Is BEA Systems the Next Microsoft? Part 2.
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The Luskin Report
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RULE THE WORLD
Is BEA Systems the Next Microsoft? Part 2.
Paul Philp
Saturday, September 8, 2001
BEA Systems could end up controlling the "operating system" for eBusiness the way Microsoft controls it for the desktop.
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Read Part 1 of this article
In Part 1 of this article we examined the market opportunity for BEA Systems. As business transforms into eBusiness there will be a need for a standard platform to build and integrate all these new eBusiness applications. The opportunity for BEA is to set the standard for this new platform. In other words, BEA has the opportunity to be the Gorilla of eBusiness infrastructure.
Technology Gorillas: First Principles
As I mentioned in the part 1 of this article, the idea of the technology Gorilla was corrupted during the Internet bubble by everyone calling anything that moved a Gorilla. Since BEA is the first Gorilla candidate to emerge in the post-crash era, it is beneficial to review the main principles on which Gorilla theory is built. With these principles in front of us, we can look at the pro and con case for BEA being a Gorilla.
The Gorilla concept is built from four key ideas: architecture; network effects and increasing returns; whole products and value chains; and tornado markets. Let's look at them one at a time.
1. Architecture
The most overused and incorrectly used word to describe technology markets is "paradigm." There is always some pundit or guru pontificating about the next big paradigm shift in technology. The correct term to use in place of paradigm is "architecture."
All technology battles are ultimately architecture battles and the stakes in these architecture battles could not be higher. The IBM PC architecture was chosen as the standard and the Apple Macintosh was not. The Microsoft Office architecture was chosen and the Lotus SmartSuite was not. Apple and Lotus lost many billions of dollars in profit when their architectures lost.
What is architecture? The word comes from the Latin roots archi and techton and means leader or organizer of work. It was used in medieval times to refer to the leader of the work to build the large cathedrals. The architect made sure that all the pieces of work came together well and everything was in the right place at the right time. In effect, the architect brings order to chaos.
This is exactly the role of architecture in technology industries, to impose order on all of the systems, software, components, communication devices, storage and data that go into modern systems. Technology customers are no longer satisfied with a single vendor; one size fits all approach – the old IBM approach. Today companies piece together systems that combine the best technology products in a way that meets their unique business needs.
At the center of all the diverse pieces is one company – the architectural controller – enabling and ensuring that all the required pieces exist and fit together efficiently. In the mainframe era this architectural controller was IBM. In the minicomputer era Digital Equipment served this role. The architectural controller is a company that defines or controls at least one of the standards needed to allow all the system components to interconnect.
Most architecture controlling companies now make all or part of their architecture open. That is, they publish the standard interfaces that allow other companies to build products to fit into the architecture and enhance the value of the overall system. For example, the communication protocols and page descriptions used to control a Hewlett Packard laser or ink jet print are published. This makes it easy for companies to build product that are compatible with HP printers. A classic example of a company that kept their product architectures closed is Apple with the Macintosh.
Currently the largest market with a closed architecture is that of the video game consoles. Sony and Nintendo keep their interfaces tightly guarded and only give access to licensed game developers. This closed approach has allowed these companies to be very profitable in the games market. However, the strategy of using the game console as a general-purpose entertainment and Internet device will fail until one company develops an open architecture. The open architecture strategy is a game Microsoft plays very well and it will be interesting to see how open they make the Xbox.
The last key issue regarding architecture is proprietary vs. nonproprietary architectures. Proprietary architectures are ones where the standards and interfaces are owned and set by one company. An example of a proprietary architecture is Windows controlled by Microsoft. Non-proprietary standards are ones that are set by industry committees or government agencies. Examples of non-proprietary architectures are the Internet standards such as Internet protocol (IP), XML, HTML and HTTP.
Conventional wisdom states that customers would be better off with all non-proprietary standards so that they are not beholden to one company. In many cases this is actually the case. However, standards that are set by committee tend to be lowest common denominator standards, which are extremely hard to change or improve. Proprietary standards are set by one company and can be altered in an orderly manner, as market needs change. It is the economic role of the architectural controller to be the ongoing source of innovation in its industry.
