market reputation favor both scope and scale economies.

Semiconductor Value Chain and State of the Industry

As of 2011, worldwide semiconductor sales attributed to IC’s and components reached $299.5 Billion. The market is fragmented across all sectors except in the area of microprocessors were a duopoly exists. The worldwide pure play semiconductor foundry market totaled $29.8 billion in 2011. The top five foundry players accounted for almost 80 percent of the foundry market share.

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Electronic Design Automation (EDA) vendors accounted for revenues of $4.19 Billion in 2011. Semiconductor chip design, verification and implementation tools accounted for almost 90% of this market, with the rest owned by PCB design tools.

The market for semiconductor IP registered sales of $1.58 Billion. Design Services made up another $350 Million in revenue for 2011. IC Packaging and Assembly generated revenues of $13.9 Billion and the embedded software market registered sales of $1.2 Billion. Semiconductor FAB’s demonstrated revenues of $29.8 Billion in 2011.

Across the value chain semiconductor chip companies and semiconductor FABs account for the lion share of the revenue. The former exploits economies of scope and the latter economies of scale.

Revenue Drivers

SemiconductorMarketSize(2011)

Cost & Value Migration

An amalgamation of processor cores, feature rich IP and fab for hire have pushed the value frontier to a new normal. Aided by quantum jumps in feature size and design productivity, SOCs redefined products and markets.

The first generation of SOC’s saw processor, peripherals, interfaces and memory integrated. The second generation of SOC’s built on the previous by harnessing multiple cores, RF and power management functions. The third generation of SOC’s will bring together photonics, high density memory and MEMS into the main stream.

CostPerformanceRatioCost Performance Ratio, SOC’s – The New Normal

On the value frontier, a leading edge System-on-Chip (SOC) offers cost-performance ratio that rivals the elite microprocessors of today. The new players with vastly different business models are increasingly threatening the old guard. However both have seen semiconductor design costs reach epic proportions.

With increasing levels of integration and multicore processors becoming the norm, hardware and software costs have exploded. Verification engineers and software developers now covet over half of the development team. As geometries shrink, tooling efforts to account for increasing variability of parameters and DFM (Design for Manufacturing) requirements have further exacerbated the problem.

The Economics of Chip Design

A typical semiconductor company spends anywhere from 20% to 25% of its revenue on R&D with COGS accounting for another 40%-45% and SG&A in the region of 10% – 15%. With these assumptions and using the Semiconductor Chip Design Cost Model the numbers that emerge tend to favor products that can be milked over relatively large periods of time or in markets with large demand side economics of scale.

SOCCostVolumeRatio

To put things in perspective, the annual shipments of microprocessors (all segments) in 2011 stood at 350 Million units. High-end smartphone shipments reached 60 million units in 2011. The returns necessary to justify investment on a new chip requires double digit market share.

Fabless Semiconductor Startup:

The picture is no different for emerging startups wanting to unleash the next biggest idea or invention. Although startups rely on VC money to fuel R&D in the initial stages the return necessary to justify venture investment are increasingly out of reach for many.

A semiconductor startup pursuing an opportunity in a fast growing market needs to capture more than 10% market share and demonstrate higher probability of success. To deliver both, the odds are as good as winning the lottery. (See: Fabless Chip Startup Business Plan)

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Startup Exit Valuation:

EconomicsofFablessSemiconductorStartup

Note: Startup is funded, based and operates solely out of USA

Implications for Product Innovation

It is imperative for designers to leverage legacy designs, in die form, surround them with abundant memory and unleash rich software to create value. New alternatives in 2.5D packaging (side-by-side die on an interposer) or 3D packaging (Through-silicon-Vias) will aid this effort. Many low to medium volume applications will make this transition. OEM’s in commodity markets will increasingly adopt COTS and rely on ODMs/EMS to bring solutions. Software will be the basis for differentiation.

For high volume applications the next wave of innovation will require products that can integrate wider range of heterogeneous functions (mobility, sensing, intelligence, adaptability and connectivity).

ChipofTomorrow

The market will essentially evolve to provide one or all of the following functions- Intelligence, Connectivity, Stimuli and Gratification in varying degrees. A chip that can integrate all of the above functions and satisfy the needs (price/performance) of the market will unleash major realignment and shakeout within the industry.

Imagine a TV in the not so distant future that morphs into a Gaming Console, a PC, a Web-TV or an entertainment hub based on the need. Embedded Hardware Virtualization will make this happen and enter mainstream market in a big way.

Intelligent Devices constitutes another market area with a potential volume larger than PCs, Mobile Phones, Servers, and Tablets combined. With a 2020 vision of 25 Billion devices the market requires Sensing, LBS, Augmented Reality, Analytics, Security and Self-Monitoring to be prevalent in most nodes. A platform centric vision for intelligent nodes can unleash innovation and propel existing players to new heights.

We are entering a realm of devices capable of features analogous to what we humans are born with. Ironically most humans share the same feature set. It is the DNA that confers uniqueness and character. For chips, with similar features, software will emerge as the key differentiator and enabler that can morph into something unique depending on the context.

The Road Ahead

Globally the aging population (65+) will grow to 2 Billion by 2050. The world’s emerging middle class will reach 4.9 Billion by 2030. Developed and emerging economies share of the middle class will reverse from the current 50% to 22%. A slow-cycle market characterizes one and a fast-cycle market exemplifies the other. The challenge lies in managing both at the same time and within the same organization.

1. Industry Concentration: The minimum efficient scale (MES) for a semiconductor fab is nearing $10 Billion. For a fabless chip company the ratio of minimum sales volume (MSV) to market size has reached double digits (~15%). As platform products and services, with winner-take-all dynamics, become more prevalent, the industry will consolidate. Firms either need to pursue broad line differentiation or risk being caught in the middle where the future is anything but certain. Each market vertical will converge to the “Rule of Three” with an uptick in M&A based on horizontal product line reach.

2. New Business Models: The new winners will be those who can enrich customer captivity (combination of switching and search costs) and combine it with supply side economies of scope. The industry will favor fast-followers and late adopters over innovators. An asset lite model supplemented by just-in-time design methodology and standardized hardware platform with software differentiation will redefine competition.

3. Vertical Integration: OEM’s will be forced to ensure that their semiconductor suppliers remain viable and continue to create value. Some form of vertical integration either in the form of minority stake, multi-year supplier partnership or outright purchase will become a necessity. Pure play foundries and EDA specialists will integrate forward to offer one stop R&D solutions by assembling a portfolio of IP’s and engineering resources. At the technology level high density Memory (3D), MEMS, Interconnects, Photonics and Embedded Software are prime targets for M&A.

4. Operational Efficiency: Ultimately all firms needs to generate returns that cover the cost of capital. The less efficient companies will struggle merely to remain afloat. Efficiency governs all activities from engineering, production, marketing, sales, to operations. The organizational power structure, long the bastion of engineering, will cede control to marketing and finance.  ROIC the new mantra.

