After a long hiatus...

I'll be updating this blog more frequently. 

Why does the world need another browser?

Google launched their browser last week with much fanfare and a rather odd marketing strategy. Sure, Chrome has some nifty new features and curiosity value drove its market share way above Opera in just two days. But does the world need another browser?

Obviously, Google is very worried about Microsoft controlling the majority of browsers since that may put a large dent in their search market share (if people start using the browser box to search and MSFT uses Windows Live Search by default - and it's good enough, will people change the browser box to use Google, or will they be happy with Windows Live Search?) But why couldn't they continue to work with Mozilla? Firefox is, by all accounts, a great browser, and it could be much better with the help of the brains and dollars at Google. Why not back a neutral browser?

Could it be that they don't really want a neutral browser? That they want more influence on the browser market than they could have through influencing a neutral browser maker? That they're hoping that Chrome will become a serious contender, and they can integrate it well with Google's tools, possibly optimize Google AppEngine (a couple other things that they have up their sleeves) for working with Chrome?

Or will they, in future, introduce "features" that track even more of what users do (like what URLs they visit) in the hopes of improving ad targeting? Perhaps because people weren't really installing the Google Toolbar for IE that could have done the same thing(s)?

Or is this just a way to keep the market talking about Google?

The Science of Sales

I wasn't born in the US - I moved here soon after I turned twenty. I remember the first time I opened the newspaper on one of the big sales days (I think it was the 4th of July weekend, but it's been a while) - and I saw sales on pretty much everything I could possibly imagine wanting over the next year. I felt really lucky to have this opportunity to buy some cool stuff at "unheard of prices," but as a recent immigrant, I didn't have a fat bank account, and I hadn't cottoned onto the American Way of credit card debt (fortunately, I still haven't!). And then the next holiday weekend came around and it was the same story - sales as far as the eye could see. And then the next, and the one after that.

So, why all the sales? That's a two-part question.

Why would anyone have a sale?

Well, obviously sales draw customers, but if people get to expecting a sale every major holiday, won't they just defer their major purchases until the next holiday? Are all the stores insane?

Turns out the answers are yes (for some people - but that isn't a bad thing) and no, the stores aren't insane.

It all comes down to a form of what economists call second degree price discrimination - allowing people with different levels of price sensitivity to self-identify and buy the right "product" for them. The reason I put the word "product" in quotation marks is because the time at which you buy a given product changes the product. For the elite gamer, for example, owning the latest hot game the day it comes out is more valuable than owning the same game several months later. Similarly, some people want to have that new car, TV, patio set today. Waiting three months just isn't worth what they expect to save when it goes on sale. They're going to go and buy it now, unless the sale is around the corner.

Other people really do want to pay the best price they can for something and they can (and don't mind) waiting to get it. So, they wait for the sales and battle the crowds of like-minded individuals to get that new wide-screen TV, while the less price sensitive people get to sit out the rush and relax on the patio with a cool drink. Or something like that. The ability to relax on the patio while everyone else is out shopping is one of the benefits the less price sensitive people get in return for the higher price they paid for the same product - and they value it more than the people who waited for the sale.

Why does everyone have a sale?

Because if they didn't, they'd lose out on the price sensitive customers (assuming at least one competing store does have a predictable holiday sale), and they don't want that to happen. Would everyone be better off if nobody had a sale? Possibly, depending on the demand curve for the product your store sells. But that isn't what game theorists call a Nash Equilibrium - in other words, even if everyone did best in a world with no sales, in that state any store could increase their profits by having a holiday sale. Turns out that if at least one competing store is having a sale, you'd do better by having a sale than not having a sale (since you'd get some of the price sensitive shoppers instead of none). So, under no condition can you do better than having a sale. Hence the rash of sales.

... So what Should the XBox team do now?

As I mentioned in my previous post, the XBox team has a bit of catching up to do, with the loss of the HD format wars giving the PlayStation a nice boost.

So what should they do?

Focus on the software. It's one of Microsoft's core strengths anyway. People buy value, so the BD-PS3 combo seems like a better value than the XBox 360 console when all other things remain equal. But by focusing on encouraging game exclusives, delivering better value as part of the Xbox by improving its software and add-ons, Microsoft can deliver better value in the area that matters most - games. After all, this is a game console war - if they can deliver a significantly better gaming experience, they can still win.

Update: And they're doing just that. This one isn't over yet. The next few months should be very interesting.

Console War Update

Microsoft has dropped the prices of the XBox 360 in an attempt to remain competitive with the PS3 (as I had predicted in January). The new price for the 20GB Xbox is $299, which is $100 cheaper than the cheapest PlayStation 3 (40 GB). However, an XBox 360 + standalone Blu-Ray combo will cost you at least $100 more than a PS3.

In the meantime, the end of the Hi-Def wars have seen accelerated sales of the PS3 vs the XBox 360, with the PS3 now outselling the XBox.

EA makes a big strategic blunder...

