4 Questions for the Acid Information Age
By John Julius Sviokla Sr. -- Supply Chain Management Review, 6/1/1999
Information is an acid. It is active and reacts with almost everything it touches. The stronger the information, the stronger its activity. Information is a social acid. It changes the nature of relationships. Information is an economic acid. It changes the nature of costs. Information also is a perceptual acid. It changes customers' expectations of service and performance.
Whether you choose to acknowledge it or not, the acid of information is eating away at your industry structure, your economics, your customer relationships, your organization, and your supply chain. If that information is left unmanaged, established players will see their margin taken away by new entrants who use the standardization and ubiquity of the Internet to aggregate demand chains swiftly.
Investors are throwing capital at these new entrants so fast that it is possible to go quickly from small to huge and use the cheap currency of Internet stock to achieve global scale and buy innovations and market share. Just pause on the fact that it took the top five industrial distributors (W.W. Grainger, McMaster-Carr, Westco, MSC, and Westburne) roughly 40 years to get to $10 billion in combined sales. Ariba, a new buy-side entrant aimed at helping purchasing agents get a better deal and lower process costs, in four short years has brought more than $87 billion under its management. CommerceOne, a similar buy-side aggregator, has more than $130 billion. In terms of market influence, these new enterprises grew 10 times as big, 10 times as fast. And they'll go public later this year with a market capitalization of billions of dollars, each swamping the value of their physical competitors.
In the consumer market, Yahoo! could buy the New York Times Company (which owns both the Boston Globe and the New York Times newspapers along with many other publishing assets) for a mere 15 to 20 percent of its stock. The acid of information is radically changing market after market.
As the song asks, "So what's a poor boy to do?" The most vital management challenge for the CEO and senior management of an established company is to change how the organization thinks about this threat and opportunity. Many organizations think it's fine to pursue a fast-follower strategy in this space. The error in this thinking, though, is that history shows that first movers win in most information businesses. Whether it is Yahoo!, the American Airlines Sabre system, the early telegraph and telephone, newspapers, or financial information houses ... they all enjoyed tremendous first-mover advantages.
The leadership challenge is to ask the right questions so that you and your organization can internalize the disruptive, acidic power of information and learn to use its active nature for leading change and creating advantage. The four questions that can focus the mind and sober the soul are:
- How is my industry structure changing?
- How are my economics changing?
- How are my customer behaviors changing?
- How do I organize in response?
Together, these questions create a set of interlocking observations that can help a management team begin to reinvent its business or find interesting startups to go join if the corporation cannot reinvent itself fast enough. Either way, it will begin a process of needed change.
Question 1: How is my industry structure changing?A: From vertical to horizontal.
The coming of the Internet has unleashed (and will continue to unleash) significant forces of commoditization and price pressure. At the same time, there are tremendous opportunities for creating barriers to entry and huge economies of scale in the management of service, search, and learning. But to unlock the Internet's potential value, executives must understand that their traditional information systems have been oriented to create a "vertical" look down the supply chain—usually to maximize control.
Over time, businesses have, more or less, constructed a replica of their tangible business and its processes in the intangible form of information. I have written about this concept with Jeffrey Rayport in an article titled "Exploiting the Virtual Value Chain."1 In that piece, we made the point (so long ago in Internet time) that information technology investment for much of the past 50 years had created a "mirror" of the physical value chain in information. Some of the more advanced companies used this approach to redesign their processes by substituting information for inventory, simulations for actual model building, and other obvious applications of technology for control and substitution. The article also pointed to the opportunity for wholesale reinvention of the customer relationship. That day has come, and the primary movers for reinventing those relationships in today's economy are the information intermediaries (which John Hagel aptly called infomediaries).
What has caused this radical change to happen now? In a word: standardization. The Internet brings a common platform for content, context (for example, the look and feel), and infrastructure (e.g., the transport mechanism) of all information activities. The first effect of information standardization is lower costs by reduction of redundancies, increase in quality, and reusability of effort. From a management standpoint, lowering costs by imposing control and standardization is one of the world's easiest arguments to make. It goes through a budgeting process like greased lightning.
