How Might the Tech Bubble Burst?

Tech company valuations are through the roof right now, and many people have been questioning whether we are presently living through a tech bubble. In this blog post I set to one side the thorny question of whether we are in a bubble or not. Instead, I go through a thought experiment: I assume that we are in bubble, and play out a few scenarios for ways in which it might burst. Here are my top three:

Scenario 1: A Rising Star Falls
Present tech valuations are only warranted if you believe in the fundamental quality of their management teams. A high level of future growth is already priced into current valuations. This will only be attainable if they can expand their horizons, for example by expanding internationally. Such expansion puts a lot of pressure on organizational infrastructure. It is hard for a Silicon Valley-based headquarters to ensure that every local subsidiary maintains the quality standards they aspire to globally. Businesses who scale up slowly often have problems; those doing it at an accelerated pace (such as Uber) are even more likely to trip up. If too many local scandals mount, the managerial quality of the whole enterprise will get called into question, as will its valuation. The bold, fresh-faced management team will suddenly look hapless and inexperienced, flailing in the midst of a crisis, or riven by internal politics.

We only need look at Enron to see the risks that free-wheeling growth can expose an organization to. Now I am categorically not saying that every tech start-up is an Enron.  waiting to happen. What I am saying is that it could take just one high-tech corporate implosion to cast doubt on all the others. And once investors start to doubt the fundamental managerial quality of these tech ventures the game is up for the whole pack. Let me be totally clear: this line of argument is about perceptions. In the context of venture capital investments ‘risk’ is highly subjective, in other words it is a matter of perceptions. One dramatic fallen star could change the perceptions of investors about the risk of all the other stars, leading to the tech bubble deflating.


Scenario 2: The Advertising Pyramid Collapses
Many tech ventures rely on advertising as their main (or sole) source of revenue. Advertising is the bedrock of the tech sector, worth an estimated $43bn in 2013. It has allowed the industry to evolve in such a way that consumers expect services to be free. Take it away and those apps and websites suddenly don’t look like such appealing investments anymore.

Where do the pressure points lie when it comes to advertising? I see two potential sources of strain. First is the question of the proportion of advertising accounted for by tech companies and websites themselves. Apps tend to display adverts for other apps; websites display adverts for other websites. Webmasters buy ads to drive eyeballs to their site, where they hope people will click on ads. When this kind of behavior occurs, the online sector is feeding on itself – it is autophagous. Here we are in classic bubble or pyramid territory. The pyramid is sustained as long as it draws more people in to play the game, but once it is revealed to be hollow, it vanishes at once. I don’t have data on how much advertising is of this nature – so I can’t truly judge the extent to which this is a problem. However, just from my personal experience of browsing the web it appears that a lot of advertising is of this autophagous nature.

The second pressure point is the difficulty of measuring the return on investment (ROI) of online advertising. Web-based advertising platforms throw off a lot of data. The funnel from views-to-clicks-to-purchases can be tracked, so in principle a marketing manager can attribute a given online sale to a given online advert. However, things are far from simple. A customer who clicked through a pay-per-click advert may have still made exactly the same purchase even if the advert hadn’t been there. And a lot of online advertising is bought primarily to promote offline sales (think of, e.g., car adverts). However the effects on offline sales are much harder to track. Interestingly, while online advertising opens up the possibility of using randomized experiments to measure the effect of adverts, research so far has found that the effect size is so small it is hard to reliably measure from a statistical standpoint.

The upshot of this: the online advertising industry, while huge, is not yet in a long-term, stable equilibrium, and it’s not clear whether the stable market size will be larger or smaller than the market that exists now.


Scenario 3: Silicon Valley Disrupts Itself
To disrupt an industry is the bold aim of many of Silicon Valley’s start ups. It typically entails finding a way to deliver the same service the industry presently delivers but at a fraction of the cost or at a step-change improvement in quality or convenience.* It is often said that to disrupt you need to offer something 10x better than what presently exists, in order to overcome people’s inertia and lock-in with present systems.

The industries targeted for disruption are typically of the staid, old-school variety, perhaps dominated by some entrenched rentiers – think of Uber disrupting the taxi / car industry, or TransferWise disrupting the foreign remittance industry. The narrative of disruption underlies the massive valuations these companies receive. To take Uber, for example, in debates about its valuation have moved from comparisons with the entire global market for taxi services to discussion about how it might act as a subtitute for car ownership.

