Project Network Effects: Wind River Systems (WRS; WIND)
In this post, I analyze a gorilla candidate from the perspective of network effects to see what, if anything, is added by using that concept. A generic approach to analyzing network effects is introduced and illustrated using WIND as a case study. An integrative summary of Wind River's business model and progress to date is included, with many examples. My analysis centers on the addition in value that results from adding the concept of network effects to explain the dynamics of hypergrowth in the gorilla game.
This report is broken into multiple parts: I. Executive Summary; Sections A & B; II. Wind River's Business Model and GG Criteria + the Concept of Network Effects; III. WIND's Network Effects from Semiconductor Companies; Sections A & B; IV. Other Networks that Leverage WIND's Growth; V. Competitive Environment and Progress to Date; and, VI. Conclusion: The Added Value of the Concept of Network Effects. The Parts and Sections are of varying lengths. For many readers, reading the two-section Executive Summary may be sufficient.
Part I. Executive Summary; Section A.
Wind River is a mid-cap 400 company with $399 million in revenues in the last four quarters; it has been profitable every year since its IPO in 1993. It has 1,900 employees around the world, with 650+ Embedded Development Engineers and 650+ Personnel in Sales and Field Engineering. Wind River's mission is "to be the leading provider of reliable, innovative software solutions that enable our customer to create connected smart devices." As the market leader with a proven track record of success, Wind River is a key enabler of embedded systems that enable the emerging wave of connected smart devices. Although often hidden from the end user and looking nothing like a PC, an embedded system is a specialized, self-contained computer that consists of a specialized microprocessor, a real-time operating system (RTOS) ported to its specific architecture, and an application designed to perform a fixed set of functions, which are each programmed into non-volatile memory, so that the embedded computer responds to input signals in a rapid, reliable and deterministic way that keeps its operations moving at the required speed.
Wind River dominates the COTS market as the de facto standard, because: (a) WIND's has two-thirds of the COTS market, which is six to ten times higher than its nearest competitor; (b) WIND's two leading RTOSs are in over 150 million products; (c) WIND has the broadest and deepest set of products and the best service offering, with 650 field service engineers; (d) WIND, with 650+ development engineers, is the leader in innovation and its pioneer, with about 20 "firsts" to its credit, many of which became industry standards; (e) WIND is the only software vendor to support more than 100 microprocessors in 20 semiconductor families; (f) WIND has 50,000+ active developers; (g) WIND has four Centers of Excellence and 30+ value-added resellers; (h) WIND has 500 to 600 WindLink Partners whose specialized tools are pre-integrated with WIND, (i) an EE Times Survey revealed that 56% of engineers perceived Wind River as the leader in COTS usage, compared to 4% or less for QNX, Linux, Microsoft, Microtec, or Microware, and (j) there is room to grow in its RTOS market since in-house proprietary systems still comprise about 58 % of the total embedded market, compared to WRS's 36%, and its competitors' 6%.
Wind River's strategy for growing its market is to: (a) Focus on Customer
Satisfaction and Technical Excellence, (b) Drive Market Share by Enabling Major Processors, and (c) Address the Complexity and Time to Market Challenge. To do so, it plans to build, support, and globally service vertical, end-to-end solutions by proliferating its set of tools and integrated platforms that are specifically tailored to diverse microprocessor and application architectures (thereby achieving higher ASPs) that also are used end-to-end¾across Internet infrastructure, its servers and storage, and its connected smart devices.
Gorilla Criteria. Wind River is a gorilla candidate that is not in hypergrowth. Its Discontinuous Innovation is it COTS end-to-end solution for embedded software that the Internet demands to meet the challenges of increased complexity from rapid turns and proliferation of microprocessor and for IP and wireless connectivity. WIND's Open Proprietary Architecture: its architecture integrates its five layers of enabling software. It is open at one end by being ported to over 100 processors, and at the other end to over 600 WindLink partners who add their specialized development tools for specific market niches. Yet, the architecture remains proprietary, protected by copyrights, patents, preserved by the coded knowledge in its software that comes from investing hundreds of engineering years to produce it, as it remains continually upgradeable and innovative through the intangible but valuable expertise and know-how of its engineering team. High Barriers to Entry include the competitive advantages of each contributing component of an end-to-end software solution, including porting to over 100 processors, pre-integration of hardware-software, a RASS, memory-protected RTOS, the most complete set of tools for developing embedded applications, vertically integrated development environments for niche markets, a broad-range of middleware, and the ability to service, up-grade, and manage the embedded software through the WEB. The highest BTE is the increased complexity of embedded systems, including the needs for connectivity and management. High Switching Costs inflected upward with the ISI merger, which significantly increased their already strong competitive advantage gap by broadening their product line, increasing their design wins, and reaching a critical mass in engineers that lets them rapidly create new and enhanced products while providing outstanding service to embedded product developers. Having far surpassed their competitors in the range and depth of CAs, the cost of switching for existing customer are immense. Tremendous value is generated by WIND's Strong Value Chain based on its collaborative relationship with microprocessor firms in its four CoEs and in the reference designs of its 30+ VARs. WIND's strategic acquisitions of Rapid Logic for its management software and and EST for its hardware-assisted pre-integration with microprocessors, plus its development of Tornado IDEs designed for specific niche markets by scaling up and adding middleware to its RTOS increased both its influence and the relative value that WIND adds to the embedded system. Tornado is Foreseeable but not extant. WIND may become the recipient of cascading diffusion from several anticipated market tornados within the Internet markets, including lily ponds encompassing I/O servers, Internet infrastructure, and smart devices. Conservative investors may choose to wait for the Tornado's beginning or the anticipated growth in run-time royalties and the return of operating margins to the traditional 20% + level before investing.
