Winning the Internet market-share war may not be all it's cracked up to beConventional wisdom says that Internet markets are winner-takes-all and there is no reward for being second best. Couple this with the prevailing view that the first company in a market segment to establish a presence on the Internet will usually be the winner, and we end up with first-mover-takes-all. Finally, there are claims that Internet winners will be next to impossible to dislodge, even when a superior rival comes along - a condition known as lock-in. Add this all together and it's hard to avoid the conclusion that first movers take all - and keep on taking.
If you are a little late to this market, don't give up hope. Before the first movers head off to count their billions, and before the rest of us head off to contemplate what might have been, know that our research tells a very different story. Despite all the hype in the press, failing to be the first online entrant in your market isn't that much of a handicap. Markets - online and off - are rife with initial entrants being dislodged by superior products. Furthermore, most businesses are not in winnertakes-all markets. There is in fact room to be the second best, the second biggest or the second to have a Web site.
What Makes a Market a Winner-Takes-All Market?
Winner-takes-all markets are likely to occur when a company's size alone gives it an advantage over actual or potential rivals. Traditionally, bigger has been cheaper, at least up to a point. This was Henry Ford's theme a century ago. The average cost of making Model Ts went down significantly when Ford began making large quantities of them. With average costs falling, building more cars meant increased profits. The same holds true for software today: developing code tends to cost a lot, but since reproducing it and delivering additional copies doesn't, average cost falls as more units are sold.
Of course, economies of scale do commonly run out of steam - beyond some point, bigger isn't necessarily cheaper. For example, several of the world's leading automobile producers already squeeze the maximum benefits out of large-scale production, despite being smaller than GM. In this case, size may become a disadvantage because of the complexity of managing an extremely large organisation.
Lately, economists have focused on a different form of scale economy called a network effect. A network effect occurs when customers benefit from the presence of large numbers of other customers. For example, the owner of a fax machine benefits from the fact that there are many other people with fax machines. Some say that this type of scale economy does not run out of steam - consequently, bigger is better and better gets still bigger.
Do Winners Keep Winning?
Suppose a market is a winner-takes-all market after all. Does this mean that the winner locks in its winning position?
There are numerous cases in which this type of lock-in was widely alleged by economists, popular writers and even the US Department of Justice. The QWERTY keyboard and the VHS video-recording format are examples of allegedly inferior products that keep on winning. Our book, Winners, Losers and Microsoft: Competition and Antitrust in High Technology, reports on many of these cases, concluding that there are no convincing instances of lock-in, but instead that products succeed because they are superior to their rivals. In the software industry, market leaders with tremendous market shares were vulnerable to attack from higher-quality competitors. In fact, these market-share turnovers occur in the software industry amazingly fast. Intuit's superior personal finance software, Quicken, for example, reversed positions with the entrenched incumbent, Managing Your Money, in a two-year period, a shift in market share of 40 points.
The Internet Impact
If the Internet is going to transform an ordinary market into winner-takes-all, it will be where the online presence introduces strong network effects. Strong network effects are likely when the product is information, or when buying becomes easier or more efficient through comprehensive access to sellers, to consumers or both. The multiple listing service used by real estate agents is a good old-fashioned example of a product with strong network effects. Databases such as these, which pool information received from their users, will exhibit strong network effects when developed for the Internet because they will dramatically increase realtors' access to others' listings. Online auctions may take advantage of network effects better than traditional newspapers. By extensively pooling information, parts or component suppliers using B2B models can capture strong network benefits.
Not all Internet businesses experience strong network effects, however. For example, someone shopping for toys has very little interest in the number of other toy shoppers who will patronise a particular Web retailer. Instead, their online interests are the same as the ones they have in the brick-and-mortar world: market price, return policy, whether the item is in stock and reliability of the retailer. Of course, a bigger retailer may have a more comprehensive inventory, but this is not so much a network effect as it is a traditional scale economy.
Toy retailers will continue to coexist online, just as they did in the brick-and-mortar world. First will just be first. Being first will not make them bigger or cheaper or better. It will not protect them from competition from new upstart companies. If you are that potential upstart, the Internet does not create a new barrier to your entry.
Our work on network effects - winner-takes-all markets and lock-in - offers two simple principles for managers. First, not all Internet markets are winner-takes-all. For many industries, the Internet will not bring about a fundamental restructuring because it does not introduce a strong network effect. Second, even markets that are or become winner-takes-all are better characterised as winner-takes-all-for-a-while. A company with a dominant market position can expect to maintain that position only as long as consumers regard its products as the best.
In addition to these principles, we would offer a few corollaries. Faced with the choice of rushing a weak product or Web site to market in order to be first, or taking the necessary time to be best, go with best.
Indeed, a company that takes big losses this year in order to win the market-share wars online may find that it has won only a Pyrrhic victory. Good Web businesses that continue to innovate may hold their positions for a long time, but no one should count on being locked in, and you need not consider yourself locked out, so long as you have the best product in the industry.