I've been a little delinquent in writing of late, but will soon be updating this blog regularly again. A number of things have been sucking away at my time and it seems like there's never enough time to get to a few things that I've been wanting to do for a while. However, today I'm writing a brief PSA and a shining example of terrible strategy. It seems like the powers that be at EA have chosen to implement a new DRM scheme on their PC games that allows only three "activations" per license. Let me explain what constitutes a new activation in their books:

1. Changing your hardware. Game running slow? Need a new graphics card? Oops! There goes an activation. Hard disk died? Oops! There goes an activation... etc.
2. Installing the game on a new computer - even if you uninstalled the game from the old computer.
3. Reinstalling your OS. None of us have *ever* had to reinstall Windows have we?

It's the most boneheaded piece of strategy I've heard of. Want to get more sales? Treat your customers like thieves and make them pay for the same thing over and over again. It also sounds illegal to me (although I am not a lawyer) - it appears to be, at the very least, a violation of the First Sale Doctrine - you won't ever be able to sell your game once you're done with it.

So, lest they forget that strategy is about customers (and competition that tries to steal them from you) ... vote with your pocketbook. You have a choice - avoid EA's PC games ... and any other publisher that foists this kind of ridiculously crippled product on you. 

Combating the Low Price Strategy

In an earlier post, I talked about the Low Price Strategy and the conditions under which it can be effective. To recap, the following conditions must hold true for a Low Price Strategy to be effective:
1. The economic structure of the market should be appropriate - typically a market with high fixed costs and low variable costs.
2. Driving additional volume should reduce marginal costs (not just average costs) - i.e. the additional amount of money required to produce/sell one more unit should decrease as the number of units produced/sold increases.
3. Price should be the key driver of value for your customers.
4. Finally, a long-term commitment to being the low-price player is necessary to sustain this strategy.

But what if you're in a market where there is a viable low price strategy, but a competitor has already capitalized on the advantages of volume?

Well, unless you have very deep pockets, taking them on head-on is unlikely to be beneficial. The best way to compete in a market that is already dominated by a low-price player is through segmentation and differentiation.

Almost every market has customer segments whose preferences differ. One way to win in a market is to identify a segment that isn't being served well by the low-price player and to go after them. This is the strategy followed by companies like Stella Artois (premium beer), Nordstrom (retail), etc.

Supposing the exhaustive list of attributes a product could offer are A, B and C, and there are four market segments. All customers value A equally and will not buy a product that does not offer A, and they all think A is worth $100.
Segment I values A at $100, B at $5, C at $10. This is the largest segment.
Segment II values A at $100, B at $20, and C at $10
Segment III values A at $100, B at $10 and C at $25.
Segment IV will not buy a product without A, B and C, and values this product at $150.

A costs $50 to produce, B costs $10 to produce and C costs $15 to produce. Because of complexity, a product that offers B and C costs an additional $5 to produce.

The Low Price player will likely go after Segment I, with a product that only has attribute A - but there's still room in the market for:
- A competitor who produces a product that offers A and C at $124 (Capture Segment III)
- A competitor who produces a product that offers A and B at $119 (Capture Segment II)
- A competitor who produces a product that offers A, B and C at $149 (Capture Segment IV)

So, the key to competing in a market which already has a dominant low-price player is to identify customer segments who are inadequately served by the low-price offering, identify the attributes that matter to them and how much they're willing to pay for those attributes, and craft an offering that serves them uniquely by offering them better value for their money. This is possible because different customers have their own ways of assign value to the different attributes a product may offer. This strategy is most effective when the attributes that your segment value make a low-price strategy impossible to execute - e.g. customers who value high-touch sales.

The "product attributes" I refer to above above need not necessarily be "features" - customer service, support, and even intangible attributes like aesthetics and experience are very valid ways to differentiate. Often, if you can't find a way to differentiate - you haven't yet tried hard enough.

Branding and Websites

It's easy to tell when a firm thinks of a website as a "necessary evil" or a "function" rather than an extension of the firm, and a representative of the brand. A great website lives the brand, is functional and user friendly and its information architecture reflects the intent of the user who is visiting the website.

When a large number of your most valuable customers visit your website, it becomes their secondary exposure to your brand (the primary being the product itself). It's very important that your brand is reflected correctly through your website, from visual presentation that is evocative of your products and/or packaging, to information architecture that gets your customers (and that your customers get). It's a very important part of your customers' connection with the company.


Examples:
(Sorry, no screenshots, didn't want to run afoul of the Terms of Use, even though I'm pretty sure critique is covered under fair use)

The Good:
Apple: There are lots of things I admire about Apple, but their biggest accomplishment is that everything Apple does lives the brand. From creating a retail experience that's uniquely and recognizably Apple, to one of the most polished, functional, and brand-appropriate websites out there.

What's great about it? Here are a few things.