The ironic beauty of this standardization process is that the apparent investment of "control" and "standardization" actually increases the pH of the acid of information significantly. Once the information is in standard form, it begins to eat its way out of the container. Customers want direct access to product information, specifications, and technical help. They want to be able to reuse your information both inside their organization and with their commercial partners because it speeds up their process. They also demand direct access to your virtual value chain. The tip of the iceberg is the mantra for "status" of my order. On its Web site, UPS sees 800,000 people a day looking for order status (and this number does not include the direct non-Internet connections). Every day, the company services 60,000 requests for quotes over an automated, Web-interfaced quote tool. Customer desires for more and more information will be insatiable as their service expectations increase.
The implications for industry structure are profound—especially for the channel partners and intermediaries. It is easy for UPS to go direct because it has no distribution chain. But for others, it is more difficult. As in the world of atoms, vertical extension produces channel conflict as providers move down the virtual value chain. The more deeply entrenched the distribution channel, the greater the contentions. For example, Pirelli, the global tire manufacturer, began Internet activity as early as 1995, gradually enhancing its site to build brand and traffic through promotions—most notably, its globally famous calendar.2 But it was only in 1998 that the company began to offer support and transactions to its dealers online.
Why did Pirelli wait so long? One reason may be that even greater assistance can appear threatening to dealers when, as has been estimated for tires, there are as many as 50 percent too many of them in the world. It is no wonder that Pirelli is cautious about how it goes to market or that its dealers are hypersensitive about being cut out of the picture.
For Merrill Lynch the trip toward granting customers direct electronic access to markets has been even more tortuous. Their strong internal power allowed the firm's financial consultants to make direct retail trading over the Internet extraordinarily difficult. Yet the market demand is just too strong to resist. Eventually Merrill will go direct. But the delay has cost the company any first-mover advantages it otherwise might have gained.
First versions of virtual value chains have similarly supported this kind of move from producer to consumer. In the open, standard environment of the Internet, however, the information flow through every distribution channel will trend away from a hierarchical pattern, in which each layer only communicates with the next layer in the chain, and toward a network in which all points interconnect.
On the back of these "vertical" strategies, we are beginning to see a second phase of industry structure change emerging as it becomes possible to create "horizontal" organizations that span multiple companies. The strength of such cross-company efforts is that they take the best information resident in the overall system and use it to provide the buyer with more power and greater service. Value America and Net Market are two examples of such companies. These new discount retailers look a lot like the wholesale clubs of old—except that they can offer shoppers even greater ease of comparison, while they themselves benefit from much, much less asset intensity.
Of course, these advantages make the new horizontal competitors even more dangerous. A retailer's evolution from vertical to horizontal integration can be very, very detrimental to industry margins. The new entrants tend to be exceptionally price aggressive—all the more so when they can arbitrage between high-margin and low-margin suppliers.
Interesting variants also are emerging for intermediary businesses. One is for the newly digital competitor to act as a pure "jobber," to use an old-style term. Another is embodied in www.buycomp.com, a "wholesale" price-to-consumer Web store. Like the wholesale clubs and factory outlets of old, BuyComp offers low prices to end consumers. The new twist is that the company takes no margin whatsoever from the consumer. Instead, it charges demand-hungry manufacturers for the privilege of direct marketing to its customers. Thanks to its asset-lean economics, BuyComp is really selling its entire inventory as a loss leader in order to gather otherwise-hard-to-get information. The sobering thing is that a new competitor like this probably attains significantly different overhead and operating cost breakdowns, and consequently greater economies of scale, than traditional competitors. This means it can change the game.
In the industrial realm, we see the arrival of www.ariba.com, a company that has relationships with some of the largest industrial organizations in the world like GM, HP, and Sun Microsystems. Ariba's focus is to lower the costs and difficulty of procurement. SAP, the German software giant, is trying to become this type of horizontal player by creating a "total solution" for procurement built right into its enterprise software. CommerceOne also is gathering demand as a new horizontal.
Established players are not standing still either. Grainger, the market leader in the $200 billion-plus MRO (Maintenance, Repair, and Operations) distribution market, began its Web efforts almost five years ago and is spending more than $20 million to create OrderZone and www.grainger.com. At more than $4 billion in sales, Grainger hopes to grow the core business by using marketspace methods to gain market share through lowering the total cost to its customers. Grainger.com is an extension of the company's existing business with more function and availability. Early customers have shown their support by almost doubling the size of their average order. OrderZone is a more radical play, in which Grainger got together a list of noncompeting suppliers (including Marshall Industries, Lab Safety, and Corporate Express) to provide a one-stop shop for all of MRO. As platform host, Grainger hopes to garner fees and incremental revenue to its core business and new brand value.