Ultimately all technology markets become architectural battles where the best product and best marketing do not always win. Successful architectures tend to be both open and proprietary. Understanding the dynamics of architecture is crucial for the Gorilla Game investor since it is the Gorilla that becomes the architectural controller.
2. Network Effects
The network effect explains some of the seemingly strange behaviour of technology markets. In particular, competition in technology markets is extremely brutal and in most markets the winner takes most of the market and along the way market share can be very volatile. On the other hand, industrial markets tend to have very stable market share with one winner and two or three large followers. In the automotive industry GM, Ford and Chrysler established their number 1, 2, and 3 positions by 1930, and the relative positions have not changed for seventy years.
Network effects emerge from one key property of networks – the more participants there are in the network, the more valuable the network. Small networks are inherently less valuable than large networks. This is why AOL has such a strong lead. AOL has 25 million members, which is 5 times more than the closest rival, MSN. Which network is a new member likely to join? Since it is probable that friends and colleagues are already AOL members it makes sense to join AOL. It matters little what features or information MSN adds. The point of belonging to a network is to be able to connect and share with other members of the network. AOL has a too strong a lead to be seriously challenged. The same reasoning accounts for the success of Ebay.
Industrial economics are self-limiting. When one company begins to make a good profit others soon enter the market and begin to compete. As more companies enter the market price begins to drop and the amount of profit available begins to decline and later entrants fail for a lack of profitable opportunity. This self-limiting mechanism maintains order and stability in industrial markets.
In technology markets, success is self-reinforcing. The more a company succeeds initially the more likely it is too succeed in the long term. This leads to what economist Brian Arthur calls "increasing returns." Increasing returns are the tendency for the company that is already ahead to get further ahead. In technology markets, seemingly small advantages can be magnified and become enormous advantages very quickly.
Increasing returns is why technology markets have a winner take all nature and lead to apparent monopolies. Winners in these markets don’t just get a lead, they get a virtual lock on the market. Technology markets require a standard and winners are the companies that set the standard. In this way, the value of the standard setter in a network includes not just the value created by that company but by the entire network.
Another property of networked technology markets is what Brian Arthur calls "groove-in." Once a company or consumer chooses one network it is too expensive to change to another network. In the AOL example, it is difficult to learn how to use AOL and once you do it does not pay to take the time to learn MSN. Also, your friends and family have your AOL email address and you are already on all their Instant Messaging buddy lists. Groove-in assures that once you are a customer of AOL you will never switch.
The combination of increasing returns and customer groove in assure technology market leaders virtual dominance over their market once they can get even a small lead. This effect is central to understanding how Gorilla companies have the massive power they wield. In the case of BEA, understanding the power of the network effect is required to understand their powerful competitive position.
3. Whole Products and Value Chains
I remember when I was growing up that I wanted to have a kit radio. The kit included all the parts needed to assemble a radio and some rudimentary instructions on how to put it all together. The joy came in turning on a radio you had built yourself and hearing the first songs crackle through the speaker. The first personal computers, including the Apple 1, were similar kits for enthusiasts who enjoyed putting the things together. Most consumers and business buyers have no interested in piecing together their own solutions. They want to have all the pieces they need to solve their particular problem available in some integrated form.
Customers don’t buy individual products; they buy the entire system of products and services that best suit their needs. This entire system of products and services is the whole product. The whole product is more extensive than any one vendor’s product. Imagine the limited value of automobiles if there were no gasoline stations or repair shops. Technology products usually require the core hardware, systems software, applications software, development tools, interface to integrate into the current environment, end user training, custom configuration, maintenance and service that will change the product system as the business environment or needs change.