5. R&D: Escalating costs, will force many chip companies to offshore R&D. In the next five years leading edge designs, the stronghold of Silicon Valley will move overseas as markets there become large. Many companies will transform their model to one of an IP provider. Foundries, the current gateway for all semiconductor chips will move up the value chain to offer one stop solutions as will EDA companies. Development of process technology for new nodes will require pooling of industry resources together.

6. Value Migration: For firms to generate economic profit it is imperative to adopt a software centric vision for the products as value migrates from hardware to software. Firms that can package and deliver hardware-software together will remain immune to commoditization and reap the benefits of lock-in and network effects. If you are somehow not plugged into one of the platforms, competition will force you out.


Closing Remarks:

As the economics of semiconductor business undergoes fundamental shift, changes in the value chain and ecosystem is inevitable. To sustain economic profits exploiting economies of scope in R&D resources will become critical and challenging. One business model that could disrupt the industry is “Just in Time Design” harnessing elements from Dell’s supply chain model and Toyota’s production management system. When transaction and search costs associated with semiconductor Intellectual Property and Engineering Talent intersect on an EBay like trading platform the vision will become a reality.


References:

  1. Semiconductor Annual Revenue Data sourced from WSTS, April 2012
  2. EDA Annual Revenue Data sourced from EDA Consortium MSS Newsletter, Q1-Q4 2011
  3. Semiconductor Foundry Market Data sourced from Gartner, March 2012
  4. Processor Market Shipments by Industry and Architecture, IDC, February 2012
  5. Semiconductor Industry Profitability Analysis based on financials from 2007 – 2011 of Top 10 players in each category excluding outliers. Data compiled from Annual reports, Morningstar, Bloomberg and SEC filings.
  6. 2011 PC Shipment Data, Gartner, January 2012
  7. 2011 High End Smartphone Shipment Data, Berg Insight, February 2012
  8. Intelligent Systems, The Next Big Opportunity, IDC, August 2011
  9. World Population Aging, United Nations
  10. World’s Emerging Middle Class, sourced from Dr. Homi Kharas, The Brookings Institution,
  11. Global Semiconductor Alliance, March 2012
  12. EDA Consortium, Quarterly Marketing Statistics (2011). Market Research Reports
  13. ChipSTAT Annual Review, April 2011
  14. NASSCOM, Opportunities in Embedded Software (2010)

Acknowledgments:

To my colleagues and peers in the semiconductor industry with whom I have shared and enjoyed an incredible journey. Your inputs on the Survey are highly appreciated. Thank You for taking the time to answer it.

The Lure of Emerging Markets– India

With growth looking more and more anemic in the developed world and the fundamentals (expenses outpacing revenue) clearly pointing to a lackluster demand going forward. Can products and services from the developed world find a market elsewhere? Can the Indian consumer market offer a road ahead.

Adopted from Economist, Daily Chart March 7th, 2011

A burgeoning and transitioning Indian economy with buyers on the move bodes well for businesses local and global. Do the numbers justify India’s rise or are we once again succumbing to temptations of finding growth where the fundamentals just don’t add up. Is now the time to step in and serve unmet, latent and unaddressed needs ?

In a two part analysis lets investigate what it means to do business with consumers in India analyzing fundamental drivers of demand, the market potential and the challenges of meeting those demands.

Part-I: Demystifying the Indian Consumer – Market potential, the real numbers

  1. Demystifying the Indian Consumer (Download)
  2. India Consumer Durables Market Forecast: 2011 – 2015 (Download

Part-II:  Go-To Market Challenges – Leveraging networks, Igniting demand.

  1. O Buyer Where Art Thou
  2. Channels – Leverage, Make or Buy

Demand – The Holy Grail

Fundamentally there are only two ways to generate demand for any product or service:

  1. New Sales: Attract new buyers who have never experienced the product category or service.
  2. Replacement Sales: Entice existing buyers to replenish, replace or upgrade their existing product or service.

At the macro level demand is driven by population growth, income growth, productivity gains, monetary policy, trade policy, innovation that renders products accessible and affordable or changes in the regulatory environment.

At the micro level demand is stimulated by awareness, cultural norms, cheap credit, accessibility, education levels, income levels, price, technology, product quality and lifecycle.


Demystifying the Indian Consumer

The Indian market is squarely divided between the urban and the rural. A projected consumer model1 of the Indian market resembles a direction post reflecting the many possible roads businesses can take to reach the various segments.

imageSource: NCAER; MGI Consumer Demand Model.  (Using 2010 $PPP)

The Globals and Strivers are where most MNC’s focus today. But it is the Aspirers and Seekers together making up about 160 million households by 2015 where the mass market will converge.  The Deprived numbering 70 million will continue to march along, relegated to the sidelines and will find it increasingly difficult to break through without government support.


Note: For a detailed discussion on the consumer segments refer to the McKinsey / NCAER report: The ‘bird of gold’: The rise of India’s consumer market. 

Rural and Urban Divide:

Employment Status: The most striking observation one can glean from the employment status of Rural and Urban India is that over half the workforce is categorized as being self-employed. Cash flows within this segment remains volatile something marketers need to keep in mind when projecting numbers.

Another significant proportion falls into the category of casual laborers. This base of the population survives one day at a time. Lastly, the vast majority of salaried professionals are public sector employees with a few participating in the private sector.

An average graduate earns $ 9,474 per year in leading cities, the comparable rural figure is just $ 4,789. The difference, in fact, is higher for illiterates as well –average of $ 3,684 in the elite towns versus just $ 1,184 in the villages2.

Note: The purchasing power of the Indian rupee is much higher than its exchange rate value in USD

image Source: RBI Monthly Bulletin, April 2011

Expenditures: Rural and Urban India spend almost equally on all fronts although the share of the wallet dedicated to food is marginally higher in the rural area. This can be attributed to differences in the average household size which stands at 4.7 for rural and 4.2 for urban3.

image

On an average, the urban Indian earns 85 percent higher than his or her rural counterpart, spends 71 percent more and saves nearly double.

How Indian Consumers Pay:

The retail industry, with transactions valued at USD 410 billion per year4 is predominantly cash based. India’s consumer durables market was valued at around USD 33 billion5 in 2010, with electronic products (computing devices, mobile handsets and audiovisual products) accounting for almost 76%.

India has 173 million debit cards users (13%) and 23 million credit cards users (2%). However cash continues to be the only mode of transactions for the 40% unbanked population in the country. Overall, 67% of transactions are carried out in cash, while only 33% are done through electronic means6 (60% of these are P2P transactions).

The penetration of PoS terminals in India remains low at 419 terminals per million inhabitants7 (2009). On an average, the debit and credit cards together account for only two card transactions per day per PoS terminal. The economics clearly point to a need for alternate payment mechanism.