• The design is very evocative of their products. From the brushed aluminium look that evokes the PowerBooks and MacOS X, to the rounded edges that Apple loves putting on everything. I could remove the products, and you'd still know it's Apple's website.
• It's minimalist. They choose a very small number of messages to surface on the main page, and that's it. They resist the urge to make the website a link dump that contains a boatload of information that's irrelevant to most of the people visiting the site, but useful to a small minority.
• It's pretty and friendly - basically what you'd think of when you think Apple. It lives the brand.
  
• It's very functional, even with only 6 tabs and a search button. Again, classic Apple. It takes hard work to make something simple, and Apple loves simplicity.
  

While I like Apple's overall design better, the redesigned Microsoft corporate site is pretty good too. It's evocative of Vista, has clear navigation, and has only a few "loud" elements that catch your eye.

The Not-So-Good:
HP: HP's site design isn't terrible - I've seen much worse. However, it still illustrates a few common mistakes made by people who are actually serious about their website:

• No clear brand association other than the logo (and possibly the blue color, although they also use orange and other colors when you hover, so - not really).
  
• Visual overload. So many buttons and links and high-saturation graphics I don't know what to do next.
• No clear information architecture. Information is broken down by product line (how the company thinks of their customers) rather than by user intent (how the user thinks of their products and what they want to do). When I visit a website, I'm not really interested in identifying myself as a "Home & Home Office" (vs "Small & Medium Business", "Large Enterprise", "Government, Health and Education" or "Graphic Arts"). That's how you think of your customers, but it doesn't reflect what your customers want to do. So, the top level navigation on the website reflects the company's information architecture, not the customer's. HP isn't alone in doing this - it's an antipattern that's quite prevalent. Until very recently, Dell did this too (they still have links for different "customer types", but they've de-emphasized it, and it's not the prominent website feature).
  

Do you have other examples that illustrate great and not-so-great brand experiences reflected on company websites?

(Slightly offtopic: A last word on simplicity/complexity - the engineering/design tradeoff. An engineer loves to build a feature-packed product with knobs and gizmos that do a million different things. Engineers also love command-line interfaces. Users, on the other hand, don't see complexity as a good thing. A simple tool that helps them get stuff done is way preferable to a complex tool that looks like it can do a million things, but they have to read the Encyclopedia Brittanica before they can begin to use it. It's terrible when you have a sneaking suspicion that you could actually get something done once you learn the interface, but the task of doing so seems daunting, and makes you feel like an idiot.

Some engineers, on the other hand, thrive on complexity - that's part of what makes them so good at their jobs. Most of us don't though, and it's a good bet that your users don't want to "learn" your website, they just want to find what they're looking for quickly and easily. That's why designers and information architects are invaluable. A good information/interaction architect will work with a design team to lay out your website with detailed user input. That allows the engineers to do what they do best - take the inherent complexity and build something simple that your users love).

Startups: Valuation Terminology

After reading my post on Zillow's valuation, someone asked me what I meant by post-money valuation.

There are two ways to express startup valuation at the time of an influx of new funds - pre-money and post-money.

Suppose your firm gets $10 million of funding in exchange for a 25% equity stake. This means that 25% of your company is worth $10 million, or that your whole company is worth $40 million. This is called the post-money valuation.

To figure the pre-money valuation, subtract the funding amount from the post-money valuation (Why? Because the funding has increased the value of your company by exactly the amount of cash that has come in). For the above example, the pre-money valuation is $30 million.

In general, you can figure out the pre-money valuation by first figuring out the post-money valuation, then subtracting all new funds that have come in. There are more complicated scenarios where the pre-money valuation can be slightly different from the example above (e.g.if the funding event triggers the exercise of options, conversion of notes, or other changes in the existing funding structure of the company). In general, though, it's the post-money valuation that matters for everyone except the people who are invested in the company.

Hope that clears it up.

Web 2.0: Bubble?

I was reading a note about Zillow's new round of funding (WSJ link, paid) a couple months ago, and their post-money valuation, at $350 million, seemed a little high to me. I didn't have time to do the math, but I returned to it today to do some back-of-the-envelope math. I wanted to use a more analytical approach to to a gut check on whether here's any truth to the b-word being bandied around about Web2.0.

Zillow's business model is advertising-based, and they're allegedly profitable. They're a fairly well-known brand in the home valuation arena, but are they really worth $350 million?

Let's do the math together.

Here's how I'm figuring it: The nearest comparable is a public, ad-supported, web-based business. There aren't any that I can directly compare with in the industry, but I decided to use Google as a baseline. Treating Google as purely advertising-driven isn't strictly true; Google also sells products like the Google Search Appliance, extra drvive space for Google apps, Google Premium Apps for small businesses, etc. However, since the majority of their revenue still comes from advertising, this should give us a ballpark estimate, if nothing else.

Here are the rough metrics on average stay and visits/month:

http://siteanalytics.compete.com/zillow.com+google.com?metric=avgStay

http://siteanalytics.compete.com/zillow.com+google.com?metric=sess

Let's assume the value to advertisers is roughly the number of visits times the length of stay, and for argument let's assume Zillow's ads are worth the same as Google.