But there's no particular reason only old industries are vulnerable to disruption. It is perfectly conceivable that one of the current tech giants itself gets disrupted. People appear pretty locked-in to social media platforms such as Facebook, but if a company were to come along with an offer 10x better than one of these, it is easy to see customers switching. And, in fact, many already did: in the last few years plenty of people switched from Facebook to Twitter or Instagram as their primary social media feed, and in future something even better than either of these may come along. Well aware of this fact, Facebook paid a billion dollars for Instagram and $22bn for WhatsApp primarily because of the threat that these businesses posed to its dominance.

I can’t predict what a social media platform 10x better than Facebook would look like, but then neither could I have predicted Facebook’s creation before it existed. And, as with Scenario 1, it only takes one giant to fall asunder for many of the others to lose their appeal to investors.
 

So, there we have it, three scenarios for how the tech bubble might burst. Which do you find the most plausible? What other scenarios sounds realistic? Answers in the comments below! 

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*Note: this is a fairly colloquial definition of disruption. It is a somewhat warped version of its original academic usage by Clay Christensen, which referred to creation of new performance dimensions for emerging market sub-segments that eventually become large markets in their own right. Here, the colloquial meaning is the one I intend.

Notes from the cutting room floor: "Google has mastered technology, but they need to better understand people"

I wrote the following paragraph on 3rd November, 2013, shortly after a big rise in Google's share price. I never got round to expanding it into a full post. This week the Google Glass developer program was put on hiatus so it seemed like an apt point to dig it up. 

Google has made the news this week for its share price reaching record highs. I’ve been observing the company keenly for many years and greatly admire the technical prowess and creativity of its employees and the vision of its founders and leaders. In the past the company has pioneered a vast array of internet services and is one of the chief reasons why much of what is online is available for free (including this blog). Now it looks as though they plan to be a pioneer in the hardware world, and this is likely to be the greatest challenge they will ever face. There are numerous possible miss-steps, and above all I want to highlight the risk that, while they have mastered technology, they lack an understanding of how it is socially adopted and accepted. This will leave some of their greatest innovations – Google Glass and driverless cars – down a rocky path, with a real chance of outright rejection by society.

The Meaning of the 21st Century by James Martin: Review part 1 - Humanity’s Greatest Challenges

“There’s a reason for the 21st century. Not too sure, but I know that it’s meant to be.” - The Red Hot Chili Peppers

The work of James Martin was brought to my attention when I read his obituary after his passing on 24th June, 2013. One of the UK’s most influential computer scientists, and probably its foremost futurologist, his early work¹ foresaw much of what would unfold as IT evolved and revolutionized society. He helped to create the digital revolution through his work on information engineering at IBM, as well as through several companies he founded, amassing considerable personal wealth along the way. His fascination with the future led him to deploy this wealth by founding The James Martin 21st Century School at the University of Oxford and dedicating the latter part of his life to understanding and communicating the challenges facing humanity.

'The Meaning of the 21st Century' contains his reflections on the challenges facing humanity over the next hundred years, and some of the possible solutions. Published in 2006, it is unabashedly subtitled 'A vital blueprint for ensuring our future.' It weighs in at over 500 pages, and I read it gradually over the summer of 2014. Its expansive themes make it sometimes heavy going. I have come to agree with many of the accolades it receives on the inside cover (‘A wonderful book… a privilege to read.’ ‘A fire bell warning.’ ‘ a short course on the most pressing mega-problems of the new century.’) It is somewhat daunting to try and distill the book into a blog post sized text. In this post I focus on the Grand Challenges he identifies facing humanity². Martin touches on a great many over the course of the book, which I find helpful to arrange in three broad categories: (1) ecological and environmental challenges; (2) social and institutional challenges, and (3) technological challenges.

