Project Network Effects: Wind River Systems (WRS; WIND) (Cont.)
Part VI. Conclusion: The Added Value of the Concept of Network Effects
Conceptual distinctions clarify what was obscured before the distinction was named. I argue that the term "network effects" names the "dynamics of the process of adoption" within the Technology Adoption Life Cycle. The diffusion of innovations involves a social psychological process in which influence meets susceptibility, influence that is communicated through network-like social channels.
Being able to identify the inflection point in the S-Curve appeals to investors. Recognizing that some forms of "lock-in" create a sustainable competitive advantage, the key to a long CAP, is among the most significant insights that a long-term investor can achieve. However, the GG elevates the conceptual distinctions summarized as "Open Proprietary Architecture" as its penultimate criteria of a lock-in, with, perhaps, "proprietary control over the architecture has already created a demonstrated control over the value chain during a tornado" as its ultimate criteria of lock-in. In the GG, a long CAP depends on HSC and BTE; whereas, a DI that adds significant value ensures a tall GAP.
I have argued that Wind River has achieved considerable architectural control: as they continue to add features to their RTOS, set of tools, and software building blocks, competitors must equal them or experience significant competitive disadvantages. Five recent acquisitions added significant value to Wind River. Not only are they significant individually, when their effects are combined, they also appear to be beyond duplication. First, the EST acquisition, which that brought them hardware-assisted pre-integration, further increased their competitive advantages in porting, including certain advantages that are both unequaled and proprietary. Second, the Rapid Logic acquisition, which brought them a sophisticated software management system, permits them to service and upgrade embedded devices over the Web, an increasingly important feature in the Internet era that further expanded their competitive advantages in this area. Third, the acquisitions of AudiSi and IceSoft strengthened their already strong Java-based offering in the burgeoning realm of Internet appliances. Finally, the ISI acquisition gave them two significant advantages: first, it created network effects in engineers, products, and customers; second, it substantially raised switching costs by permanently changing the structure of the COTS competition. That is, the closest alternative company for an RTOS and tool set fell from the level of ISI, who was a credible competitor, to competitors who are about 6 to 10 times smaller and less competitive than the combined companies. The difference between Wind River and ISI equals the value added to Wind River's value proposition by acquiring ISI. The difference between the value proposition of the new Wind River and that of its much smaller, current, next closest competitor estimates the switching cost (the difference in relative value added) of moving from Wind River to the much smaller and less full-featured COTS competitor. This is a tall GAP.
By joining the multiple networks of ISI with the larger, multiple networks of WRS, the network effects of the new Wind River inflected sharply upward. The key point is this: network effects amplify the value of all competitive advantages. That is, instead of competitive advantages (CA) being additive, network effects multiply the arithmetic number of nodes of each CA exponentially. Competitive advantages become stronger through a compounding explosive growth in value from the amplification of network effects.
Moreover, network effects are the dynamic drivers of the TALC. This implies that network effects, because they are the dynamic amplifiers of competitive advantage, directly drive four gorilla game effects that are embodied as the six criteria of a Gorilla: Strong Value Chain, The Tornado of Hypergrowth, High Switching Costs, and Barriers to Entry. Each arithmetic addition of competitive advantage in these four realms produces the exponential increases in value that are both created by and reveal the presence of network effects.
Although network effects have a discontinuous affect when they reach critical mass, they are, of course, not a Discontinuous Innovation. Nor are network effects implicit in Proprietary Architecture. However, the concept of "Openness" is all about the sort of compatibility that creates indirect network effects.
As I understand it, the principal analytical question is whether network effects that reach critical mass or become locked-in, indeed do produce a strong and sustainable competitive advantage. If so, is that network-effect-driven competitive advantage sufficient, without a proprietary architecture being necessary; or, going further, are locked-in network effects as strong and enduring an advantage as the one created by a proprietary architecture? Given that no one currently can supply adequate empirical answers, investors must form their own individual judgments.
I believe that Wind River is a gorilla candidate that is not yet in hypergrowth. Also, I believe that WIND has achieved a technology and business lock-in: the strength of its products and value chain produce competitive advantages that are multiplied by its network effects to lock-in a strong and enduring competitive advantage.
But, Wind River's business momentum at levels of hypergrowth is promised but not yet fulfilled. The lily ponds are growing but are not yet visibly manifested in an unmistakable way that the end of summer brings.
To invest early in the summer, you must embrace an investment theory that posits that network effects achieve a lock-in when they reach critical mass. It is to believe that indirect network effects based on pre-integrated compatibility in hardware and software produced a needed solution that already has created strong competitive advantages, so strong that they ensure that subsequent direct network effects are highly probable if not inevitable. It is to believe that you can forecast what is now invisible before it becomes obvious and inevitable. It is to believe that strong network effects can be sufficient to produce a sustainable competitive advantage. The conservative GGer, however, may consider this pursuit to be brash and speculative, as greed seducing the unwary and unwise.
Of course, I believe it is this dynamic of network effects reaching critical mass that inflects product adoption in the now susceptible early majority that underlies the tornadic growth within all gorilla games. I contend that this dynamic inflection combines the indirect network effects of a value chain forming around a compatible total solution and the direct network effect of mass adoption by consumers. Network effects engender visible explosive growth when the numbers of nodes producing continually compounding growth reach critical mass and inflect skyward.
That this still invisible process will occur may become apparent from other information about product adoption (recall Mike's pointing to QCOM's CDMA subscriber numbers before the Ericcson deal) before the criteria for sequential and year over year growth in revenues that define a Tornado have been reached. (Given the time lags between design wins, product manufacturing, and products sales reaching an inflection point in the TALC, Wind River's royalties are lagged at least two to three years behind a design-win-inflection.) Making such a predictive inference is undoubtedly far less certain than clear evidence that the Tornado has begun; it is an early warning sign, a tornado watch, not a tornado warning announcing, "invest now because the Tornado is imminently upon us."
Long term investing requires independent thinking, patience, the discipline to control our own fear and greed. This post is an exercise in independent thinking; you must supply your own independent thinking about its value, and, of course, only you can supply your own patience, and your own discipline.
I hope this integrative summary and analysis helps. Its purpose is primarily educational. I know that it is no substitute for your own due diligence, but I hope it helps you begin.
Don
Disclaimer: I have been long Wind River since spring-summer of 1997. Each year I make a fervent toast, saying, "Next year in Jerusalem." I am neither a technologist nor a financial expert; so, this is all just my opinion. I do believe Allen Benn is an expert; he responds to questions on the WIND, Up, up, up! thread. I have learned a great deal by studying his posts. If you disagree with me, please post your comments; if you find any of this useful, please let me know by private message. Sometime, I begin to believe and fear that I am merely amusing myself with these long posts and annoying everyone else. |