As an innovator, Grainger got an early lead. Most of its traditional competitors are no longer very strong. The real challenge for Grainger is to continue to run faster than the new entrants and new innovations. The race is on to continue to add value in the channel.
In their first iteration, these different platforms will create a superior convenience and control environment for the user. For the consumer market, early Internet retailers gave good selection and some price advantages. The new ones are much more price and auction focused. The industrial market will see the same activity; it is just lagging the consumer market by about 18 months.
Question 2: How are my economics changing?A: Toward high fixed cost, low variable cost.
It would be sobering enough for a management team to fully internalize the implications of these new horizontal players who will lower the viscosity of price information and create much higher consumer and business expectations. That alone would be enough to give any senior executive major heartburn. Yet the economics and the economic possibilities of these new businesses are even more striking.
Every new, open infrastructure makes new business structures possible. The railroad and the telegraph led to coordinated markets of vastly enlarged scale and scope.3 Manufacturing, distribution, and other functions could be geographically concentrated, and their output dispersed over the network of railroads on a predictable, reliable basis—unhampered by seasons or tides. It was during these times that Swift, Armour, Kellogg, and Procter & Gamble built their empires.
Similarly, the new economics of scale in information will allow simultaneous aggregation and disaggregation of capability. This new capability will come in many, many forms. The first, and most obvious, is self-service access to information. With the open system of the World Wide Web, companies can have a dialogue with customers throughout the product life cycle, as shown in Exhibit 1.4 This lengthy relationship across the electronically enabled marketspace requires all information—from its original recording to its final transmission—to be digital.
The immediate effect of the customer's doing more entering, verifying, and analysis of information is obvious: lower transaction costs for the provider. The strategy's cost-effectiveness depends on the nature of the substitution. If the company can avoid a phone call, it may spend only 1/50th of what it would have spent to make a sale. If what is avoided is a $350 face-to-face sales call, the cost comparison is far better still. Specifically, the in-person call is about 7,000 times as expensive as processing customer information online.
In addition to lower absolute costs, the nature of the costs is changing. Sales calls and call centers both have a small fixed-cost component and a large variable-cost component that scales up linearly. Self-service information on the Internet has a different cost structure—that is, mostly fixed with very little variable. Thus, while Dell invests to set up the system and its customer interface, the customer bears both his own cost of access (for a computer) and his own cost of connection (for Internet and phone service). Plainly, the economics of scaling up to serve vast numbers of Internet service relationships is extremely beneficial to sellers like Dell and their shareholders.
Companies should provide service support in a way that leads less-savvy customers to select themselves out. First-time computer buyers are at once expensive customers to support and price sensitive. Second-time computer buyers are the sweet spot in Web-based self-service for both cost and revenue reasons. These repeat customers know how to educate themselves on new systems and can gain access to needed information without assistance. Furthermore, they appreciate the value of trade-up options. As they teach themselves about the core product, peripheral products, and related services, they will buy up as their original product matures.
Perhaps the more profound impact on costs is the shift from material-based value to knowledge-based value. As Michael Dell said to Bill Gates, "Physical assets used to be a defining advantage. Now they're a liability. The closer you get to perfect information about demand, the closer you can get to zero inventory."5 Because Mr. Dell's business is essentially to create a giant supply chain—or more accurately, a supply network—it is especially telling that this is the man who has made a fortune defining the physical assets he pumps as liabilities.
Companies that begin this learning dialogue with customers get a three-bagger. The first bag is that they will learn faster than the competition. The second is that they will have lower marginal costs thanks to the economies of scale. The third bag is that growing, public companies will have a valuable stock that they can use to acquire audience and innovations through purchases; they will rapidly achieve scale.
Question 3: What is happening to consumer behavior?A: The customer is out after your margin.