Ecological / environmental challenges

Ecological / environmental challenges are now broadly recognized and widely discussed. Our ecological / environmental challenges include: water scarcity, deforestation, topsoil erosion, soil salination, loss of biodiversity, depletion of marine life, and global warming (with its sub-problems of: ice caps melting, ocean current perturbation, sea level rising, extreme weather events). Many of these contribute to the possibility that we will reach our agricultural limit, a thesis famously put forward by Malthus. Many would say it has since been discredited, but just because it hasn’t happened yet, that doesn’t mean it never will. Some of the ecological problems receive more attention than others; ultimately any of them could spell disaster for the functioning of society. Also, the degree to which these problems are inter-related is probably underestimated. For example deforestation has a cluster of knock-on effects, it (i) reduces biodiversity, (ii) releases greenhouse gases, (iii) reduces the rate at which CO2 is absorbed, (iv) leads to topsoil erosion, (v) contributes to desertification. When we realize that tackling one cause can stem many effects, the rationale for taking action increases considerably.

Social / institutional challenges

Social / institutional challenges are beginning to receive attention, but mostly to their symptoms, i.e. the latest flare-up of unrest or the latest act of terrorism. Relatively little attention is paid to their root causes. Social challenges include: population growth, poverty, religious extremism, terrorism, social unrest, rising inequality, illiteracy, bureaucratic paralysis, regulatory capture, public service mismanagement, and institutionalized short-termism. Again, these are intertwined in various ways, for example rising inequality is a catalyst of social unrest, extremism and terrorism, and also leads to regulatory capture and political stasis due to the concentration of power in the hands of an entrenched plutocracy.

Technological challenges

Thirdly, technological challenges are probably the ones most overlooked in the mainstream discourse, and it is here that Martin’s insight adds the most to the conversation. He takes a critical eye and looks at technology not as an unalloyed benefit but also as a threat – potentially a grave one – to the wellbeing of humanity. Technological challenges include: ease of access to weapons of mass destruction (in particular nuclear or biological weapons), computer intelligence, risky scientific experiments, hormone disruptors in the water supply, ethics of transhumanism and genetic engineering, new destructive weaponry (e.g. nanotechnology, robotics, and new bio-weapons), and rising scalability contributing to unemployment and inequality. Martin stresses that computer intelligence is ‘non-human-like’ so we should not expect computers to suddenly gain consciousness in the conventional sense. However, the Singularity still poses a threat, as intelligent computers would be inherently unpredictable:

‘Technical controls will be needed for computing, perhaps in the form of hardware design, to ensure that when computers become incomparably more intelligent than we are, they act in our best interests.’ (p.287)

Relationships between the three areas

One of the book’s great strengths is that it looks at how all three forces interact. For example, Martin (correctly) predicted a rise in Islamic extremism facilitated by the spread of internet technologies for recruitment purposes. Long before the rise of ISIS, he framed these comments in terms of Al Qaeda:

'Al Qaeda’s recruiting video is on the Web… Osama bin Laden’s rhetoric is highly persuasive to many young Muslims, telling them that God want them to help end Islam’s humiliation. Right now [i.e. 2006], most of the vast target audience for this message doesn’t yet have the ability to see Web-delivered TV. As the technology spreads, this means of recruitment will reach far more potential volunteers.' (p.342-343)

Martin feared that technological advances will make weapons of mass destruction accessible to terrorists. Drawing on the work of Graham Allison, he saw a high probability that we will see nuclear terrorism sometime in the 21st Century.

Another highly inter-connected challenge is population growth. At its heart, population growth is a social issue, with fertility rates highly dependent on a country’s level of economic development. But population growth has enormous consequences for the environmental and ecological problems (including the ultimate question of whether the planet can sustain the world’s population).

A third example is the rising scalability in production technology (a recurring theme on this blog). Scalability is facilitated by technological advances. It can increase economic output, but it also contributes to inequality, which in turn stimulates social unrest and terrorism.

A key dilemma that Martin does not really address, but which became apparent to me while reading the book, is whether ending poverty and saving the environment are compatible goals. If we could raise the living standards of the world’s population to a Western level, the damage to the environment would be untenable. Realistically, we have to find ways to make the Western lifestyle ecologically neutral (what Martin terms ‘eco-affluence’) before the rest of the world catches up to our level of development. Anything else will spell environmental disaster for all of us.

The opening chapter of the book is available at JamesMartin.com

You can follow me on Twitter: @David_Clough1

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¹ Including 'The Wired Society' in 1977 and 'Technology's Crucible' in 1987
² In chapter 13, Martin presents a list of 17 challenges, but these are not exhaustive of the many challenges he covers elsewhere in the book; my three-bucket structure is hopefully more digestible. In future I plan to write a separate post about the solutions or avenues for progress that Martin identifies.