Consumers in a Transitioning Economy:  A Moving Target

As a new middle class emerges across India, people will seek greater quality in what they pay for (food, housing and clothing). As incomes rise further, the same will look for convenience and pay for it. Finally once the Indian economy leaps into the league of developed nations buyers will seek customized offerings and services. This scenario has played out numerous times and each time the pattern has repeated itself in every country that made the leap from underdeveloped to the developed.

MovingConsumerShortBreadFactorIndia will be no different although the needs, composition  and behavior of the different segments may deviate.


Note: For an in-depth look at the lifecycle in an emerging market refer to the pioneering work by Alonso Martinez and Ronald Haddock, The Flatbread Factor,  the finest work to emerge from the strategy landscape over the last decade.

Moving Segments, Changing Needs 

Over the years a gradual shift from a joint family system to nuclear family has taken hold across India. The trend will only accelerate further as incomes rise and people demand more freedom, expression and personal space.

India is already witnessing the arrival of new consumers expressing themselves boldly by trying and adopting new offerings triggered by: 

  1. INCOME Effect: As the 2nd fastest growing economy, with 8% plus growth people have more to spend.
  2. MINDSET Change: The post liberalization population numbering 35% is just coming of age.  
  3. AWARENESS: Access to information brought on by increased media proliferation, technology reach and 15 million foreign travellers annually.
  4. ASPIRATION Effect: Desire to experience new things as a consequence of moving up the value chain and the need to fit in by emulating others.  

By 2015 the various consumer segments in India will demand and pay for goods and services differently. Some of the opportunities that will open up:

EmergingMarketsConsumerEvolution

The Numbers Game:

When all said and done, it ultimately boils down what level of sales can the economy sustain given the consumer makeup and country specific environment they live in. The best way to gauge the health of an emerging economy is to project Consumer Durable (CD) Sales.

Consumer Durable (CD) sales are a bellwether of broader trends and underlying fundamentals in the economy. CD Sales are primarily driven by discretionary spending which correlate strongly with per capita growth in GDP earnings. CD penetration rates are a good indicator of shortcomings in the economy on account of infrastructure, credit availability and stability in household earnings.

Here is what one projection on achievable CD sales looks like and the assumptions made.

GrowthAssumptions

CAGR for Consumer Durable Sales (2011-2015E)CAGROne should pay close attention to the adoption rates for the basket of consumer durables under consideration. The adoption rates are a way to cross check sales projections and ensure that sales mirror the size of the consumer segments.

AdoptionRates

Sizing up Demand:

To develop the same sales estimate from bottoms up one has to look at potential market size among all the available segments and put together a detailed plan to capture individual buyers. One such framework that maybe employed is depicted below.

BottomUpDemand

GBL: Globals (High Income), MMI: Middle Middle Income, UMI: Upper Middle Income

I will leave it those interested to arrive at individual targets for CD sales at each of the segments under consideration.

In Part-II of this discussion we will investigate how having established a sales target one can go about selecting a Go-To Market Strategy to realize the set objectives.


Note: It may appear to the reader that I am biased towards the Indian Market. It just so happens that I can relate to the Indian market better on account of my origin and roots. The worst thing any marketer can bring to his profession is an inherent bias in selecting target markets.

A lack of in depth knowledge and expertise on China and Brazil has hampered my ability to conduct a similar analysis on their market potential.


References:

  1. NCAER; MGI India Consumer Demand Model
  2. NCAER- Inclusive Urbanization Needed, Oct-2010. The numbers are adjusted based of the 2010 $PPP.
  3. National Sample Survey Office (NSSO), Report No. 531
  4. A.T. Kearny Global Retail study, 2010
  5. Confederation of Indian Industries Data, Dec-2010
  6. Mobile Payments in India – Deloitte/ASSOCHAM, April-2011
  7. Bank for International Settlements
  8. McKinsey – Comparing urbanization in China and India, July-2010 (Pg-2)
  9. Energy in India for the Coming Decades, Anil Kakodkar, Chairman, Atomic Energy Commission, India
  10. India- Energy Efficiency report, ABB, Jan-2011 (Pg-2)
  11. World Bank, GDP Forecasts.
  12. International Energy Agency (IEA)
  13. International Monetary Fund (IMF)
  14. Planning Commission of India
  15. India Census – 2010
  16. Modeling Diffusion of Electrical Appliances in the Residential Sector, Michael A. McNeil and Virginie E. Letschert, August 2010
  17. Bass Diffusion Model


Update, Oct 28th 2011: The Implications of the Global Web for US Startups, Point Judith Capital (some interesting data)

Update Oct, 22nd 2011: Economist Special Report : Business in India, rightly captures the challenges of doing business in India and impediments to its growth.

Update Oct, 17th 2011: India could become one of the top 10 e-commerce hubs in the world by 2015

Update Oct, 16th-2011: Top US based corporate giants like Wal-Mart, Starbucks, Morgan Stanley, New York Life Insurance, Prudential Financial, Intel, Dow Chemical, Pfizer, AT&T, Boeing, and others lobbying hard to enter India



The Future of Advertisements

Half Of All Advertising Doesn’t Work, The Trouble Is We Don’t Know Which Half ” still reigns supreme in the world of advertising.


Emerging new technology, shifting consumer behavior, always on consumer touch points and evolving new media are converging to create a new paradigm in advertising.

Advertising – Traditional, SEM, Social Media or Mobile ?

Universally almost all purchase decisions can be categorized into either a High-Involvement Purchase (ex: Home Appliance) or a Low Involvement Purchase (ex: Grocery). The former entails significant risks, is driven by situational needs and involves complex decision making. The latter seeks to minimize time, as Low-Involvement products engulf eighty percent of all purchases, is predisposed to impulse buying and familiarity/awareness plays a  key role.

It is no surprise than that most of the advertising (traditional) we see and hear around us encompasses Low-Involvement products.

Then the internet came along and SEM captured the attention of marketers. As a platform Internet offered conversations with and between buyers to be captured and acted on.

The one notable difference – Internet Search is preceded in most cases by a situational need (i.e. most buyers are either looking for something specific or researching a product category). In certain cases an enduring need also finds expression on the internet in the form of Blogs, Chat-Boards, User Forums or Special Interest Groups to name a few.

One could argue that SEM is ideally suited for High-Involvement products, but this does not seem to be the case. There is a reason behind this….. Legacy for one and….Risk Aversion for another.

With Social Networks people share rich information about their lifestyle, habits, interests and needs on an ongoing basis. A new dimension – Individual Behavioral Data is now available to marketers. What we get with Social Network Advertising is a hybrid between traditional and internet advertising.

With Mobile web we are on the cusp of something phenomenal. An ability to bring together all elements from Traditional, SEM and Social Network Advertising in a way unimaginable until now.

The Elusive Target:

According to The 2011 Digital Marketer, Benchmark and Trend ReportThe most influential element driving purchase decisions today is still  Word of Mouth (54 percent), followed by information from a Website (47 percent).” Advertising in video games and on mobile phones seems to influence far fewer consumers in purchase decisions.