The executive team that has internalized these new competitive realities and seen how the acid of information is eating the company's margin needs an answer. How will traditional businesses compete in this age of hyper competition? The good news is that there are still lots of ways to differentiate in the information space. By and large, today's information experiences are like the cars of the 1920s or the phones of the 1910s. These devices were popular at the time. But the truly reliable, dependable car was more than 20 more years in the making. And, of course, the phone of today is vastly superior and more efficient than its counterpart of eight decades past.
New grammars will be needed for interacting with customers via electronic media swiftly, precisely, and profitably. I can't say what these new grammars will be. But by looking around us, especially outside of commerce, we can get a few hints. Customers' expectations of a product or service are set by comparable experiences. Consumers have been conditioned for the virtual world by the telephone and the movies. These media boast fantastic user interfaces—in fact, the technical aspects of interaction are imperceptible to the user. They create what might be called "facile environments." In them, what you see and hear seems real. Indeed, the artificial signal can seem more real than the real. The sound quality you demand of an intercontinental phone call can surpass what you've come to expect of a cross-table conversation in a busy restaurant. Your involvement with a film heroine can be deeper than any feelings you have for your next-door neighbor.
Communications technology and entertainment media have set expectations for all of consumer business on three important dimensions: reliability, immediacy, and flow.
Reliability. The telephone system has 99.999999 percent uptime for each of the components of the vastly complex phone network. These components are designed with such demanding specifications because the system's average quality is only as good as the product of the interaction of all the components. In the worst case, the reliability is xn where x = the number of components in the system and n represents the quality of each individual part. Again, the point here is not to suggest that each and every part and module of a marketspace consumer experience be engineered to reach 99.999999 percent accuracy. Rather, it's that consumers have extremely high expectations for the quality of interface and interaction with complex information spaces.
Immediacy. Phone-to-phone contact has been instantaneous for decades within the United States. With the arrival of wireless phones—coupled with advances like e-mail to mobile personal computers, online stock quotes, and more—people are becoming accustomed to making contact across a wider range of modes anytime, anyplace, anywhere. There's no delay. And even the most casual observer can detect a loss of patience with delays, especially in the commercial sphere.
On the one hand, it becomes very challenging to satisfy customers in this environment. On the other hand, new technologies create many simple means to differentiate your offering if you understand the importance of end-to-end process quality. One of the most important differentiators of a PalmPilot vs. even a laptop is its immediate access; PalmPilots boot up immediately. Likewise, companies can differentiate their distribution through the low-cost means of designing a Web site that opens quickly, navigates logically, and provides the requisite information and services.
Flow. More subtly, the media condition us to view the world differently from ever before. Again, take the movies. When you or I look out the living room window, we see the street from one vantage point only. But a movie changes shots frequently. It presents the same street as seen from the sidewalk, the living room across the way, or perhaps in tight close-up. So natural has it become to view a scene from multiple camera perspectives that most times we don't notice the cuts.
Network technology is starting to give us multiple perspectives too. We can interact with our computers in any number of modes. We can read text, view pictures, listen to music, click to select, play games, and much more. More profoundly, we are groping toward a new grammar of interaction with our machines that is analogous to film's splicing different camera shots together. Admittedly, bandwidth limitations hinder our ability to operate in some of these views or to switch between them.
For the present, we still can be distracted by a silent movie-like flicker. So we are not really "in the flow" of this new medium yet. But how much "faster" will the technologies have to be piped into our homes before that stroboscopic effect of breaking up the flow into fixed images disappears? Possibly not much. The early silents were projected at about 15 frames per second. Today's movies run at 24 frames a second. That difference is just enough. Research (first done over 150 years ago, by the way) has found that the human mind freezes an image for about 1/20th of a second before moving on to the next one. Quicker changes can't be tracked. Thus, the movie seems utterly fluid to us.
The software and network designers of an interface aimed at a customer interaction must recognize how other media have ratcheted up expectations. Even if consumers do not complain about the quality of interface or a degree of delay in interacting with it, they still will prefer faster interfaces and better quality. What constitutes "normal" speed and "normal" quality of interaction was set for them not in the realm of commerce, but in the realm of everyday entertainment—beginning shortly after birth.