	Site	Average stay (mins)	Visits (million)	Valuation Metric (Stay * Visits)	Valuation ($M)
	Zillow	525	3.3	1,732.5	550
	Google	405	1400	567,000	180,000

This gives us a valuation of $550M for Zillow. Factor in a discount for startup risk (if you can make the same return on Zillow as you can make on Google, most rational investors would choose Google) and lack of liquidity (for the VC investment), and $350M isn't looking completely outlandish after all, even though this back-of-the envelope calculation assumes away a number of factors.

Some of the simplifying assumptions that could skew this one way or the other, once accounted for, are:

• Google sells products like Google Mini/Appliance, etc. Some of Google's revenue also comes from AdSense. Since Google doesn't publish revenue/profit breakdowns, the true share of valuation that comes from on-site advertising is indeterminate.
• We're also implicitly assuming similar cost structures even though I'd expect Google's long-run cost structure to be more favorable than Zillow's, partly because of scale and partly because Zillow has to buy a lot of its data.
• Advertising value at Google and Zillow isn't the same. People spend less time on Google by nature, but they visit often and get lots of excellent targeted advertising. On the other hand, the average value of products sold through Zillow (mortgages, brokerage services, etc.) is expected to be higher than the average value of products or services sold through Google.
  
• Google's and Zillow's prospects are assumed to be equally bright, so there's no growth premium on either site. While Google is an older firm and can't grow at the same rate as a startup, it is still priced as a growth stock, and with good reason - it has the potential to grow into many new market segments. Not so much with Zillow.

So, unless you believe that Google's valuation is way overblown (which you may, depending on how pessimistic you are about GOOG's growth potential) Web 2.0 startup valuation, as proxied by $350M for Zillow, doesn't seem completely outlandish.

I have to admit that surprised me.

The Low-Price Strategy

One of the most common (and misused) pricing strategies is: "Price it Below the Competition." If you are a significant market presence, one of two things can happen when you adopt this approach - if you do so strategically and in a market whose structure and customers make the lowest-price approach viable, you may carve a hard-to assail competitive advantage for yourself, like Walmart did. If not, there will likely be a price war that will leave both you and your competition with lower margins and lower profits than before.

So when can the Low-Price Strategy become a viable long-term approach?

I. Economic structure of the Market

Industries where the Low-Price Strategy is viable are typically characterized by relatively high fixed costs and low variable costs. Retail is an excellent example: The fixed costs are high (cost of the facilities, staff, etc), but the variable costs (the cost of goods sold) are low in comparison. So, the more you can sell with your fixed infrastructure, the less the average cost of each article sold is.

To illustrate this, let's imagine a hypothetical widget store. Running the store costs $500K per month regardless of how many widgets are sold. Each widget is built in-house and costs $100 to sell. So the average cost of a widget is a downward sloping curve; at one extreme, if you sell only one widget, it cost you $500,100. This average cost goes down with every widget you sell, so that, at the other extreme, if you sell an infinite number of widgets, they cost you infinitesimally above $100 each. So, the more you sell, the less it costs you to sell a widget. This also means as you sell more, you can price lower and still maintain (or even grow) profit margins.

But the benefits of volume in this industry are reaped by everyone who can drive high volumes. In a pure commodity business, this is exactly what happens - the market consolidates into an oligopoly, with each player producing at least their Minimum Efficient Scale. But market structure alone doesn't yield a strategic advantage to low price - the prices are driven down by competition.

If your business is not characterized by high fixed costs and low variable costs, a low-price approach is unlikely to be successful.

II. Direct Benefits of Volume

In order for a low-price strategy to yield a sustainable long-term advantage, volume should also reduce the variable (or marginal) cost of goods being sold. For the hypothetical widget store, this means that the cost of each widget being built and sold isn't fixed at $100, but rather, reduces as additional widgets are built and sold.

This reduction in variable costs can be driven by a number of factors, some of which are:

1. Learning: As you sell more products, you learn how to build an sell them more efficiently.

2. Negotiation Leverage with Suppliers and/or Distributors: In many cases, suppliers and distributors will be willing to offer deep discounts to purchasers who buy large volume. This is particularly true if they are selling commodities, or if they are not operating at their minimum efficient scale. One example of this is the bandwidth business. If you search online for metered bandwidth, you may end up paying $200/Mbps or more. However, firms that drive a lot of traffic negotiate with their vendors and get prices as much as an order of magnitude lower (or more) by offering large commitments (guaranteed use).

3. Cost of Customer Acquisition: Driving high volumes can strengthen the brand and reduce your average cost of acquiring customers. When this happens, every incremental customer you bring in costs you less in marketing and sales dollars.

III. Price should be a key driver of Value

The costs are based not on the product you're selling but the value you're selling. So, while Walmart can execute this strategy effectively, Nordstrom can't. The market segments they serve are different. Nordstrom's value proposition is based on the shopping experience and service, which is not a scale business. Similarly, McDonalds can execute a volume strategy, but Chez Panisse can't, because McDonalds sells fast, cheap food, while Chez Panisse sells a gourmet meal experience. The value they're selling is different, even though they're both in the same industry.