Network Effects. The value of the Internet as an asset is determined by the expected benefits that it will generate. Yet, the use of the Internet will permit scientists, engineers, and entrepreneurs to leverage innovation beyond our expectations. The Internet is destined to generate benefits that we do not yet know that we want or need and that we cannot even imagine.
Metcalfe's law tries to quantify the nonlinear value of network effects. It approximates the magnitude of that increase in value by specifying: as the number of elements or nodes increases arithmetically, the value of the network expands exponentially. However, given the Internet, not only one-to-one, but also one-to-many, many-to-one, and many-to-many communication(s) occur among many sets of people. Necessarily, moving from one-to-one communication to many-to-many communications increases the number of potential interactions. Thus, it must expand the exponent beyond the square. What we know for certain about network effects is the bigger the better: the more elements, the greater the value. Therefore, "exponential" growth is properly used only in the vernacular sense of "compounding explosive growth."
Thus, the idea of compounding non-linear growth is at the heart of what is meant by network effects. Network effects exist when the value of a good increases because the number of people using that good increases. Michael Mauboussin argued that successful networks generate huge shareholder value once they reach critical mass and that a locked-in network effect produced a sustainable competitive advantage. He noted that the strongest network effects are driven by (a) interactivity, where there is a lot of contact among the members or nodes, although (b) compatibility, among transactions, communities, or devices also can produce strong effects.
Within the technology adoption life cycle, a network effect describes a dynamic of suddenly noticeable and rapid inflection in cumulative adoption when the diffusion reaches a critical mass and begins to generate explosive growth. Thus, a network effect is the dynamic of hypergrowth. Efforts to describe the inflection point of this accelerating growth dynamic have included phrases like "when a total solution is created," "when a compelling price point is reached," "when the value chain organizes to support a single standard," "when the buzz declares X is the next big thing," "when the last barrier to product adoption is overcome." These can be summarized as, "when the accumulation of competitive advantages tips decidedly in favor of a solution that either is in the process of becoming or is expected to become the popular or standard choice." Influence, as competitive advantage plus marketing, has met Susceptibility at the adoption threshold of the majority, generating explosive growth, that nonlinear growth-surge called "hypergrowth."
Since these Network Effects Reports are intended, above all, to be educational, you want to learn how to identify network effects generically. First, simplify the task by remembering that Everett Rogers, the Father of Innovation Research, defined "diffusion as the process by which an innovation is communicated through certain channels over time among members of a social system." Second, to examine potential network effects, focus on the drivers of strong network effects, interactivity and compatibility by finding both the social networks that permit the process of interaction among susceptible individuals to occur and the elements in a value chain in which compatibility among linked elements creates a total solution. Third, after identifying promising interactions in networks and compatibilities in value chains of products, imagine how influence specifically diffuses specific innovations that become more valuable as they become more popular until they reach critical mass or become a standard solution. Fourth, consider whether network effects have reached critical mass or just when cumulative adoption is expected to inflect rapidly and lock-in a strong, sustainable, and measurable competitive advantage.
Let's examine some networks effects in WRS. First, an End-to-End Solution. Each element, even each feature of an element that offers a competitive advantage, in its end-to-end software solution is an arithmetic node that creates an exponential indirect or compatibility network effect. So, the five enabling layers of software might be counted, say, as five nodes. However, the differentiation of products within each of these layers as specific software features providing a competitive advantage must raise that arithmetic number of nodes considerably. So, how do we count the compatible nodes? Do we count the layers, the tools, or the features? Each tool saves development time and reduces errors; each technical feature adds functionality. Do we multiply technical features or the tools across the five layers to approximate their non-linear value? Of course, what matters here is not a precise metric but the realization that integrated technology exponentially increases in value because of indirect network effects. The total value expansion becomes much more than the sum of the parts, inflecting skyward as it explodes in value.
Given the overarching need for a compatible and integrated end-to-end software solution, these value-additions, when taken together, promise a future of explosive growth. As the complexity of Web-based devices, the need for high-availability and memory protection, and the need to continually update the functioning of smart devices continues to grow, the value of WRS, the ubiquitous embedded enabler, will expand both its markets and penetration exponentially. Because its broad and differentiated, but integrated, products and features add exponential value to WIND's software solution, these compatibility network effects also must produce a higher rate for run-time royalties as well.
