Ian Richards and James Morrison
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PDF Help A key challenge for those starting a new business is to
figure out if and how the venture will create value. Traditionally, business
analysts have determined possible value by developing forecasts and business
cases using spreadsheet tools.
But this approach is no longer adequate in the
eEconomy-where value creation depends largely on a dynamic set of
interrelationships and feedback loops known as the "network effect." For
example, spreadsheets display numerical data rather than the relationships that
create that information. While they readily compute complex numerical problems,
they are unwieldy tools for developing a series of computations over time with
feedback loops. These limitations prevent them from representing the real
drivers of success or failure in a dot-com.
A more effective tool is a dot-com "flight simulator,"
which can be quickly built using one of the powerful simulation programs that
have come on to the market in the last few years, such as I-Think or PowerSim.
Flight simulators reflect the dynamics and competitive rivalry in emerging
dot-com markets, and enable executives to test run their emerging strategies in
a virtual marketplace.
Understanding the Dynamics of Dot-Coms The key to value creation in most dot-coms is the dynamic
nature of the network effect¹. This effect describes the interaction among
three dimensions of the dot-com's business architecture-community size, scale
economies and customer lock-in. When the network effect is working to the
dot-com's advantage, these dimensions form virtuous cycles—in their own right
and together—that lead to increasing returns.
- Community size. As the dot-com's community of users (customer
base) expands, the inherent value of being part of that community increases. In
turn, this value increases the attractiveness of that community to potential
users, and, thus, leads to further increases in community size. Take an online
auction site, for example; as its community size increases, it has more items
for sale and more potential buyers, increases the site's value for both buyers
and sellers, and, thus, attracts more users.
- Scale economies. The major competitive advantage of the
dot-com business model is its low marginal cost structure compared with
traditional firms. As a dot-com's community size increases, this advantage also
increases because the allocation of fixed costs per transaction decreases, and
eventually the average transaction cost approaches the marginal transaction
cost. This advantage increases the profit per transaction, enabling the dot-com
to lower its prices or re-invest the returns to improve its offering or
marketing. In turn, these improvements attract more users, thus reinforcing
both the economies of scale and the community size effect.
- Customer lock-in. When a dot-com secures an investment from
its users-either in the form of information they provide or time they spend
becoming familiar with the site-it creates some inherent value for the
customer. This value translates into customer loyalty and the probability of
further investment, thereby creating an effective barrier to switching.
Customer lock-in supports the dynamics of community size and scale economies.
The risk is that these virtuous cycles can also become
vicious cycles of small size, diseconomies of scale and eroded loyalty. The
challenge for investors and entrepreneurs crafting a dot-com strategy is
understanding how to make the network effect work to your advantage in a
competitive environment.
Creating a Virtual eEconomy An effective way to develop this understanding is to create
a virtual eEconomy in which you can see how your ideas and strategies affect
the evolution of virtuous or vicious cycles. The leading thinking in this field
suggests that models of competitive markets are best developed using a "dynamic
resource system view,"² based on systemic thinking principles. The key
principles of this resource-based approach are
- The resources of a dot-com determine its performance at any
moment. For example, advertising revenue is determined by the number of
customer "hits" on a site, and customer switching is determined by the relative
attractiveness of each site at that moment.
- Resource levels are determined only by transfers of resources
over time. For example, the number of customers using a dot-com service at any
time is the sum of all customers who have taken up the service over time, minus
those who have left.
- The rates at which each resource changes depends on the
levels of other resources in the system. This reflects the essential nature of
feedback in the dot-com-for example, the number of customers choosing to use a
dot-com's services depends on the number already using that service.
By describing the dynamic resources of the market in this
way and by incorporating multiple "competitors" into the flight simulator
model, you can simulate emerging competitive dynamics in the dot-com's market.
In addition, the process of building this virtual world often yields valuable
strategic insights that you can then "hard-wire" into the logic of the flight
simulator.
Dot-Com Flight Simulators "In Flight" The end product is a tool that combines the underlying
resource-based dynamic model with a user-friendly interface or "dashboard" to
help you develop and refine your dot-com strategy. The dashboard provides
access to high-level levers—such as pricing strategies and investment
levels—that enable stakeholders to test-run multiple strategies. The dashboard
also represents the consequences of different approaches and their effect on
projected revenues in this virtual world. Using flight simulators with a wide
group enables the rapid dissemination of ideas using a common, demonstrable
framework, and is also an effective way to build the commitment required from
investors.
Exhibit: A typical dot-com flight simulator dashboard
Enlarge this image
The dashboard enables you to learn the hard lessons of the
eEconomy without the hard consequences.
- The importance of speed to market—and why first is best
- The effect of initial pricing strategies and their long-term
effect on business viability
- The critical role of advertising and the need for deep
pockets
- How "me too" competitors can impact business performance.
Flight simulators are only one of many approaches to
developing robust business strategies. But in the dynamic and often frenzied
environment of dot-coms, they provide an invaluable tool for clarifying the
market dynamics and creating plausible scenarios for the dot-com start-up. When
traveling at eSpeed, it is reassuring to know that you have virtually been
there already.
Ian Richards is an associate partner in the Accenture
Financial Services Strategy practice. He is based in Sydney.
Dr. James Morrison is a manager in the Accenture Resources
and Utilities Strategy practice. He is based in Sydney.
For more information, please
contact us.
¹ W. Brian Arthur; "Increasing Returns and the New World of
Business"; Harvard Business Review, July-Aug. 1996
² Kim Warren; "The Dynamics of Rivalry"; Business Strategy
Review, 1999, Volume 10, issue 4
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