The Essence of Innovation? When Needs and Solutions Meet

“Innovate!” is the imperative that today’s managers most often seem to hear. So often, in fact, that it’s easy to lose sight of what that actually means. “Innovate or die” and “Disrupt or be disrupted” have become the reigning slogans in tech circles. As Gillian Tett describes in this weekend’s Financial Times, there seems to be a race on to uncover the secret recipe that can spark creativity in any organization.

In this blog post I boil down innovation to its fundamentals. The thesis is simple: innovation occurs when needs and solutions meet. In a world obsessed with technology, it is easy to overlook this simple fact. Technology puts the focus on solutions. It has raced ahead at such a pace that we have far more solutions than we know what to do with. And the needs – often the most dire, urgent needs of humanity – are going overlooked, because their solutions are not technological. The gap between our present needs and solutions is a massive deadweight loss to society, and to close it we need much more innovation to be ‘pull-driven.’ If we can transform the ‘innovation production line’ to work on Toyota-style, demand-driven principles, we might be able to solve far more of humanity’s pressing problems¹.

When do Needs and Solutions Meet?

I’ll start off with two success cases. The first is borrowed from Gillian Tett’s article. Delos Cosgrove was a heart surgeon in Ohio in the early days of open heart surgery. One of the challenges he faced day-to-day was installing a ring onto the valve in a human heart to keep it in shape. The prevailing design was a rigid ring, which didn’t work very well. To quote Tett:

“Then, some years later, Cosgrove happened to spot a kind of flexible hoop that 19th-century American women used for embroidering pieces of cloth. That’s when he had his “aha!” moment: why not utilise the sewing device and apply it to human hearts to create a valve that could move with human tissue?”

As you may guess, the invention worked, the flexible hoop replaced the rigid one and became dominant. There’s doubtless a lot more subtlety to the full story, but the principle is this: a person with detailed knowledge about a particular need came across a potential solution. Once the need and solution were ‘in the same head’ as it were, the invention could come about.

The same narrative is visible in the invention of the CamelBak hydration device (an example I learned of from Eric von Hippel). The CamelBak is essentially a backpack with a polymer bag inside, filled with water, with a tube and a valve on so that you can drink from it while exercising. It has become highly popular with runners, trekkers, and cyclists (and I’ve used it myself on many occasions). It was invented by Michael Eidson, who in 1988 was a keen cyclist trying to find an easy way to stay hydrated during long-distance races. He also happened to be an Emergency Medical Technician. He improvised a device made from an IV bag in a tube sock, and it worked. The invention was possible because the need – easy hands-free hydration – and the solution – the flexible plastic ‘bladder’ of an IV bag – were known to the same person.

Organizations which specialize in product development have systematic ways to encourage needs and solutions to meet. In a typical product development process consumers’ needs are elicited using interviews, focus groups, or ethnographic methods, and then a team works on novel ways to solve the problem. The team is inter-disciplinary, so that they can combine knowledge from different domains to come up with a solution. Companies such as IDEO have carefully honed these practices and they are on the whole effective – but the types of innovations they provide tend to be those that make life a bit easier for consumers who already have pretty comfortable lives.

When do Solutions fail to match up to Needs?

Due to the innate human fascination with science and technology, we quest after new discoveries. We often make inventions first, then later figure out what to do with them. It can take decades for the uses of a new technology to become clear, and for the ‘gale of Creative Destruction’ to blow². A great historic example is the laser: it was discovered in the 1950s by quantum physicists investigating atomic emission spectra. Its many practical applications only became apparent later, when scientists familiar with the laser noticed and acted on the connections to possible uses³. Lasers are now ubiquitous, used in barcode scanners, printers, DVD drives and hundreds of other devices. At any given time, then, there will be a stock of technologies we don’t yet know what to do with.

Technological progress adds to that stock, while the process of ‘matching’ technologies to needs depletes it. What if technological progress accelerates? Unless the matching process also speeds up, the result is a ballooning stockpile of unused solutions. This is exactly the situation I think we are facing now.