There is also the perception value of price to consider - luxury products are expected to be exclusive and cost more. A cheap luxury product isn't really a luxury product because it's not exclusive.

If benefits (tangible or intangible) rather than price are the key driver of value in the segment you're targeting, the low-price approach is the wrong one.

When the economic structure of the market yields significant volume benefits that are further supplemented by additional volume benefits, a low-price strategy can work well to gain a significant, sustainable advantage in price-conscious customer segments. This is particularly true when products are seen as commodities and price is the key driver of value.

In most other cases, you're better off gaining an edge on your competition by creating a unique value proposition that makes your product worth more than the competition. Walmart will never unseat Norstrom, because they can't offer the same value (experience, service) as Norstrom does, nor will people stop going to Chez Panisse even if McDonald's decided to offer the same food for a tenth of the price at McDonald's.

Finally, commitment to a Low-Price Strategy requires a relentless focus on keeping costs and prices down. It requires the discipline to resist the urge to let prices creep up (if you're a public company, this will often mean ignoring Wall Street), and a relentless focus on identifying and implementing new cost-reduction strategies. Jim Sinegal, the CEO of Costco, sums it up nicely:

"When I started, Sears, Roebuck was the Costco of the country, but they allowed someone else to come in under them. We don't want to be one of the casualties. We don't want to turn around and say, 'We got so fancy we've raised our prices,' and all of a sudden a new competitor comes in and beats our prices."

The predicted demise of HD-DVD: Implications for the Console War?

I am, sadly, the proud owner of a HD-DVD player that is predicted to become a heavy paperweight soon, in spite of the fact that current Blu-Ray players (other than the PS3) are short on features and long on price. With content squarely on the side of Blu-Ray, unless the HD-DVD consortium can force some Blu-Ray conversions (seems unlikely), I think we know where the chips will fall.

(Source: Wikipedia)

Here's what I think went wrong.

1. Microsoft didn't build the XBox 360 with an included HD-DVD player: D'oh! In order to release early and keep costs down, MSFT chose not to include HD-DVD with the XBox 360. This got them to market first, but hobbled HD-DVD relative to Blu-Ray (and was possibly a bad long-term strategic move). HD-DVD could have had a significant installed base early if the 360 had included HD-DVD capability. Perhaps MSFT and the HD-DVD consortium underestimated how much clout Sony would have once Apple (and Disney) joined the Blu-Ray consortium. In fairness, being first to market was important - in the console business, there are strong network externalities, (i.e. success breeds success) and a strong installed base really helps to win. On the other hand, Microsoft could have released a later update that included an HD-DVD player. This decision would not have been a slam dunk because it may have annoyed early adopters. However, as long as any console could play any Xbox 360 game, I don't think this would have been a showstopper.

2. In the meantime, the PlayStation 3 was quietly building up a large installed base in the living room: Yes, the 360 is outselling the PS3 today (although not in Japan), but the PS3 comes bundled with a Blu-Ray player, whereas you have to buy the HD-DVD player (standalone or as an attachment for the 360). So, there's now a fair number of Blu-Ray players primed for use.

3. Prediction: Apple is about to release a Blu-Ray equipped (range of) device(s): This is a no-brainer. Apple has to join the High-Def battle soon, and they're on the Blu-Ray board. This might even happen today. The studios likely got wind of this early, and they know not to bet against Apple's streak in the digital media market. This could well have been the tipping point for WB and Universal's recent decisions to support Blu-Ray.

What does this mean for the Console Wars?

That's anyone's guess, really - there are a number of variables - but here are my predictions.

People will continue to buy consoles for the games they offer, but with Blu-Ray gaining popularity, the market will tip towards the PS3. Today, the 360 has better content, period. But Sony has a lot riding on the PS3 and a decent in-house studio. With PS3 sales already on the rise after the price cut, Sony should spend more money to convince studios to create exclusive games for the PS3 (and/or release games early for the PS3 if they support other consoles too). Given the right incentives, studios will begin to build more PS3-exclusive games. Since most next-gen console owners also own HDTVs, the Blu-Ray factor will be on everyone's mind. All other things being equal, a 2-in-1 device is better than a single-use device - and game and movie studios know this. Sony does have at least two things working against it though. The rumblings in the industry is that it's more difficult to develop and debug games on the PS3 than the Xbox - but with time I'd expect the tools to get better, and this to become less of an issue. There's also the fact that the 360 is a better console. So I'd doubt that Microsoft would lose to Sony, but their victory over them won't be quite as emphatic as it might have been. There will be another round.