Geoffrey Moore, in The Gorilla Game, defines a value chain as “an interdependent collection of companies working together to assemble the various products and service offerings needed by the new market”. In other words, it is the value chain that delivers the required whole product to the market. Until there is a value chain in place to deliver the whole product a new technology product will appeal only to hobbyists, visionaries and small niche markets. The pragmatic mass market will not be compelled to try the new product until all the pieces are available.
The total value through a product is equal to the total value of its value chain. Now we can combine the concept of architecture and network effects to begin to understand how a Gorilla comes into existence. Since customers demand a whole product beyond what one vendor can deliver, architecture becomes critical. An open architecture that allows and encourages other companies to build product and services offerings is needed to create a value chain. The better the architecture and supporting tools, the faster a value chain can be created and the more value in the whole product.
Equally, as companies use the new architecture, they are, in effect, increasing the value of the network surrounding the new architecture. The more value there is in this network, the more attractive it becomes to other companies to adopt the architecture. In this way, once a Gorilla-candidate has developed a slight lead in developing its value chain, it creates a self-reinforcing virtuous cycle -- the end effect being that the large majority of possible value chain members select its architecture.
In this way, architecture, network effects and whole products work together organically to create the conditions necessary for a new Gorilla to emerge. There is just one missing element – the tornado.
4. Tornado Market
When a new technology is introduced it promises breakthrough benefits and amazing new possible applications. The companies selling the new technology speak passionately about how fantastic the world will be once everybody uses this latest technological wonder. The press writes article after article praising the wonders of this latest new new thing.
What is the response to all this excitement from the pragmatist majority in the market? Yawn! "I have heard it all before and I won’t get fooled again." "I am not going to do anything until everybody else does something." For the first few years after the introduction of the new technology, this remains the attitude of the pragmatist majority. They study the new technology, they attend conferences and they join web chat forums to discuss how and when to use the technology. They write cost benefits studies to show they are up on the new technology and might even start a pilot project. In short, the pragmatist majority will do anything but commit to the new architecture.
Meanwhile, the vendors pushing the new technology keep making their products better each year and begin to recruit value chain partners to extend the value of the whole product. After a while, the technology appears to be credible and even working for some people. Still, there is no movement from the pragmatist majority.
What happens next is one of Geoffrey Moore’s central insights in his books Inside the Tornado and The Gorilla Game. Suddenly and without warning, the pragmatist majority drops their resistance en masse and decides in unison that they must adopt the new technology NOW! The majority has become a herd, a rampaging herd. The resultant surge in demand is what Moore calls the Tornado.
What happened? First, the value chain delivering the required whole product for the mass market came into existence. Now it is possible for the pragmatists to buy a complete working solution. No tornado can form until this value chain and whole product exist. However, this does not explain the rampaging herd.
Remember, the core attitude of the pragmatist is they will not do something until everybody else does something. Suddenly, one day, the pragmatists look at each other as if to say, “I will if you will!” The idea is that by all moving at the same time they reduce the risk of adopting the new technology.
Once the herd has decided to move, they usually decide to all support one vendor – no point being the only one in a vendor’s camp. Which vendor gets chosen? The vendor that is prepared and able to sell to everybody all at once. The herd now wants to move together and get the change over with as quickly as possible. Any vendor putting obstacles in the way of the herd will not get chosen. This is why the best product is not always the chosen product. The herd doesn’t care as long as the product is good enough. They just want to be served immediately. The company with the biggest sales force, value chain and distribution channel will almost always be chosen by the herd and the industry settles on that company’s architecture.
The chosen company becomes the Gorilla in that market and their value chain becomes an industry. It is important to remember that it is the herding behaviour of the pragmatist majority which creates the Gorilla and it is very difficult to predict ahead of time which vendor the herd will choose. This is why there can be no Gorilla in a market before the tornado has formed.
In summary, technology markets require a common standard and architecture be set in order to maximize the value of the network and the whole products available to the herding pragmatist majority. It is the function of the Gorilla to set, maintain and revise this standard in a timely and orderly manner. In this way, the Gorilla in each market becomes the architect, imposing order where there would otherwise be chaos.
Now lets see how BEA stacks up. |