Let me provide two contemporary examples. The first is 3D printing. The technological know-how for this has been around since the 1980s. There have been commercial uses for it since the 1990s, though the sector has only taken off in the last 5-10 years. Most experts agree that the scope of 3D printing is limitless, that it will hasten in ‘The New Industrial Revolution⁴.’ But we are only just figuring out how to use it. Many of the early ventures in this space arose when someone with a particular need first came across a 3D printer and noticed that it might solve the need⁵. There is so much more to be done with 3D printers and I am genuinely excited to find out what imaginative uses people will find for them.

Another example is drones, of the tabletop ‘quadcopter’ variety. These hit the mainstream relatively recently, relying, as they do, on miniaturized electronics and lightweight materials that have only become available in the last few years. They are a solution that is begging out for a need. So far their widest use seems to be to take breath-taking videos and photographs. This is great, but there is so much more that these devices make possible, especially if we recombine them with other technologies in imaginative ways. It would seem a waste if the best we come up with is delivering parcels for Amazon.

Winning image in a National Geographic / Dronestagram photography competition

The World is Full of Unsolved Needs

A surfeit of solutions might seem like a great thing. And it would be, except for the fact that we also have an abundance of needs, needs which these technological wonders aren’t solving. I will leave it to a future post to detail the world’s challenges, when I review James Martin’s book ‘The Meaning of the 21st Century.’ For now I’ll make two observations: (1) Even the most basic technologies for the bare minimum of living standards are failing to diffuse to the third world. Simple life-support mechanisms like running water and sanitation are only available to the richer half of the world’s population. (2) The world is facing environmental / ecological catastrophe due to over-use of finite resources and our tendency to over-pollute. Both of these look like enormous needs, or clusters of inter-related needs.

In recent history we’ve relied upon capitalist market processes to match needs and solutions. These have been enormously successful in generating the kinds of innovations that make life easier and better for rich people. But unfettered capitalism provides little economic incentive to solve problems for poor people⁶. Similarly, it provides no economic incentive to solve ‘tragedies of the commons’ such as our environmental problems. These needs require a different approach. They also, most likely, require innovations of a social variety rather than a technological variety. Other mechanisms exist to match needs and solutions, such as innovation contests, and latterly crowdsourcing. But new ones may need to be invented.

And thus I conclude by re-iterating my main points. Innovation occurs when needs meet solutions, and this requires them to be in the same place. Most often, in the same head. There are structured ways to try and ensure this occurs, call it ‘engineered serendipity.’ There is also a tendency for technology to be viewed as an end in itself, so that we generate myriad solutions, and bumble around in the dark until we find needs that they meet. This is a great opportunity for aspiring entrepreneurs who are familiar with an under-utilized technology. But it is also, in a sense, a waste, because right now the world has so many needs that are not being met. If we could re-engineer the production line of innovation, so that it was pull-driven instead of push-driven, we might just be able to overcome the world’s greatest challenges. 

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¹ We might term this ‘Lean Innovation’ but I wish to avoid confusion with the term ‘Lean Start-up’ which is rather different.
² This insight led Schumpeter to theorize about technological causes of business cycles, an often-overlooked aspect of his work.
³ One of the laser's inventor's, Charles Townes, recalls it as "a solution looking for a problem."
⁴ Subtitle of the book 'Makers' by Chris Anderson [the WIRED one, not the TED one].
⁵ See research by Scott Shane on 'Prior Knowledge and the Discovery of Entrepreneurial Opportunities'.
⁶ As pointed out to me by a friend, there are some notable cases of profitable ventures serving the poor by engaging in frugal or jugaad innovation, for example the Aravind Eye Care Hospital. There is, therefore, some reason for optimism.

The Downside of Scalability: The Piracy Problem - and the Business Model Solution

I have written previously about how scalability is allowing enormous rewards to accrue to top performers across a range of industries. This phenomenon is behind large bankers’ bonuses as well as soccer players’ and movie stars’ outsize paychecks. At first glance, scalability seems to be an attractive property of an industry to be in, if you are amongst the most capable in that industry. However, I’ve recently been considering one big downside of scalability: the way that imitation, or piracy, can erode your position. The gains to be had from scalability are fragile.