Microsoft now has three choices (well, four if you include "do nothing", which is still a viable option now, but may not be for too long if Sony plays its cards right):

1. Drop the price of the 360 to the point that the 360 plus a standalone Blu-Ray player is cheaper than a PS3. This will cut deeply into their margins, and might be met by a corresponding (and therefore less deep) price cut by Sony. To win the price battle, Sony needs to be priced at a JND (just noticeable difference) vs the Xbox + Blu-Ray player combo. That's not hard to do, give the price of Blu-Ray players. The bottom line is if this becomes a price war, Sony is almost a shoo-in to win.

2. Drop out of the format wars and adopt Blu-Ray. Bundle a Blu-Ray player with new consoles. Ouch. That would involve admitting they made a big mistake, but could still be their best move, especially if they offer current HD-DVD attachment owners a nice rebate on the new Blu-Ray attachment (early adopters understand the risks, but you don't want to annoy them too much - witness the iPhone price drop fiasco). If they do this, though, they'd owe Sony royalties on every console they sell. Regardless of who wins the console wars, Sony would win big if this happened. Microsoft is unlikely to want to hand Sony that kind of advantage because it could hurt them in the future.

3. Bundle the HD-DVD player with every new Xbox. I think it's already too late for this to work now, although it just may give HD-DVD a stay on execution and some time to try to win more content. Sony's console sales are already on the rise, and the clock is ticking. If Microsoft wants to adopt this strategy, the time to do so is yesterday. This will also likely annoy people who have spent money on buying the HD-DVD player as a standalone attachment, but I think it's still viable.

Could Microsoft have seen this coming? Could they have done something about it?

Yes and yes. The writing was on the wall for a while. None of what's happened recently should have been hard to predict, given Sony's incentives (they were betting the farm on PS3 + Blu-Ray) and Apple/Disney's choices (made quite a while ago). With many consumers staying out of the market while the HD wars rage, Sony's technique of building an installed base of Blu-Ray players in the living room needed to be countered quickly. After all, once you have an HD player, the cost to try the new format is just the cost of a high-def disk. This effectively means zero lock-in, which in turn encourages trial. If Microsoft had bundled their HD-DVD attachment with the Xbox 360 in Q3 of last year, the holiday season sales might just have changed the outcome. It's a fair bet that it would have prevented the camp-switching by WB and (effectively) Universal that now looks to be the death-knell for HD-DVD and, in consequence, a significant strategic win for Sony in the console wars.

On the other hand, it could very well be that Microsoft saw this coming, weighed the pros and cons and decided that the success of HD-DVD wasn't important enough for them to invest further in the console, and chose to take a wait-and-watch approach to Blu-Ray. This is the do-nothing approach, which in my opinion is not the best tactic given the strategic landscape.

Final words: After the Sony rootkit fiasco, I really really hoped Sony wouldn't win. A company that cares that little about its consumers really shouldn't be controlling the next generation of media. But this blog is about strategy, not wishful thinking. :-)

Update: Today (1/29/08), Woolworth's in the UK announced that they will stop selling HD-DVDs in store, and will only sell Blu-Ray players in the future, and cited the Playstation 3 as the main reason for the success of Blu-Ray over HD-DVD.

Update: Today (2/11/08), Neflix and BestBuy threw logs on the fire by announcing that they, too, will only be stocking Blu-Ray.

Update: (2/19/08) It may be happening already. The rumor mill says Toshiba has decided to stop manufacturing HD-DVD hardware, and the PS3 outsold the Xbox 360 in January even though the game library for the 360 is significantly better. [Source: Kotaku]

Update: (3/10/08): Microsoft just dropped the price of the Xbox 360 in Europe. Almost certainly a result of the price pressure being put on them due to Sony's victory in the High-Def war.

Offtopic: Windows Live Writer Rocks

Thank you, Microsoft, for a truly awesome tool - Windows Live Writer. Life's better when you have a real offline editor for your blog!

The Art of Warcraft: Business Strategy Lessons from Warcraft 3

My first strategy game, a long long time ago, was Dune - the game that made Westwood (now part of EA) famous, the franchise that was the foundation for the seminal Command and Conquer series.

I have to confess, though, that ever since Warcraft 3, I haven't really gotten into another strategy game (if you have suggestions, I'd love to hear them), even though I've dabbled with several, including the latest Command and Conquer (Tiberium Wars).

Over the years, it's struck me that strategy games are an excellent analogy for business. So I sat down to pen the list of business lessons I've learned playing Warcraft 3.

 

1. It's all about resources: Ultimately, the player who can gather resources quicker and spend them more effectively will win. It's a law of nature. Effective resource utilization beats luck every single time.

2. But it's also all about how you spend your resources: Plan how you spend your resources, but don't hoard. When you save, save up enough to build something new. I've lost more than one game where I've gathered resources at a prodigious pace because I forgot to spend them. If I ever lose a game with more than 500 gold, I know I've lost because I didn't spend my resources wisely. That's also part of why a small, nimble company can beat a goliath - because they spend their resources effectively.