That for you is the dichotomy facing advertisers: How to target advertisements effectively, in what media, to whom, where and when. 

Consider the decisions confronting a marketer when trying to influence a new car buyer. Depending on the buyer’s needs and life-stage a simplified decision matrix could yield 16 different options resulting in a specific choice of vehicle make and model.

NewCarBuyerDecision

Traditional means of serving an AD to such a prospective car buyer is a “Hit-or-Miss” game of chance. While Internet Advertising (SEM) added a new level of dimension by tying AD’s to the “search keyword” it is still blind to the prevailing need driving the search.

Critical information on Individual Buyer’s behavior and his or her preferences at various stages in the decision cycle eluded advertisers and advertising platforms. Today this data can be a near certainty.

Out with the Old in with the New:

The Old: The old world of Advertising relied on eyeballs, media concentration, economies of scale, POS data and consumer surveys to create awareness, cultivate brand attitudes and induce purchase intentions.

It did so using a careful selection and allocation of advertising spending across fifteen different media with the aim of maximizing reach and effectiveness.

EvolvingADMedia-Final

The New: Platforms today are flush with rich behavioral data on shoppers, their life-style, geo-demographics, touch points and interactions as they happen in real-time.

In addition the incremental cost of delivering an AD impression today in ‘”Real-Time” is nearing “ZERO”. The ramifications are clear, an era of 1-ON-1 advertising is on the cusp.

The new age of advertising is all about capturing rich information flows in real-time within and across media platforms. Economies of scale or leveraging the networks with the largest reach become secondary as fragmentation is the norm.

New Rules of Advertising:

  1. Multi-homing – New age consumers will move seamlessly between platforms and media– with platform service providers incurring most of the multi-homing costs.
  2. Spatial vs. Temporal Relevance – The new advertising paradigm is all about harnessing relationships-interactions and developing models that morph information. The frantic bidding to secure the most coveted time slot will lose prominence.
  3. Real-Time / 1-ON-1 – The era of real-time, personalized on the fly AD delivery is here to stay.
  4. Ubiquitous Network – AD impression and delivery must traverse the intended target’s choice of platform across the behavioral sequence model.
  5. AD Markers – Just as DNA holds key genetic information governing humans, so too will AD Markers come to define buyers.

Update Sep-21, 2011: WSJ Article: “TV Lures Ads but Viewers Drop out”


References:

  1. Consumer Behavior – A Strategic Approach, Henry Assael
  2. IAB Internet Advertising Revenue Report, April 2011
  3. The 2011 Digital Marketer: Benchmark and Trend Report
  4. Radio & Television Business Report

Mobile Banking – An Acute Emerging Market Need

India’s Mobile Banking Potential:

A precursor for any open market economy to flourish is the free flow of capital and goods between buyers and sellers. 

Myth and Reality:

Out of 1.2 Billion Indians only 240 million citizens have access to banking services; Whereas 764.76 million people have mobile phones. McKinsey estimates that 180 million1 new job seekers will enter India’s workforce over the next two decades—a potential demographic dividend. 30% of India’s population lives in urban areas. The 4.5 million wealthy households that consume luxury products and services are concentrated mainly in the top 10 cities.The Labor force participation by occupation is Agriculture (52%), Industry (14%) and Services (34%). A vast majority of the population living in Tier-2 / Tier-3 cities are either small business owners, entrepreneurs or self-employed laborers.

The Indian economy depends far less on exports compared to its other brethren’s in Asia. Most of the growth is fueled by domestic consumption.

Bigger Pie / Bigger Slice:

An emerging middle class estimated to be increasing by 20 million a year, with a median age of 26 when weighed against the backdrop of 400 million people in India that do not have a bank account, severely dampens the market potential. One look at how MNC’s have fared over the past decade is ample proof of what went wrong with the rosy projections.

An estimated 37.2 %2 of India’s population falls below the poverty line (BPL). Microfinance was supposed to serve the needs of the poor but went wary with its focus more on credit delivery rather than help people escape poverty.

The banking system can evolve as a key gatekeeper that can bring together missing parties, unleash spending, enhance trade and in the process create new opportunities for livelihood.  

India’s Banking Reach

The number of bank branches in India is 85,3003 of which 32,000 branches are in the rural hinterland where almost 70 per cent of Indians live. Almost 38 per cent of banks have branches in rural India and 40 per cent of the country’s population has bank accounts. The average population per bank branch with above statistics is 13,900.

Last Mile Challenges – High Cost of ATM’s

If current statistics are to be believed India’s ATM density is around 35 ATM’s per million people which is abysmally low compared to the US’s ATM density of 1300. At last count the number of installed ATMs stood at 69,324 (January, 2011).

Setting up an ATM currently costs around Rs.8 lakhs ($18,000), including the VSAT, interiors, signage’s, etc. Rental costs would differ from area to area and would range from Rs.5,000 ($120) a month in small towns to Rs.50,000 ($1200) a month in upmarket areas in metros. The total expenditure per ATM would be around Rs.25 lakh ($56,000) over a 5-7 year period. The cost for a bank to set up say around 1,000 ATMs will be at Rs.100 crore ($22 Million).

In India the ATM network is mainly operated by FSS called FSSNET used to connect ATMs of 32 Nationalized banks. A cost of Rs.20 is incurred per transaction on these platforms deeming them unsuitable for micro-transactions, the lifeblood of rural India.

The economics can deter anyone from reaching out to segments that are deemed unprofitable to serve.

Opportunities – Abound

All is not lost yet, extreme rural poverty has declined from 94 percent in 1985 to 61 percent in 2005, and projections are that it will drop to 26 percent by 2025.

The challenges of serving India’s rural hinterland, where 70% of the population resides, are enormous – poverty, weak infrastructure, illiteracy coupled with the high costs of serving customers in the last mile.

A solution for these challenges is Technology coupled with Innovative Business Models that can bring about both change and create opportunities for businesses. Serving customers at the Bottom of the Pyramid is not going to be easy or promising.

Technology to the Rescue – Mobile Penetration

India has achieved a tele-density of about 65 per cent, thanks to the major contribution from mobile phone services. According to TRAI the total number of Telephone subscribers in India reached 806.13 million5 at the end of January 2011. Tele-density in Urban stood at 150.67% and that in rural at 32.11%.

McKinsey research forecasts that the total number of Internet users will increase more than fivefold, to 450 million, by 2015. Total digital-content consumption will double, to as much as $9.5 billion. Including access charges, revenues from total digital consumption could rise fourfold, to $20 billion—twice the expected growth rate of China

image

With falling handset prices, strong government support (UID, National Rural Employment Guarantee, Inclusive Banking Policy) and aggressive rollout by mobile service operators the projections will soon be a reality.

However a “cookie-cut” approach to taming this large market will not work. What is needed is a localized offering developed from ground up that can cater to the diverse and heterogeneous Indian market.