Scalability applies when the marginal cost of reproducing a product or service is low-to-zero*. In these circumstances, some fixed cost is expended to create a product, but then it can be distributed widely very easily. This creates a ‘winner-takes-all’ dynamic in an industry, where customers gravitate towards the best offerings in the field. The movie industry makes most its money from a few blockbuster hits, the book publishing industry earns its profits from a handful of bestsellers, and top selling singers sell millions of records, while the majority of musicians scrape by.

Digitization means more and more industries are showing this scalability property, as digital delivery of has close-to-zero marginal cost. What used to be delivered in person can now, sometimes, be done online. For example, in the higher education industry, online courses (MOOCs) are threatening to disrupt the traditional lecturer-based pedagogical model. In finance, exchange traded funds (ETFs – often marketed over online trading platforms) are highly scalable and low-cost alternatives to traditional stock broking or mutual fund investments, and have already captured substantial market share.

However, the very nature of low-to-zero-cost replication means that scalable products are the most vulnerable to piracy and imitation. The most obvious manifestation of this is digital piracy: the peer-to-peer sharing of music, movies, TV shows and software over the internet**. Piracy has led to a dramatic decline in some industries, for example the market for (legal) recorded music has been shrinking for some time. Scalability is therefore a mixed blessing, even for top performers in a given industry.

Examining the economics of piracy is rather interesting. To provide a simplified sketch: copyright holders are essentially trying to take the role of a monopolist, arbitrarily restricting the supply of a good. They try to pick a price that maximizes their profit. The introduction of piracy creates a parallel market, with a structure resembling perfect competition, in which price falls to marginal cost – which in this case is essentially zero.

In this light, an industry becoming scalable looks destined for decline. However the erosion of profitability is not inevitable. It depends a lot on how the industry responds, and in particular on what business model the firms choose to adopt. The TV industry has weathered the digital storm far better than the music industry, with channels such as HBO going from strength to strength. This may have a lot to do with their subscription-based business model, which provides viewers unlimited usage once the fixed fee is paid.

The music industry was amazingly slow to respond to the transition to digital media, and in fact it was new entrants such as Spotify who successfully marketed unlimited-use subscription based services. These services are far more appropriate for a digital age than the outdated notion of buying individual albums. The record labels’ attempt to sustain high album prices in a digital world was misguided and hastened the album’s decline. Musicians have had to adapt by concentrating more on generating revenue from live shows, a distinctly unscalable service, now that the scalable recorded-music revenues are evaporating***.

Having praised the TV industry’s subscription based models, I should also point out that not all is well here. Many people are driven to illegally download TV shows for the simple reason that the legal ways of obtaining the shows are either inconvenient or don’t even exist at all. I would love to subscribe to Netflix, as they have some great shows, but they are not available in France where I’m presently based.

Furthermore, illegal content can be higher quality than the legitimate offerings. When I was in the US last year, I paid for and watched Breaking Bad’s final season using Amazon Instant Video. The first problem was that the checkout process was painful, just because I was using a British credit card. Then, having purchased the episodes, my enjoyment of the streaming video was harmed by a poor internet connection, and there was no option to download the shows. If I had downloaded whole episodes using BitTorrent instead, my viewing experience would have been, quite simply, better.

In summary, scalability can be a route to massive rewards, but it can also be a path to major disappointment, when piracy or imitation prevents a top-performer from appropriating a slice of the enormous value they can create. The careful crafting of a business model can mitigate that risk, but it requires foresight and an ability to change the standard ways of doing things. Entrepreneurs have an opportunity to experiment with new ‘scalability-robust’ business models when incumbents fail to adapt – and those that succeed can transform an entire industry.

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* It is actually highly relevant whether the cost is low or zero. Piracy is much easier when the replication cost is zero than when it is some small but non-zero amount.
** There are other manifestations that don’t rely on internet technology, such as taping songs playing on the radio or photocopying pages from a book.
*** Academics concerned about the rise of MOOCs might want to take note: a demand for live tuition will likely remain, as long as (like live music) it offers a superior experience to the recorded version.

Co-opetition, Complementarity and the 'Sixth Force' of Competitive Strategy

What’s the most powerful force in the economy? If you’ve studied some basic microeconomics, you might suggest it is competition, which (in theory) drives prices down to marginal cost, and maximizes social welfare. You might be drawn to a similar conclusion if you’ve studied business strategy or marketing, and learned about the importance of differentiating your offer from your competitors to prevent profits being competed away.

