Business Models and the Singularity

What happens when technology cycles become shorter than corporate decision cycles?  That’s the question I posed in an earlier post about Facebook’s acquisition of Instagram

Saul Kaplan takes it even further in his new book The Business Model Innovation Factory, when he points out that the concept doesn’t just apply to technology, but business models as well.  That, if anything, is a much more difficult problem.

Whereas a firm used to keep the same business model for a generation or more, now the way in which a particular industry creates, delivers and captures value can be disrupted every few years.  What’s more, the process is accelerating and business models will become even less stable.  So we’re going to have to rethink much that we thought we knew.

How Google Made Itself a Destination

In 2004, Google had already revolutionized Internet search.  They were dominant (handling almost 90% of all Internet searches), hugely profitable and had recently went public at a valuation of over $20 billion (big money before Facebook).  After just 5 years in business, they seemed unstoppable.

However, they had a problem.  People would go to Google, find what they were searching for and leave.  While that was great for users, Google recognized that they would benefit from having them stick around for a while.  The question: How could they increase the time that users spent with them without undermining their core search business?

They found the answer in Gmail, a new e-mail service that they launched with an offer few could refuse – 1 GB of storage.  That didn’t just one-up the competition; but completely changed the game, offering literally hundreds of times the 2MB-4MB that the market leaders, Hotmail and Yahoo, were offering at the time.

Before Gmail, webmail was the poor cousin of e-mail.  You would often have to delete old e-mails to save space and receiving even one good sized attachment would take you over your limit.  With Gmail, the capabilities exceeded even what most corporate servers would allow.  With one stroke, they disrupted what had become a sleepy digital backwater.

The Unavoidable Truth of the Singularity

What Google did wasn’t just bold, it was very, very smart.  They realized that with storage efficiency doubling every 12 months (a phenomenon known as Kryder’s law), their scheme would become increasingly more economical over time.  They actually transformed their lack of a user base into a huge advantage!

Take a look at the chart above and you can see how the economics work.  In 2005, hard drives had a capacity of less than 100 gigabytes, but by 2010, that had already increased to over 1000.  In 2015, we can expect that to reach over 10,000.  So the cost will be less than 1% of what it was when Gmail launched.  In another decade, it will fall to 1% of that!

That’s what Ray Kurzweil calls it the singularity and it pervades our modern economy. While we tend to think in linear terms, our capabilities advance exponentially, enabling new ways to create, deliver and capture value.  While Gmail used the storage trend to compete in webmail, other companies like Dropbox saw an entirely new industry of cloud services.

Moreover, cloud services are enabling a whole new post-PC computing environment, which in turn powers new business models.  On and on it goes, creating a domino effect. The process will continue to accelerate, the cycles will continue to shorten until, theoretically, change becomes instantaneous.

Diminishing Returns to Scale

Besides technological progress, there is another factor in the shortening life spans of business models: the diminishing advantages of scale.  It used to be that big companies could protect their business models by exploiting their size and incumbency.  They had the infrastructure, the client lists and the marketing budgets to crush new competitors.

To a large extent, that’s not true anymore.  Infrastructure can cheaply leased (e.g. through cloud services) and the Web is making it easier for small companies to find customers. Digital technologies are also enabling cooperation between small firms to compete with larger ones.

That’s the essence of the new semantic economy.  We’ve become accustomed to start-ups like Facebook and Instagram becoming billion dollar companies within a few years while established firms like GM and Kodak come crashing down in the same timeframe. Past performance of a business model is no longer a guarantee of future success.

The Increasing Importance of Data and Design

Another disruptive force is new technologies like 3D printing, which allows products to be made infinitely customizable without expensive retooling.  Further, programmable matter will one day (possibly within a decade) allow us to download new designs for physical objects whenever we feel like a change.

Like the hard disk storage trend that enabled Gmail’s success, these capabilities are advancing exponentially and will further enable new business models to disrupt existing ones.

As information costs fall to nearly zero and the information content of products and services increases, advantages of scale will diminish further.  Infrastructure, capital and marketing are already informationally dense and Kurzweil predicts that someday, “all technologies will essentially become information technologies, including energy.”

The future then, will be designed rather than built.  There is no monopoly on good ideas. They can happen in a boardroom, an R&D lab or on some kid’s laptop.  When products become data, barriers to entry become ethereal and there really is no place to hide.

A New Approach

No doubt about it, business model instability is a very nasty problem.  You have entire organizations, constantly striving to get better at what they do and then one day they wake up and find out that they’re doing the wrong thing.  No justice. No mercy.

In his book, Saul advises us to embark on a program of R&D for business models. For decades, corporations have planned for the obsolescence of products, why not business models?  Why don’t we experiment with them under controlled conditions just as we would a new chemical compound, TV show or consumer product?

He also points out the need for more collaboration. Some forward thinking companies are already embracing open innovation.  Like Procter and Gamble, who now gets 35% of its new products from its connect and develop program.  Or Microsoft who, when hackers started fiddling around with their Kinect system, didn’t sue them, but offered a prize.

One thing’s for sure, business models can no longer be treated as stone tablets divined by wise men on mountains to last for eternity.  They have become increasingly perishable. Saul entreats us to “think big, start small, scale fast.”  Sounds like good advice.

– Greg