The Five Networks of Portability, Value-Added Resellers, Centers of Excellence, WindLink Partners, and Embedded Application Developers.
Second, Portability. WIND is in an enviable one-software-complementor-to-many-microprocessors-relationship across the domain of embedded semiconductor companies. WIND's ability to abstract the process of porting its software to many microprocessors (over a 100 variants in 20 families currently, and semiconductor product-turns are speeding up) is a significant competitive advantage. If you are not ported, you cannot compete.
Third, Value Added Resellers (VARs). WIND has over 30 VARs who sell embedded systems (or other enabling hardware or software) that pre-integrate WIND's software with their processor, core, or controller. Traditionally, the OEM's process steps have been: (a) select vendor, (b) integrate system, (c) develop application, (d) test product, and (e) manufacture it. The increased complexity and faster turns in processors, and, hence, the need for new products has pressured the system integration portion of the OEM cycle, expanding the time demanded from about 10% in 1995 to about 30% in 2000.
Fourth, Centers of Excellence (CoEs). The process of pre-integration to individual embedded microprocessors is carried further still in Centers of Excellence, which are strategic alliances of Wind River with specific embedded semiconductor manufacturers that jointly optimize embedded system functioning. CoEs speed up application development by providing reference designs, simulation and prototyping tools, and road maps of future embedded systems. WIND's CoE partners distribute Tornado/VxWorks with their microprocessor, acting as a VAR, but this CoE relationship is more extensive because of the planned collaboration on new processors variants and families in the future. Four CoEs have opened, with Intel (2), Hitachi/ST Phillips, and MIPS Technologies.
Direct Network Effects with Semiconductor Companies. Indirect network effects based on compatible products become direct network effects when people influence one another to consider or adopt new technology. The three types of complementor relationships discussed above create social channels for communication between engineers at Wind River and semiconductor manufacturers. Not only that, within each corporation, interaction meets susceptibility because announced strategic relationships both increase the level of influence from above and decrease the threshold of susceptibility of those below. We are particularly susceptible to the influence of our leaders, who represent authority and provide social validation, particularly when they tell us that a strategic relationship with Wind River will make our jobs easier as it raises our profits.
Because porting is necessary and pre-integration optimizes performance and speeds time to market, these competitive advantages of WRS, which has the only hardware-assisted approach, as well as the COTS industry's only value chain of VARs and CoEs, extended and propelled Wind River to dominance in the COTS market.
The competitive advantages created by indirect network effects build momentum through influential interpersonal interactions through channels of communication in social systems, producing strong direct network effects that reach critical mass, in turn, producing strong and sustainable network effects. If you need RASS, you are locked in; if time to market is critical, you are locked in; if management of connected smart devices is necessary, you are locked in; if you want to compete with others who are using the WRS solution, you need to lock in. After it VARs and other hardware customers are locked in, WRS has a sustainable competitive advantage.
Because complexity and Web-based communication requirements are increasing, it becomes the easiest and best business practice to standardize on the end-to-end leader. This does not create a monopoly that restricts trade, because any software company can pay, say, Intel to let it port its embedded RTOS to one IC or to a family of Intel microprocessors. Nonetheless, standard business practices tend to create a natural monopoly through the bandwagon direct network effect. Everyone wants to ride with the popular leader. At the same time, an indirect network effect based on WIND-compatibility is created across diverse embedded microprocessors that are all using WIND embedded software in diverse applications. This may prove to be increasingly useful in the Internet era of connectivity as WIND links millions of smart devices, becoming a valuable real option in Wind River's future.
Fifth, the Network of 500 WindLink Partners. According to a recent press release, WindLlink has grown to 600 members; it is the largest network of embedded-software partners in the world. WindLink's members provide products and services that work hand-in-hand with Wind River to supplement WIND's end-to-end software solution in specialized niches. Wind River Direct describes all needed products and services in one place. Some partners are providing software or services that extend or expand functionality, including the sort of middleware that extends the RTOS into an operating system that manages specific niche functions, say, in a cable modem or an input-output processor in a server; other partners have more extensive partnerships with WIND. As an example of the latter, the Motorola Computer Group and WRS have a long-term partnership that encompasses field sales, marketing and business, product development and engineering, and technical support.
Many WindLink partners join the leader in embedded software to insure their products ride along on Wind River's bandwagon. This requires pre-integrating their products with Tornado/VxWorks. Eric Johnson, the President and CEO of Banderacom tells us why, "A survey of our customers indicated that Wind River Systems already supplies the most popular embedded software and development tools for InfiniBand equipment in development or planned." The many members of Wind River's value chain repeat this refrain of "most popular". WIND's popularity shouts, "direct network effects." |