Payment Networks:

International Payment Networks like VISA and MasterCard are both present and doing well in India. However both these networks carry with them the legacy of originating in the western world, catering to the needs of well developed markets with an organized retail sector and serving a largely homogenous customer base. India, with its diverse languages, heterogeneous markets, rampant illiteracy, poverty and underserved infrastructure offers insurmountable challenges in achieving higher penetration rates.

According to the data released by Reserve Bank of India (RBI) for 2009-2010 there were 18.3 million credit card users and 181.4 million debit card users in India.

Mobile Payment Networks:

Private mobile payment gateways have come up to meet the demand of micro payments like OxiCash, mChek. However, both cater to the urban pre-paid segment, utilize debit / credit-card networks and are primarily positioned to serve as an E-Wallet for the end-user.

National Payments Corporation of India (NPCI)

The future of India’s Banking and Commerce lies in a Mobile Payment Network like the one proposed and being deployed under the National Payments Corporation of India (NPCI), a government backed initiative. The envisioned architecture (Figure 1) proposed under the NPCI looks very comprehensive.

image

Figure 1: National Payments Corporation Network Architecture.

What’s unique about this network among other things is the ability to authenticate users using both conventional PIN and biometric technology, a must for serving rural customers, low transaction fees (Rs. 0.10 per transaction) and seamless integration with financial institutions. In addition technology has been leveraged and deployed to circumvent infrastructure and regional barriers in reaching the last mile.

image

Source: NPCI

Mobile Value Added Services & NPCI Network

Now it is up to businesses and entrepreneurs to harness this network at the backbone to deploy Mobile Value Added Services (MVAS) that can both develop trade and foster inclusive growth. The opportunities are boundless:

  1. Real-time Commerce.
  2. E-Business
  3. E-Billing
  4. E-Health
  5. E-Education
  6. E-Banking
  7. E-Logistics
  8. E-Entertainment 
  9. E-Travel

image

Source: ASSOCHAM Financial Pulse Study – Emerging Landscape in Mobile VAS Industry

It is a win-win situation for all stakeholders involved – Higher ARPU (Mobile Service Providers), Transaction Fees (Financial Institutions), Enhanced Trade and Commerce (Market Participants), Wider Tax Base (Government), Financial Security (End Users)

Closing Remarks:

I have spent the last six months travelling extensively across India, studying the ground reality, gathering first hand data, understanding the pitfalls, challenges and opportunities with doing business in one of the fastest growing emerging markets. While I am ecstatic of its potential one must tread this important market very carefully for the political, legal, cultural and infrastructure challenges are daunting and not for the faint at heart.

However with extensive market research, immaculate planning, localized offerings and innovative business models I am convinced one can succeed in what is shaping up to be the most important market of our generation. 

Recommended Reading:

Myths and Realities of Being an Entrepreneur in India (Knowledge @ Wharton)

Acknowledgments:

I am thankful to officials (Government, Banks, Businesses), friends and eager citizens of India for their support and warm hospitality.

References:

  1. India’s urban awakening: Building inclusive cities, sustaining economic growth – McKinsey Global Institute
  2. Planning Commission of India.
  3. Reserve Bank of India (RBI)
  4. Retail Banker International (RBI)
  5. Telecom Regulatory Authority of India (TRAI).
  6. McKinsey Digital Consumer Survey, 2010
  7. National Payments Corporation of India (NPCI).
  8. Learn Telecom

Coupons–Is the time right for going Mobile ? ( Part-I)

The primary use of Coupons, delivered through various mediums, for the CPG manufacturers is to facilitates sales (purchase behavior)through one of the following means:

  1. Trials.
  2. Repeat Purchases.

It is an established fact that Advertising Communications and Promotions (AC&P) play an integral role in stimulating sales across the consumer packaged goods industry. Depending on the product / industry lifecycle a brand manager can employ different tactics (Appendix) that are geared towards one of the following:

  1. Increase Sales on account of Trials by New Users
  2. Increase Sales on account of Trials / Repurchases by Other Brand Loyal’s
  3. Increase Sales on account of Trials / Repurchases by Favorable Brand Switchers
  4. Increase Sales on account of Trials by Other Brand Switchers
  5. Increase or Maintain Sales on account of Repurchases / Stock-Up by Brand-Loyal’s

For the end buyer, Coupons help realize one of the following objectives:

  1. An economic motivation – where the main goal is to save money
  2. A hedonistic motivation – where the aim is to derive pleasure associated with striking a great bargain.
  3. A routine-loyal, or risk-avoiding motivation – where the goal is to reduce the risk associated with trying a new brand or product.
  4. A functional one – where the aim is to reduce search costs.
Buyer

Group

Intrinsic
Motivation
Situational
Motivation
Strategy Tactics
Brand Loyal’s High Low Increase
Consumption
Advertising suggesting additional or alternate applications of product
Favorable
Brand Switchers
Medium High Build Loyalty Advertising to enhance
image.
Price Discounts
Routine Brand
Buyers
Low Highest Attract buyers keep
search costs high.
Price Discounts
Other Brand
Loyal’s
High Low Entice Brand Switching
Minimize Risk
Comparative Advertising
Price Discounts
New Category
Users
Lowest Lowest Initiate
Trials
Advertising – Create Awareness, Link Brand with Category need.
Price Discounts

Table-1 : Promotion Strategies and Tactics based on Buyer Groups


Challenges facing Brand Managers:

  1. As newspaper circulation continues to drop across America, Marketers need to adopt new vehicles to push Coupons onto consumers. The available options include Direct-Marketing, Internet based Coupons or Mobile Coupons.
  2. The current means of distributing coupons are not driving incremental sales. They are more likely to offer discounts to those already planning to buy, thereby cutting at the margins for manufacturers and retailers.
  3. Coupon usage history cannot be traced down to the individual level. The best available data is geo-demographic level. This lack of transparency hampers price discrimination and identifying well qualified prospects.

Coupon Usage – An Emerging Market perspective

My observations from studying how Advertising Communications and Promotion work in emerging markets (India) highlight two important deviations:

  1. Coupon distribution is still very much unheard of. Coupon fraud and absence of an organized retail infrastructure have prevented Coupon based marketing promotion from taking off.
  2. A second reason, an important one, arises from the industry lifecycle. A high growth market such as India offers, CPG manufacturers, brands and market segments that are yet to be established and defined. Consequently the use of Advertising to both position a brand and stimulate sales works very well at this stage in the market.
  3. The closest thing to using Coupons is the BOGO offers or Bundling that offer manufacturers an option in attracting buyers.