This means there's a constant opportunity to improve the value to a customer of an electronically enabled marketspace by making it more robust, faster, and more facile. Just about anything can be differentiated based on the quality of information interface.6
Missing in today's management is a realization that lack of attention to the marketspace quality issues is a brand statement. Every Web-based transaction that is slow and unfriendly, for example, makes a brand statement about your company and its capabilities. Until management realizes this, it will not give the problem the attention that it deserves. The shift in thinking that needs to occur is from emphasizing content to managing the quality of the interaction process. This is just like doing an analysis on service quality,7 since the online interface is a "service."
A key handling and process question becomes "How far will these process improvements go?" Another related question might be "What is the natural limit of the speed of interaction?" I believe the natural limit occurs when the speed of interaction surpasses the equivalent of 1/20th of a second. What this gives us, importantly, is not just improved speed. It offers a different quality of interaction. Suddenly, we are looking at an animated cartoon instead of a flip-book.
When each desire is interactively and instantaneously fulfilled, the user becomes engaged at a deeper level and has a very different experience. Work done at IBM in the early 1980s gives empirical evidence that smoothly flowing interaction is far more productive than jerky interaction—and that it does not take much delay in the process to destroy the flow. The IBM researchers studied engineers, computer programmers, and keypunch operators working with computer terminals to perform a variety of tasks ranging from mechanical to creative. As it happens, in one of their experiments they even monitored the effectiveness of IBM operational planners—those people responsible for tracking electronic component inventories, adjusting production and delivery schedules, and initiating billing.
The IBM researchers had expected productivity gains to tail off as the system's response became faster. In fact, they found just the opposite.8 (See Exhibit 3.) If workers must wait even a second for their input to register in a computer system and for new information to appear on screen, they lose focus or fall out of the rhythm of their activity. But once "system delays" drop down to subsecond intervals, workers stop perceiving them. With each gain in response time, the work process achieves flow and productivity improvements accelerate.
When we look at product development in the marketspace, we find that the best companies invest in an ongoing relationship with a set of advanced customers that can act as testers of future products and services. This always has been true of software companies in their process of alpha testing, beta testing, and wide release. The challenge today, when customer behavior has not yet caught up with technological possibilities, is to be first to generate a small amount of concrete data suggestive of likely future demand. The key word here is generate. Consumers' behavior will change radically as new capabilities are opened up to them to organize, shop, coordinate, and opine. Only by letting live customers experience the future can an innovator begin to understand the nature of the new interaction and how customers will adapt to it. In the words of Alan Kay, a key figure in the development of personal computers, the best way to predict the future is to invent it.
Question #4: How do I organize in response?A: Get past the asset-based culture.
New business models always give rise to new managerial roles and reconfigure or sweep away others. As operations in the marketplace and marketspace have begun to merge, the impact on organizations has been profound. Huge investments in information technology catalyzed the vast downsizing of the late 1980s and early 1990s. The technology made possible extensive command-and-control systems that could manage far more revenue per person—even as the traditional information processes of the organization (what had been the domain of middle management) shrank.9 The ensuing depopulation of large organizations has been documented extensively. The tally: In 1990 one in every five jobs was housed in a large corporation; by 1998, the number was only one in 10.10 Better management of information allowed organizations to deal with much greater product/service complexity and volume with far fewer labor hours and far fewer managers.
The challenge now is to go to the next level; that is, to make information and data "produce" corporate value directly in the market, just as physical assets do.
The greater part of the challenge is cultural rather than technological. Systemic biases work against shifting to more effective technologies.
Given their druthers, most line managers would continue to invest in the kind of "hard assets" and "real services" like logistics that form the traditional supply chain. That's natural. That's what they know best. But where does that leave information technology (IT)? Underinvested, by default.
Worse still, the accounting system misrepresents information technology's contribution. By and large, accounting expenses IT costs as they are incurred. At best, systems costs are written off on an aggressive depreciation schedule (three years is typical). This policy as much as treats IT as an expense, when compared to the longer-term handling of other plant, property, and equipment. But databases and other software have a life much longer than one to three years. Technology really contributes as an asset.
Accounting miscategorization hurts the company. In a corporate environment focused on short-term earnings, any rational manager will avoid the discretionary expense of repair and fall back on in-place technology. Repair and upgrade of old technology is an immediate cost, so it's deferred or avoided entirely. Additionally, creating new software for upgrades is often risky, notoriously difficult to manage, and susceptible to a wide variety of outcomes. The day of the large-scale software fiasco is not dead. If software rusted like a tractor, it would be maintained and updated far more frequently. (Look at the long run-up to the Y2K problem!)