3. Pay attention to all your resources: Resources are complementary. Gathering too much of one and too little of another is a common mistake because your true resource level is how much you can effectively spend. In the case of Warcraft, if you have tons of gold but no lumber to spend on an upgrade or unit, you might as well not have the gold. In business, if you have great products but don't have the marketing resources to publicize them, you won't win (and conversely, all the marketing in the world won't sell a bad product).

4. Expand quickly, but remember that you're most vulnerable when you're expanding: Getting an expansion early in the game can be a key strategic advantage. But if your opponent kills your expansion, you stand to lose a lot. Expanding is an advantage, but it divides your attention. As you expand, it becomes even more important to keep tabs on your opponents so that you can counter their attacks early and prevent them from striking a devastating blow.

5. Sometimes it's all about speed: In some cases, if you can find your opponents quickly and prepare your army well, you can kill them before they ever become a real threat. There's a reason why some players specialize in the rush - it works if you know how to do it. Sometimes winning in a market is all about outflanking your opponents early, when they're vulnerable. This is particularly true if you know they'll be formidable opponents later in the game.

6. It's all about information: If you can find your opponent quickly, you can often win the game by making guerilla attacks when he's most vulnerable. If you can keep constant tabs on your opponents, you can find out exactly what they're doing and counter everything they think of throwing at you. Use every information source wisely.

7. Sometimes you just need to control the center: Seek out key resources and control them. In Warcraft, this could be the health fountain in the middle of a map . In business, this could be a key market, channel etc.

8. If you're in it for the long run, upgrade constantly: If you can't go for the quick win, you'd better be upgrading your units (products/services) as soon as you can. Upgrade their attack (build new features), armor (nullify competitive advantages), and build complementary units that increase their effectiveness (partner well and get a good ecosystem going). Innovation is a powerful competitive advantage - in a free market, a lack of innovation is a death knell. Don't skimp on R&D - ever. Just make sure that your R&D has focus and that you're spending your R&D dollars on the most important things.

9. One powerful unit never wins the game: (at least not against a good opponent). No matter how powerful a unit, there's usually a cheap way to defeat it if you're prepared. Don't spend all your money on the big units - they can die fast if they don't have the right backup. Don't put all your eggs in one basket - remember to complement your main strategy with all the support you can bring to bear.

10. Build and protect your unique advantages at all costs: I've rarely won a game without a powerful hero or two. Identify your key competitive advantages early. Build them up so that they complement each other, so that the whole is more than the sum of the parts. Sometimes, this can make all the difference in the world. Protect those advantages well, too. No matter how small a threat may seem, defend your competitive advantages aggressively. In Warcraft, you upgrade your hero by winning small battles, against opponents or against neutral armies, and the more you upgrade your hero, the more likely you are to win. In business, the more unassailable you make your competitive advantage, the less likely you are to face a serious challenge.

11. Sometimes your biggest advantages are also your biggest weakness: In Warcraft, some units can give you a huge advantage, e.g. the mages, sorceresses, etc., but they're inherently weak and vulnerable to attacks. A smart opponent knows to target these units first. So make sure you have adequate backup and defense to keep your opponents at bay so that you can use your advantages to their fullest rather than lose them quickly.

12. Sometimes you lose, and that's a good thing: Even the best-planned strategy can go awry, and sometimes it really does come down to luck. That's when it's time to cut your losses and move on. Save that replay. Figure out what the turning point in the game was. Learn how you could have spotted that during the game and how you could have averted your loss. You may lose one game, but you'll win several more because you're a wiser strategist.

13. It's never just one game: You've just lost a game that you invested an hour in. Several times you felt like you were on the verge of winning - but you lost. There's always another game. Move on.

14. Build a home court advantage and use it:  If you have no defenses at your base in a long game, you're asking for trouble. The best way to defeat an opponent is to lure them to your base and use your defenses in concert with your units while you decimate their army. If you can force a competitor to play in a market where you define the rules, you're almost guarantee that you'll win the battle. And once you've weakened them sufficiently, you might just win the war too. Conversely, if your opponent has the home court advantage, it's a bad idea to fight them there. Lure them away, then attack them.

15. Attack when your opponent is weakest: I've won innumerable games of Warcraft by knowing when an opponent is attacking a powerful NPC and attacking them from behind. It's hard to win when you're fighting on multiple fronts. Know what your competition is up to, know when they're weakest, and use this information to secure a competitive advantage.

16. It always helps to have a Plan B: Sometimes you can do everything right and still get surprised. It helps to have a Plan B.

Any other business/life lessons you've learned playing strategy games? I'd love to hear about them.

(Update: I guess I'm not the only one who thinks Warcraft is an excellent way to learn to think strategically)

The One-Price Myth, Part One

In my first days in business school, my microeconomics professor (and an excellent professor he was) presented what I call the One-Price Myth - one of economics' favorite theories, one that is as flawed as it is compelling. The basic idea is that in a world with perfect information and no artificial barriers to competition (e.g. patents), every product is a commodity and will sell at the lowest price possible.