State of the US Coupon Industry – 2010

image

Through the first nine months of 2010, coupon redemption is up another 5.3% to 2.5 billion vs. the year-ago period, with the value of coupons redeemed up 7.7% to $2.8 billion according to NCH Marketing Services, a unit of Valassis Communications.

image

Internet coupons still account for only 1% of distribution. The majority of overall growth
in redemptions still come from Free-Standing Print Inserts (FSI), which accounted
for more than 2.1 billion redemptions overall last year, according to NCH data.

image

image

According to a recent survey by mBlox almost 70% of coupon users chose Mail/Post and Email as the preferred vehicle for receiving coupons. 

image

Source: mBlox survey conducted by OnePoll, Oct 5-2010

A follow on post will explore who technology can be utilized to alleviate and successfully administer coupon usage to build brand loyalty. How can social networking sites and local deal site come to add value. What do both consumers, retailers, CPG manufacturers and interested stakeholders wish for. 

Source:
  1. NCH Marketing Services, a unit of Valassis Communications i
  2. Advertising Age
  3. eMarketer

Appendix:

Impact of Advertising Communications and Promotions in affecting Sales based on product / industry lifecycle.

  Impact on Sales
Stage in Product / Industry
Lifecycle
Advertisements Promotions
# Introductory Phase High High
# Growth Phase

1. Differentiated Product / Leader

2. Me-Too Product

High

Low

Low

High

# Maturity Phase

1. High Brand Loyalty

2. Low Brand Loyalty

High

Low

Low

High

# Decline Phase None Low

Android Marches Ahead: 30% Market share by 2014

I had stated earlier in my blog (May 18th, 2010) that the “Android Platform” will come to dominate the market for thin-clients, cloud computing, consumer electronics and ultra mobile internet devices market.

Now Gartner has also concurred with my forecast in a latest report Forecast: Mobile Communications Devices by Open Operating System, 2007-2014,” which is available on Gartner’s website. According to Gartner, the worldwide mobile operating system (OS) market will be dominated by Symbian and Android, as the two OSs will account for 59.8 percent of mobile OS sales by 2014.

Nokia has a strong presence in the emerging market and it should not come as a surprise that Symbian will retain its foothold on the market even though Nokia continues to lose market share. image

Mobile Communications Device Sales to End Users by OS -Market Share Forecast ( Source: Gartner, Aug-2010)

I foresee RIM or one of the upstarts from either China or India emerge as a new player in the mobile handset space. Let the fun begin.

As of 2010, the market share standings for the various mobile-device operating systems is forecasted to be as follows:

image

Update: Facebook, $1 Billion Company, 2010 ?

A quick recap on where Facebook stands in Advertisement Revenues. According to the latest data released by comScore, Facebook has edged out Yahoo, the leader in Banner Ads as of Q1 2010.

Facebook is expected to bring in more than $1 billion this year(2010) in revenues, according to WSJ article citing people briefed on the matter. Yahoo earned $6.5 billion in revenue in 2009, mostly from advertising.

As I had predicted in my blog posting earlier (Facebook, $1 Billion Company, July 2009) “Social-Context Ads” offer marketers unmatched value proposition when it comes to the following:

  1. Increasing Ad Awareness
  2. Building Brand Loyalty
  3. Initiating Purchase Intentions

All of which can be accomplished under finer control, better targeting and higher ROI on Advertising dollars. According to comScore, the average price of display ads on social-networking sites is about one-sixth the price on the rest of the Internet.

FaceBookADImpressions-July8th 2010 WSJ

Looking back Facebook has delivered better than expected results and my projections of hitting $1 Billion revenues by 2014 seems overly pessimistic. Kudos to them on the perfect execution….. what about User Privacy Rights one might argue?

It is my belief that as individuals we are all driven by the pursuit of profits(benefits) and maximizing our utility from engaging in any kind of activity. As long as the benefits from participating on Facebook far outweigh the risks associated with privacy rights, individuals will continue to both participate and share information with others. The jury is still out and time will tell…….

For further reading on Facebook’s Advertising business and limitations of traditional online advertising check out these links:

Mobile Platforms Update: Android has the best long-term potential.

Update to my recent posting on Platform Products & Service: A Strategic Guide to launch, sustain and build enduring leadership.

Mountain View mobile app development platform company Appcelerator Inc. said 54 percent of the 2,733 developers it surveyed said Google’s (NASDAQ:GOOG)

  1. Android has the best long-term potential.
  2. Android is favored for its OS capabilities and platform openness.

Appcelerator surveyed 2,733 of its 51,000+ developers from June 15-17, 2010.

The survey results are a vindication of my statement (earlier blog posting) that the Android platform will dominate the market for Smartphones and eventually take over everything from thin-clients, cloud computing, consumer electronics and ultra mobile internet devices. We will get the why in a follow up posting coming soon, stay tuned.

AndroidLongTermPotential

Download the full report on Mobile Developer Survey, June 2010 from Appcelerator

Platform Products & Services: A Strategic Guide to launch, sustain and build enduring leadership

 Article at a glance: A new breed of companies has emerged on the scène that only seem to get bigger and bigger with each passing day. The companies ranging from Cisco, Intel, Microsoft, Google, EBay, Facebook, Netflix, IBM, Alibaba to Apple have one thing in common their ability to develop platform based products and services. What gives platforms the edge and what strategies can one deploy to successfully develop platform based products or service.  ( Download PDF )

A follow on article will analyze how the Android Platform has emerged from nowhere to dominate the market for Smartphones and eventually take over everything from thin-clients, cloud computing, consumer electronics and ultra mobile internet devices market.

Introduction: Why Platforms?

The relentless pursuit of globalization with diminishing borders, instant dissemination of information, ubiquitous use of information technology and swift diffusion of ideas have heralded two important changes to the competitive dynamics of companies:

  1. Imitation of new products and services at an alarming rate.
  2. Traditional sources of competitive advantage no longer guarantee sustained leadership.

Given the state of hyper-competition it is no wonder that product lifecycles are shrinking and new competitors are emerging from nowhere to erode market share and with it revenue streams.

A company with a blockbuster product has to innovate at a rapid rate just to stay ahead of competition, a feat easier said than done. The safest bet it seemed was to add “Branding” or “Service” dimension to the product mix; intangibles that are harder to replicate. But even here the advent of ERP software, CRM systems, internet advertising and diffusion of best practices are bringing competitors and products closer than ever before.

On the other hand, a different breed of companies armed with platform based products/services seem invincible; immune from commoditization of products and services with a customer base that is deeply entrenched and group loyal.

Platforms: A platform by definition is a place (physical or virtual) where mutually interdependent players (single or multiple) conduct transactions, avail services, fulfill needs or realize an experience. An important distinction regarding platform centric products and services is their “self-reinforcing character” i.e. a core product or service whose value (benefits conferred) increases as more and more people adopt it.

A common characteristic of most platform based product or services is a participation fee and the recurring revenue streams (perpetual) generated by selling complementary products or services.

Examples: EBay, PayPal, DVD Players, Personal Computers, Google, Apple-iTunes, NTT-DOCOMO, Alibaba.