The central thesis of Adam Brandenburger and Barry Nalebuff’s 1996 book ‘Co-opetition’ is that this singular focus on competition is misguided – and that co-operation is at least as important. In fact, they argue, competition and co-operation are inextricably linked, two sides of the same coin, so when they combine these words in their book title they mean it literally.

Co-opetition along the supply chain

A typical firm procures some inputs – materials and services – from a set of suppliers. It adds value to those inputs, then sells the product or service on to some customer. A long chain of many of these value-adding activities, in many different firms, will stretch from the extraction of raw materials at one end to the consumer market at the other. Brandenburger and Nalebuff point out that a firm’s relationship with its suppliers and customer has a co-operative flavor, because they are working to jointly create value for the end customer at the end of the supply chain. However the relation is also competitive, because they need to bargain over how the value is distributed between them. In other words, they need to co-operate to ‘grow the size of the pie’ but then they are in conflict over ‘how to split the pie.’

Co-opetition within an industry

The idea that firms within an industry are in competition with each other is well-known. Firms compete for market share, which by definition is a ‘pie’ that adds up to 100%. Firms also compete over input resources, such as ‘star’ talent and capital investment. Competition in these arenas is often fierce – so where does co-operation come into the equation? Collusion is clearly possible, but illegal. Brandenburger and Nalebuff do not advocate collusion, but they also question the need to act in a highly competitive manner all of the time. For example, they advise against aggressively pursuing a competitor’s customers with low-priced offers, as the competitor will only go on to reciprocate, stealing away your customers further down the road.

Moreover, there are legitimate ways for firms within an industry to engage in mutually-beneficial co-operation. They can pool resources in a joint venture when engaging in a risky initiative, such as pioneering research and development or expansion into a frontier market. They can support 3rd party trade associations which represent the industry to the government and the press. They can sit on standards-setting organizations, and back common certification standards so that consumers are better assured about the quality of the goods and services they are buying. These co-operative strategies can benefit all the firms involved, and the end consumer, and are an increasingly important part of a corporation’s portfolio of strategic initiatives.

The power of complementors

To me the single most powerful idea in the book is the concept of complementors. To quote their definition: 

“A player is your complementor if customers value your product more when they have the other player’s product than when they have your product alone.”

So essentially any pair of products or services which are typically consumed together are complementors: hot dogs and mustard, games consoles and video game software, airplanes and airports, iPods and MP3s, cognac and karaoke bars… the list is endless. Complementarity creates a form of strategic interdependence which means a co-operative strategy can be enormously effective.

Brandenburger and Nalebuff use the example of Nintendo, which managed to dominate the market for 8-bit videogame consoles in the late 1980s, largely because of its control over the complementary goods – the games. It had a strong capability to design games in house, based on its history making arcade games machines, but it also cultivated a set of external suppliers, none of which was permitted to become too powerful in its own right.

Intel is another classic case example of a firm which invests in complementary technology. By helping external firms to develop applications which put high demands on the computer processor, they stimulate demand for new generations of their CPU chips. Intel’s corporate venture capital program is legendary, and while successes are rare they have hit a few home runs (the typical venture capital ‘portfolio’ approach). Unfortunately, one example which the authors dwell on in this book is, nowadays, looked back upon as a failure: Intel’s foray into video conferencing, with its ‘ProShare’ software in the early 1990s. They invested $750m in developing this technology, but never gained a critical mass of uptake*. (The irony is that when we analyze this case now, we can trace the failure of video conferencing to take off to an absence of complementary services: high speed internet connections were very rare at the time).

When I came across Michael Porter’s Five Forces framework in my undergraduate course, it seemed elegant, all-encompassing and, therefore, close to perfect. From time to time, in unashamedly nerdy discussions with my colleagues we might speculate about what might be missing from this framework, how it might be improved. We never settled on a firm answer. Having read Brandenburger and Nalebuff’s book, I can now answer with conviction: that elusive ‘Sixth Force’ in business strategy is the presence of Complementors.