The argument is compelling - when you sell the same product as someone else, customers will only buy from the person who sells the product the cheapest, forcing everyone to price at the lowest price they can charge. The higher-priced sellers (who may just suffer from having a worse cost structure) will go out of business, leaving the remaining vendors with one low price. (This is a bit of an over-simplification since it ignores the effects of local cost structures and the fact that it costs a customer time and money to travel long distances to buy a product ... but for a given area, this should be true - shouldn't it?)

One could argue that most retail is just the business of selling products that anybody else can sell, and that the advent of the internet, price comparison websites and online stores selling just about everything makes for an environment of perfect competition. So the same product should cost the same amount everywhere, right?

The Nash Equilibrium website offers some fascinating insight. The website is named after one of the fundamental tenets of Game Theory, postulated by John Nash of A Beautiful Mind fame, which states that in any multi-person game, an equilibrium only exists when no player can benefit by unilaterally changing their strategy. The website tracks internet price competitiveness, i.e. the level of price competition seen on the internet, as measured by the price variation on various pricing sites. Here's the price gap data on the website - a graph that summarizes the difference in price between the two lowest prices for every product that they track.

Price Gap data on Nash-Equilibrium.com



What's interesting about this graph is that the price gap appears to have slowly moved towards a non-zero "equilibrium" - i.e. the price difference fluctuates in a narrow band around 2%. What gives?

The obvious answer is that a product is never just a product. This is more true in brick-and-mortar stores than with online retailers, but it does hold true online too. The reputation of a website and the customer experience it provides are also determining factors that create the potential for charging different prices. For example, Amazon.com has built a reputation for charging low prices (close to the lowest prices offered by any reputable vendor), offers many of its customers free expedited shipping on most products it sells (through the Amazon Prime program) and has an easy and clear return policy. People are usually willing to pay more for a trusted website that offers these perks. All these factors make it less likely that customers will shop elsewhere for, say, a 2% price difference.

Sure, reputation makes a difference, but what about a well-known big-ticket item sold by different well-known retailers? Shouldn't that cost pretty much the same anywhere? After all, people are more likely to be price sensitive for big ticket items, especially when reputation is less of a factor, right?

Glad you asked.

Here's the price range on a 46" flat-panel Sony TV (KDL-46XBR4), on some popular internet retailers:

Amazon.com: $2719.96
BestBuy.com: $2969.99
CircuitCity.com: $2699.99
(SonyStyle.com: $3099.99)


Hmm.

And here's the price range on a Canon EOS40D kit (with 28-135mm lens)

Amazon.com: $1399.99
BestBuy.com: $1499.99
CircuitCity.com: $1399.99

That's wacky, isn't it? What gives?


At least two things.

First, the strategy of randomization comes into play. All things being equal, it acutally pays to randomize your price from time to time within a certain price range. Why?

• You can attract price sensitive customers when you're the cheapest game in town.
• At the same time, you can charge many customers who are less price sensitive and have built a relationship with you a slightly better price, depending on when they make their purchase. Further, by offering a price guarantee, many retailers ensure that loyal but price sensitive customers don't feel screwed - if they see a lower price on the same website within 30 days, customers can ask for and get a refund of the difference. Most won't.
  Just because information exists doesn't mean people use it. You'd think most people would comparison shop for big ticket items, but there's a surprising number who don't. Once a vendor acquires a reputation for pricing reasonably, many people will just assume their price is pretty close to the best price they can get and buy from them repeatedly. Of course, the vendor has to make charging a low price part of their strategy for this to work. One or two bad experiences will drive "trust" shoppers away in droves.
• It makes it less likely that you and your competition will get into a price war and drive the prices down to a level where nobody's making much money.

In other words, price randomization within a certain range is a Nash Equilibrium - nobody can do better by unilaterally changing their strategy because they'll either make near-zero profits on every deal (by always charging the lowest possible price), or they'll bleed customers, and eventually money (by consistently pricing higher).

Second, the customer experience and additional benefits offered still create opportunities for pricing differently. Despite being well-known brands, Amazon has a very different customer experience than Best Buy or Circuit City (with Circuit City, IMHO, being the worst of the three, and Amazon up-and-away the best). Creating a superior customer experience costs money. Customers understand this, and the people who value the experience are willing to pay for it. A product is never just a product. This is the same reason why outlet shopping and traditional retail can coexist at significantly different price points - for some people, the outlet shopping experience makes the lower prices unattractive.

But what really surprised me is that Best Buy had higher prices for both the products I chose above, and the prices were significantly higher. One possible explanation is that the brand association with electronics is strong enough and carries over from the brick-and-mortar stores to the web so that lots of people who want to shop for big box items online automatically shop at BestBuy.com, and the difference in margin more than makes up for those who don't . Another possible explanation is that Best Buy doesn't yet get this online thing. :)

Introduction

I started this blog in early 2008 to share my thoughts - and spark discussions - on business (particularly strategy and marketing). In the days to come, this blog will feature articles on key business subjects, analyses of interesting strategic moves - good and bad, and miscellaneous thoughts on business (with a focus on technology and e-business).