Platform

Platforms Everywhere:

Look around you and an increasing number of products sold today are networked in some way or the other. EBay connects buyers and sellers on a virtual platform. Gaming consoles connect players with video game publishers and other players. DVD players and Televisions systems now offer an endless number of choices to provision, access and personalize content. Apple connects content producers and application software providers with end users. Google connects internet users with web sites and web portals. MasterCard, Visa and PayPal connect buyers, sellers and intermediaries with each other. Intel and Microsoft connect PC users to application software providers and other PC users. The list goes on.

What’s common to all of these players is their ability to bring together interdependent players in a way that creates value for everyone involved.

Note:

1. A key distinction between platform based products/services and internet Ecommerce sites (Ex: Priceline, E*TRADE, Amazon) is the fact that the latter restrict two individuals belonging to the same group (buyers, sellers) to derive utility from each other. A second distinction comes from the utility gained by end-users which scales for platform products/service as the number of users “N” increases while that for an internet E-commerce site has a fixed upper bound.

2. Theoretically the maximum utility derived by an end-user from a platform based product/service is a function of N i.e. Utility = F (N * N-1), where “N” is the number of active users.

What makes Platforms based products and services different?

Platforms if done right confer on the pioneering firm the following advantages:

  • Lock-In due to Network Effects.
  • Monopoly / Winner-Take-All dynamics.
  • Perpetual Revenue streams.
  • Protection from imitators and price based competition.
  • Immunity against the need to innovate products faster.

Who can win the inherently risky and uncertain platform game?

Establishing a platform is an extremely risky venture where the outcome is uncertain. The odds are in favor of a firm that is:

  • Pioneer with first-mover advantage.
  • Revolutionary new idea (product / service)
  • Access to capital or with deep pockets.
  • Iron-clad patent protection.
  • Access to complementary assets.
  • Installed base and brand name.
  • Management skills to take decisive steps at each stage of the platform evolution.

Strategic Guide for developing Platform based products and services:

The strategic options available to firms considering a platform based approach to developing products and services are:

    1. Platform Strategy – Closed, Shared or Open
    2. Licensing Agreements
    3. Strategic Partnerships
    4. Subsidies
    5. In-House Complements
    6. Complement Providers
    7. Marketing Mix

1. Platform Strategy – Closed, Shared or Open:

The What: Platforms can be open, closed or shared.

  1. A platform is open if participation is unrestricted and free for one and all to join.
  2. A closed platform by definition is owned and controlled by one firm who decides among other things participation rights, platform features, partners and scope of complements.
  3. A shared platform is a joint effort by one or more firms bound together by common interests. Decisions on platform strategy are undertaken in the spirit of cooperation and commonly agreed upon goals.

The How: The decision to pursue Open, Closed or Shared platform strategy depends among other things on:

  • Barriers to Imitation
  • Possession of required complementary assets by sponsoring firm.
  • Installed base and leverage over industry participants.
  • Ability to fund big investments.
  • Availability of complementary providers with required expertise and know-how.
  • Coexistence of multiple platforms that can serve the same market profitably.
  • Cost of building the infrastructure and resources to deploy the platform.
  • Heterogeneous demands in customer needs and tastes that a single platform cannot serve.
  • Susceptibility of the platform to free rider problem.

The Risk: A closed platform allows a firm complete control and independence. However it requires a firm to have a breakthrough idea (product / service), ability to undertake large upfront investments in capital and resources and exercise leverage over other industry participants to build partnerships along the way. A shared platform in contrast allows firms to share the risk as well as rewards. Conflicts may arise with respect to platform roadmap, features, and resource allocation. In fast changing markets consensus among partners maybe slow to emerge jeopardizing the overall platform. An open platform is prone to free-rider problems, quality and control issues. Generating profits and revenue streams can be challenging with an open platform approach.

The When: A closed platform is the best way to enter the market initially when a firm wants to retain complete freedom over how the platform should evolve, who can participate, what features to offer and when. A closed platform may be a best option to recoup investments especially when a firm needs to commit large resources and undertake upfront investments. Once the platform acquires a large installed base opening the platform increases the overall value to all participants. A firm with a valuable intellectual property and fighting for acceptance within the industry may benefit from a shared approach by partnering with an industry heavyweight. When compatibility with an installed base is and winning acceptance from powerful complementors is critical a shared approach to platform development is the best way forward. An open platform serves mainly to dislodge deeply entrenched technology or in markets that are slow to take off and hence require government intervention.

2. Licensing (OEM) Agreements:

The Why: OEM Licensing can be a very potent weapon for the sponsoring firm to widen the installed base for a technology platform. An additional benefit of pursing this strategy is to co-opt competitors who posses resources to launch a superior competing technology. Licensing can be a very cost effective way of achieving wide scale market reach and penetration. Licensing also serves the purpose of ensuring that platform adopters don’t perceive the sponsoring firm as a monopolistic threat to their very existence. A firm may not have all the resources (tangible / intangible) necessary to serve all segments of the market.

The How: One way to go about achieving licensing deals is to establish a royalty fee based on unit shipments. For this to succeed the firm must have a unique offering protected by patents and perceived by others as synergistic to their core business. Another option is to actually pay adopters and complementors a portion of the revenues derived from transactions on the platform. The publicity that comes with a large number of OEM licensing deals sends a positive signal to would be adopters and complement providers of momentum behind a platform.

The Risk: A firm following this strategy should have patents that act as a barrier against imitation. Following this strategy is a sure shot recipe to value destruction in the long run if the technology behind the platform is the sole driver of revenue and value creation for the licensing firm. Competition will eventually drive down prices and erode market leadership unless the firm can innovate faster. The uncertainty surrounding platform adoption and market potential can pose challenges when structuring royalty payments.

The When: If the firm sponsoring the platform does not have a strong track record or a dominant position in the industry a licensing strategy makes perfect sense. Licensing is also important when a firm intends to establish its technology or platform as the dominant one in the industry. A firm must judiciously exercise this option at the very beginning so as to reap benefits later. However in doing so, the firm must have patents that prevent imitators for leapfrogging or have alternate sources of revenue that it can protect and sustain over a period of time.

3. Strategic Partnerships:

The Why: If launching a platform requires large upfront investments a partnership can minimize risks to both sides. A partnership is strategic and synergistic, when partners have a product portfolio and a revenue base that don’t overlap with minimal threat of encroachment. At the same time the partnership has to bring together complementary assets that each partner can leverage and deploy. Strategic partnerships can be employed as a preemptive move to diffuse powerful incumbents.

The How: One way to go about achieving strategic partnership is through cross-licensing of IP’s and patents and by establishing a royalty free licensing pool. Strategic partnerships can take the form of joint-venture, equity investments, platform co-development, joint marketing and/or sharing of complementary assets (technology, sales, distribution and manufacturing). When access to complementary assets is paramount revenue sharing can be a viable option.

The Risk: Strategic partnerships can be difficult to enforce, monitor and realize when firms have conflicting end goals. Power struggles and battles on platform evolution, roadmap and patent infringements can create challenges in developing a long term symbiotic relationship. Strategic partners may end up as formidable competitors later.