A great 21st Century illustration of this is Apple. The success of Apple has not so much rested on its market power with respect to suppliers and customers (although this plays a part). The really critical success factor, the magic essence, is the large ecosystem of complementary products and services it has created around its core offerings. The music for its iPods, and the Apps for its iPhones, sold through proprietary platforms; the mobile network infrastructure and Wi-Fi hotspots on which it relies for mobile data delivery; the broad range of peripherals for its hardware which helps establish them as quintessential lifestyle devices. Apple has not just one set of complementors (which would be easy for other firms to imitate) but a whole array of them.

Brandenburger and Nalebuff’s book may be approaching twenty years old, but it is still well worth a read. Their game theoretic approach to strategy is grounded in timeless principles of mathematics, so it is unsurprising that it remains relevant today. If anything the technological trend towards an ever-more interconnected world makes their message of considering complementors ever-more valuable as time goes on. 

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*For a detailed account of Intel's strategy during the 1990s - including its errors - I can recommend Annabelle Gawer and Michael Cusumano's  excellent book Platform Leadership

We Need to Talk About Robocop

I’ve recently seen the 2014 version of Robocop. As an action movie, it is somewhat disappointing, but as a piece of social commentary it is extremely thought provoking. 

Set in the not-too-distant-future, the film opens with a scene in a Middle Eastern town where US troops are ‘peacekeeping’ with the assistance of militarized robots. These are depicted in the film as two-legged vehicles with in-built AI brains, an array of scanners, and a variety of deadly weapons. The public relations arm of the defense company which supplies the robots is broadcasting the patrol live, to prove how effective robotic peacekeepers are. Their aim – to have the law in the United States changed to permit the use of robots for law enforcement there – a market worth many billions of dollars. Their attempted propaganda backfires when a group of rebels attacks the patrol, and one of the robots guns down a young child that it identifies as a ‘threat.’

While the movie is pitched as science fiction, this particular scene had more than a touch of present-day reality to it. The only two differences are that today’s military drones are aircraft (not walkers), and they are piloted remotely by humans on the ground (rather than onboard AI). They are still used with impunity across the Middle East for the targeted killing of (suspected) rebels, with substantial collateral damage. The justification for their use – to ‘save lives of American servicemen and women’ – is the same as in the film. While the President finds it unproblematic to deploy them abroad, the concept of using them on home turf is far more controversial. In the film, the harassment by robots breeds discontent and rebellion amongst the occupied population. Similarly, in the real world, drones have been described as “Al Qaeda's best recruitment tool ever”.

The technological trends point towards computers being in the driving seat in future. The movie puts the spotlight on two central moral dilemmas of using computer algorithms to make life-or-death decisions. Firstly, the great strength of algorithms – that they have no emotion, so are prone to neither biases nor fear – is also a key weakness. The absence of empathy means that a computer will be unable to replicate the nuances of human judgment. Secondly, algorithms are touted as removing scope for ‘human error’. But if a computer algorithm takes a human life it is not meant to, who is responsible? Presumably if artificial intelligence becomes sufficiently sophisticated, the artificial entity itself has moral culpability. But discounting full AI, could we hold an individual programmer responsible? Or the company that manufactures the robot? This is, as yet, far from clear, and these questions are just as relevant when we consider civilian applications of robotics e.g. in factories, or in self-driving cars, which are very much present-day concerns.

We also need to debate the legitimate use of technology by the State. We have seen from Edward Snowden’s leaks that the State (at least, US and UK governments) is willing to use every technological tool possible to enhance its own power and entrench its position. Civil servants and security contractors assume a pragmatic mindset and swat away any concerns they might have about morality. The very phrase ‘National Security’ seems to obliterate any civil rights of the Individual. This is something we must bear in mind if we think the idea of robotic policemen or ‘search and destroy’ drones deployed one home turf seems implausible.

A final remark is that there is a very real chance that robots may soon constitute a new class of Weapon of Mass Destruction. The pattern of the 20th Century was for scientists to create lethal weapons (nuclear, chemical, biological), national governments to use them on some enemy, then later, upon realizing their potential to devastate entire populations, to declare them illegal. The potential problem with declaring something illegal after using it is that it might not work next time – the weapon might be sufficiently destructive that it annihilates its creator. This has long been explored in science fiction – from John Wyndham’s Day of the Triffids, to Michael Crichton’s Prey; from James Cameron’s Terminator, to Danny Boyle’s 28 Days Later. Now it is something we must take seriously as a future scientific reality.