Value Migration

What is it?

Why do some industries become commoditised, and others create enduring value?

Skate to where the puck will be

“Skate to where the puck will be” 

Wayne Gretsky

Over time, the place in the industry where most of the value is located changes:

  • Competitors catch up in the traditional ways, commoditising them and eliminating their potential to make profit
  • Customers seek new benefits, creating new ways to differentiate and earn profits

The combination of these two changes causes value to migrate from one part of the business to another.

To understand where value will migrate to, you need to understand how the Basis of Competition is changing – what becomes commoditised?

Value migration - commoditisation

Initially RIM (the blue line) had a mobile e-mail service that was far better than any competitors. They continued to improve over time – indeed, their newest features were more advanced than mass market customers cared about – the customer needs increased more slowly than the technology improved.

But note what drives commoditisation. It does not happen just because your technology “overshoots”. It does not happen because competitors improve, though you have to maintain your edge. The service is only commoditised when competitors can deliver performance that is good enough for customers. Then it is hard to differentiate and price becomes more important, collapsing profitability.

So to predict when your advantage will be commoditised look at just two things:

  • How fast are customer performance requirements increasing?
  • What is the trajectory that competitors are improving performance?

Commoditisation happens fastest (years, even months) in high-tech industries – how much technology customers can absorbs increases slowly and competitors can match technology improvement (especially in software) very fast. Commoditisation happens more slowly (decades) in other industries:

  • Emotional brands never overshoot – customers will always pay more for even stronger brands
  • Competitors can barely improve their performances if you have a high liquidity platform (Windows, Facebook, Google) or a solid patent they cannot get around

When is it useful?

What if you could predict which aspects of the industry will become commoditised, barely earning their cost of capital and which will enjoy enduring profitability?

Value migration provides a conceptual framework for mapping what might happen, increasing your ability to See the Future. 

An Example?

The PC industry has experienced value migration. It took amazing innovation to develop the first PCs. The pioneers had to develop most of the components themselves and be the systems integrators to make everything work. They wrote customised software for their own operating systems, developed components themselves and offered highly differentiated products. The first PCs were highly valued by customers and profits were good.

Value migration - PC Before

Over time, the Basis of Competition changed. More PCs companies entered, the performance of PCs improved on multiple dimensions and specialist component suppliers developed. Customer needs were satisfied on several dimensions – for example, disc drives became good enough for most customers – Hygiene factors, no longer differentiators for customers. Other dimensions became more important – the availability of applications, which made it necessary to have a standardised operating system to run them. A virtuous circle developed as developers lined up to make applications for the most popular operating system, and customers purchased PCs with the most applications. This led at a “Winner takes All” dynamic, with Microsoft Dos/Windows achieving 90% market share in operating systems.

As more and more powerful applications were developed, the component that was not “good enough” for customers turned out to be the microprocessor. Customers selected which PC to buy based on which microprocessor they used. The great negotiation power this gave the suppliers was enhanced by the “Intel Inside” advertising campaign.

Most of the value in the industry migrated to the Microprocessor and Operating System manufacturers.

Value migration - PC after

 

 

 

 

 

 

 

 

 

 

 

This value migration is common in the high-tech industry and was called the Smile Curve by Stan Shih of Acer. Value starts in the company that makes the product, then over time this commoditises and value migrates to the customer relationship and the critical components.

OK, so we can explain value migration in retrospect. The real test is whether we can predict it and position ourselves in the activities where value is migrating towards.

Could IBM have predicted the value of the Operating System, and retained the rights to MS-Dos? Certainly today, the lesson is well learnt – the Android Operating System was successful because it was open-source – smartphone vendors knew that it would not become a strategic chokehold on the industry, a “must-pay” tax on every device the way Windows is on PCs.

Was it predictable that value would flow to Microprocessors and not disc drives? Neither was good enough for customers initially – the key difference was how easy it was for component suppliers to improve performance in disc drives compared to how hard it was to improve in microprocessors. So disc drives became overshot, had several companies making undifferentiated products, whereas Intel dominated microprocessors, with AMD as an “also ran”.

OK, lets use this framework to attempt a prediction

The telecoms industry is complex covering telco equipment makers, carriers, device makers and software vendors. Historically, the carriers captured a high proportion of value in the business. Coverage and connection speeds were not good enough for customers and carriers could differentiate on these, not just pricing packages.

4G brought a breakthrough in speed – now you can download an 800MB movie in 10 seconds – streaming video was possible for the first time. This is good enough for most customers.Customers are unlikely to pay a premium for 5G, so that you can download 10 movies in a second. Maybe a new “killer app” will emerge (VR?) that requires this speed, but we have already overshot for video.

This predicts bandwidth will be commoditised, a hygiene factor in customer decision-making, with value migrating to the customer relationship (apps) that provide breakthrough customer experiences, and to the suppliers that enable carriers to cut their costs in a price-driven industry. This is the “dumb pipe” scenario for telecom carriers, where they end up like electric utilities, providing an undifferentiated essential service.

I want to know more

Read “Value Migration” from Adrian Slywotzky