The When: If the firm sponsoring the platform cannot fund all the critical resources (capital, infrastructure and technology) and/or lacks complementary assets strategic partnerships are the way forward. Partnerships are a way for a firm to minimize risks and upfront investments in amassing all necessary complementary assets. Strategic partnerships can be very crucial when the success of a new platform depends on maintaining compatibility with an installed base or needs participation of powerful complement providers.

The main difference between Licensing Agreements and Strategic Partnership is, with the former you are proliferating the market with intent to preempt competition while the latter serves to address a shortcoming in your capability to create new markets through partnership.

4. Subsidies:

The Why: Buyers generally refrain from making upfront investments on products and services that are inherently risky or new. When the technology is still emerging it is unreasonable to expect platform users to pay a premium to adopt your product. One way to circumvent this problem is by way of subsidies that lower the price for would be adopters while recouping lost revenues through complementary services or products.

The How: To stir up a large installed base “Penetration Pricing” or “Freemium” can be the right strategy to deploy. In the extreme case where developing the platform incurs huge upfront costs (Ex: Gaming console, Personal computers, DVD players) an optimal strategy would be to subsidize platform users (higher price sensitivity segment) by pricing below cost while collecting a right-to-participate fee from platform providers and complement providers. A subsidy in the form of government rebate or tax breaks can also serve as a way to stimulate adoption but requires an open platform in most cases.

The Risk: Unless the platform sponsor (provider) has a superior technology, iron clad patent protection, deep pockets and an industry leader extracting subsidies from platform participants can be challenging. In the extreme case when complementors yield more power, the platform sponsor might be forced to settle for a smaller share of the revenues and focus on volume transactions. Care must be taken to prevent fee-riders or heavy users from abusing the platform.

The When: Subsidies are the right way to overcome resistance to adoption when the product (service) is revolutionary and requires platform participants and end users to make substantial investments or forgo sunk costs in legacy products. Subsidizes should only be offered when the platform sponsor has alternate means of recouping lost revenues in the form of platform participation or usage fee.

5. In-House Complements:

The Why: Platforms by definition suffer from a “Catch-22” or what is commonly referred to as “Chicken-and-Egg” problem. Potential platform participants (providers / complementors) will hesitate making a commitment until they are sure the investment will pay off. Likewise platform end-users will prefer to wait and watch before diving in.

In the absence of a large established user base attracting complementors whose participation is a must for end users to gain utility from the platform poses a significant challenge. Developing in-house complements become a necessity for the platform to have a life. In-house complements send a strong signal to would be platform participants that the sponsoring firm is committed behind the platform.

The How: To kick starting the self reinforcing positive feedback, the platform sponsor should be prepared to develop complements in-house at least during the initial phase. Development of in-house complements should commence early on so that the platform can be launched with complements. Bundling complements with the platform can be one approach to ensuring that the cost of developing In-House complements is recouped. In-house complements must start strong and build a stellar reputation and brand name where possible.

The Risk: Developing in house complements along with sponsoring a platform requires large investments and commitment from a firm’s management. A risk-averse firm and its manager will find it difficult to secure funding and resources when returns fail to cover the cost of capital. The problem is acute in publicly traded firms where management must withstand the scrutiny of share holders and investors alike.

The When: Developing in-house complements becomes a necessity when a platform is revolutionary, evolving and incurs irreversible sunk costs in resource and capital from external platform providers and complementors. Platforms with pioneering technology that require hand holding and a longer learning curve may also prompt a firm to develop complements in-house initially. Developing in-house complements also ensures that only high quality products reach the end users.

6. Platform Complementors:

The Why: Complements enhance the value of a product by conferring additional benefits and enriching the overall experience for the end user. Complements allow a firm to establish a virtual R&D factory without the need to fund the projects. A complement may be something tangible: add-on product or an intangible: service.

The How: Developing complements requires an ability to develop relationships with multiple players and participants from all sections of the industry. It requires foresight and an uncanny ability to lead, to seek, to nurture and to develop win-win relationships. The sponsoring firm might have to fund external complementors. It must facilitate complementors to develop a viable business model that can generate revenues from the platform. An independent business unit armed with personnel, money, power and authority along with the right incentives to act in the best interest of complement providers will ensure a better chance of success. Development of technology standards that facilitate easy integration and programs that allow advanced access to technology must be instituted. The platform sponsor can consider making minority investments, taking controlling stake or signing an exclusive contract with promising complement providers.

The Risk: Complement providers may not invest the resources, talent or time to develop value added services or products for the platform. Products may suffer from quality issues or fail to meet the needs of users. If left unmonitored an influx of me-too complementors could undermine the profitability of the entire ecosystem by driving down prices through competition and imitation.

The When: The firm’s business model should clearly define its scope with respect to the platform and those of its complementors. Building trust and partnership takes time and should be prioritized constantly. Evaluation of partners that augment and enhance the platform’s overall utility to the end-user must be accorded importance at each stage of the platform’s development. In the early stages of the platform evolution complement providers that the ability to attract new users should be given priority. In the later stages complement providers that enhance platform stickiness must be sought out. As the platform evolves complement providers that bring diverse products and services should be added to the platform mix.

7. Marketing Mix:

The Why: Effective use of the marketing mix – Product, Price, Promotion and Place can make all the difference when launching a new platform. A platform that fails to solve an unmet customer need with inadequate promotion and distribution reach may fail to attract a large user base. Pricing is all the more important when establishing a new standard or platform due to the risk-averse nature of most buyers.

The How: The product should offer a value proposition unmatched in the marketplace. Targeting lead adopters and securing endorsements from key opinion leaders can be extremely beneficial. A myopic pricing policy that aims to satisfy P&L statements will only deflate adoption rates. To stir adoption and establish a wide installed base the firm must chose penetration pricing; forgoing short-term profits over long-term benefits. The firm may have to blanket the market with a full product line to meets heterogeneous segments of the market. An expansive distribution reach must follow to ensure product availability and penetration within the market. The importance of effective advertising to ease concerns regarding ease of use, compatibility, reliability and value proposition should not be overlooked.

The Risk: The platform may fail to reach critical mass forcing the firm to write down millions of dollars in marketing and R&D investments. The flip side, wide spread adoption and subsequent demand may find the firm scrambling to meet excess capacity or fulfill user requirements without scaling infrastructure. Penetration pricing requires deep pockets and the ability to fund operations in the absence of credible revenue base.

The When: The firm should spend heavily on advertisements, joint promotions and media campaigns during launch of the platform. Price aggressively early on even if it means selling at or below cost. Distribution coverage should mirror the adoption profile targeting lead adopters initially before moving to the mass market. Product and service mix should emphasize the composition of the user base with an aim to serve all needs arising on the platform.

Acknowledgements:

I am deeply indebted to Professor Hemant Bhargava and Professor Greta Hsu at the UC Davis Graduate School of Management and Professor Siobhan O’Mahony now with Boston University School of Management for providing me a foundation and inspiring me to pursue my passion. Thank You !