Lastly, all the while that infotech expenditures are being danced around, the company is underinvesting in more powerful alternatives while becoming ever more exposed to the "killer apps" likely to dominate digital-age competition.11 This is a process problem for the organization as a whole. Conferring "ownership" of technology issues on a chief information officer is no solution. The typical CIO lasts a mere 18 months in his or her position—barely longer than a budget cycle and surely not long enough to oversee major investments from start to finish.
A more fundamental tension is that the fast-track managers—those who are interested in power, prestige, and pay—typically run parts of the business that bulge with staff or tangible assets. Clout comes with having lots "under you" that is plainly visible to the naked eye.
For any company trying to adapt to the marketspace, where the differentiating assets are intangible, this is a hugely dysfunctional type of motivator. Here's why. Most established companies primarily broadcast; they make, provide, and sell to a mass of unseen customers. Marketspace tends toward the interactive mode. The smart company thinks first about how to heed and serve each customer individually.12 In the interactive mode, critical assets become an infrastructure of databases, call centers, and knowledge management systems that together can resolve the 20 percent of customer problems responsible for 80 percent of the call volume.
Electronic systems are the virtual equivalents of the physical distribution systems of old. Traditionally, the distributor's job is to "break bulk" on behalf of a manufacturer by expediting small or complex orders. E-commerce networks route information—and things—where they need to go efficiently and effectively. They identify the customer, map individual purchase patterns, relate these patterns to company and supplier inventories, and assemble and even ship orders. As yet, these new avenues of distribution are not recognized for their full value in the corporate culture, pay, or power systems.
Responding to the New RealitiesIn short, the senior executive team needs to recognize the new realities of acidic information. New entrants will restructure your industry. Your customers already are going direct to you and to your competition—and perhaps to your suppliers. The fundamental economics are changing. And yet your pay and incentive systems are from an economy that no longer drives the value in this new economic reality. Other than that, you are all set!
Companies that learn to change their thinking in this realm have the opportunity to grow and prosper (as the brokerage firm Charles Schwab has done). Those that do not may suffer the fate of Border's Bookstore. Once the industry darling, Border's now is trading at a large discount because the capital markets are convinced that it doesn't know how to deal with Internet-based competitors. If you don't start asking your senior management team the four questions in this article, Wall Street will create its own answers—and from those answers make you a hero or a heel. The time to begin is now.
| Author Information |
| A former professor at the Harvard Business School, John Julius Sviokla Sr. is a partner in Diamond Technology Partners, based in Chicago. His articles have appeared in the Harvard Business Review and other publications. |
| Footnotes |
| 1Rayport, J. and Sviokla, J. "Exploiting the Virtual Value Chain" Harvard Business Review, November/December 1995. |
| 2See www.pirelli.com |
| 3See Chandler, A. D. The Visible Hand, Harvard Business Press, Boston, MA, 1980. |
| 4This life cycle draws on the work of Blake Ives and Mike Vitali on Customer Life Cycle Management. |
| 5See Business @ the Speed of Thought by Bill Gates, Warner Books, 1999. |
| 6See The Marketing Imagination by Theodore Levitt, Free Press, New York, NY, 1986. |
| 7See many works by James Heskett in the Harvard Business Review and elsewhere. |
| 8See "The Economic Value of Rapid Response Time" by Walter J. Doherty and Ahrvind J. Thadani, http://vmdev.gpl.ibm.com/devpages/JELLIOTT/evrrt.html, 1982 and 1997. |
| 9See Creative Destruction by Richard L. Nolan and David C. Croson, Harvard Business School Press, Boston, MA, 1998. |
| 10See Future Wealth by Stan Davis and Christopher Meyer, Harvard Business School Press, forthcoming. |
| 11See Unleashing the Killer App by Larry Downes and Chunka Mui, Harvard Business School Press, Boston, MA, 1998. |
| 12See Sense and Respond edited by Stephen P. Bradley and Richard L. Nolan, Harvard Business School Press, Boston, MA, 1998. |
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