Tag: contestable markets

Will you look for jobs in Facebook?

It has been a wonderful week so far with my lectures on Platform Business Models at the University of Rome Tor Vergata over the past two days. In one of the discussions, there was a discussion about network mobilisation, and a perceptive participant quipped about how successful Facebook can be in a variety of businesses. I have been maintaining that Facebook and LinkedIn are in independent markets, with their own unique needs, and therefore would never end up competing. However, this discussion on what Facebook can do with the big, small and thick data it has about users – ads, shopping, or even jobs set me thinking.

Winner takes all markets

One of the most common discussions on platform and networked businesses is the prevalence of monopolies, in what we call as “winner-takes-all” markets. There are three conditions for these markets to satisfy to qualify as “winner-takes-all” markets – multi-homing costs should be very high; network effects should be strong and positive; and users usually do not have any special preferences (read more about it here). Social networking (with peers, friends, and family) is a winner-takes-all business by all counts – it is difficult to affiliate yourself with multiple platforms; network effects are strong and positive; and Facebook is used for pretty much everything – no special preferences.

Professional networking space, on the other hand, would have different economics. Multi-homing costs are sure high, but not so high. Especially when people have multiple identities … for instance a CEO by the day and a triathlon by the evening; or a professor of law and counsel at the same time. And they could possibly have separate professional networks, right for each of their interests, right. On top of this, online media provide us with our own masks, that enable us to insulate the two worlds when we choose to or integrate when it suits us. A sort of maskenfrieheit, a German word that translates to “masks provided to us by the power of anonymity”. Most of us surely live in multiple worlds, leveraging our own maskenfreiheits. Network effects are sure strong and positive, and in addition to social networking, professional networking business also has a significant extent of cross-side network effects (from potential employers and followers). There are special preferences in professional networking – there are those wo write for others to follow; some others just read and follow and minimally engage (a occasional like here and a share there); and there are few INfluencers (as LinkedIn calls them). So, it makes logical sense that a professional networking business is not a winner-takes-all business, and should be prepared to be attacked by a variety of competitors.

LinkedIn, for its part has done it bit, I would say. It has significantly expanded its reach to college students; allowed for writing (competing with blogs); jobs (competing with focused recruitment sites); shares, likes, and comments (competing with social networking, including micro-blogging). And its merger with Microsoft recently would hopefully provide it more teeth to bite in.

Facebook enters the jobs market

But, how does LinkedIn compete when the ubiquitous Facebook decides to enter the jobs market? I recently read this report on TechCrunch (read it here) on how Facebook is entering the jobs market. With its size of members’ network at more than thrice that of LinkedIn, Facebook can unearth more and more passive job seekers. Those of you who are not actively seeking a job, but would be interested in testing something out, if is offers great roles, salaries, titles, locations, or just more fun that your current role. In fact, the value proposition of LinkedIn was just that – one keeps building a stack of endorsements and a network that will then actively seek you out, rather than the job seeker reaching out. Facebook seems to have imitated just that – its profile tags is much the same as LinkedIn endorsements. Everyone sees the similarity … read the Fortune Business report of July 2015 here.

Is the professional networking space contestable?

Firms competing across business lines can also be explained using the theory of contestable markets. The simplest definition and explanation of contestable markets I could find online is on this page. These markets are characterised by low barriers to entry (like no economies of scale) and low barriers to exit (like no sunk costs), and therefore allow for new entrants to adopt a hit and run strategy. Incumbents typically protect their turf using asymmetric information (some specific information/ competence) that the new entrants do not possess. If we were to look at professional networking space as a contestable market, then LinkedIn had it all covered as an incumbent. Facebook anyway had a variety of small and medium businesses maintaining pages to connect with its customers; and all it had to do was to extend the same feature to job applicants connecting with the firms. Much like how a firm would announce a new product or a discount offer, it could advertise jobs on its Facebook page. Just that Facebook is trying to overcome the asymmetric information bit with its Profile Tags feature to quickly imitate LinkedIn’s endorsements (it is not available in all countries, yet). Without that Facebook would not be able to customise the feed to its readers – you would get only “relevant” job offers on your Facebook timeline, now that it would have your Profile Tags.

Facebook jobs, anyone?

So, would you apply for jobs using Facebook? I for one know a lot of active seekers and college students invest in building their LinkedIn profiles, rather than “wasting time” on Facebook. Facebook is for casual chit-chat with friends and family, sharing selfies, religious views, political statements, and even late-night party stories. Not the place where I would imagine a lot of people would apply for jobs. Will you let your maskenfreiheit down?

But hang on, what about those who do not have a LinkedIn profile? What about those who are logged on to Facebook for ever on their smart phones? What about those who use Facebook to gather information about jobs and then apply for the same using traditional job sites, just email, or through their LinkedIn profiles? Small and Medium businesses might be able to attract a lot of undifferentiated talent (I’m not talking about blue collared workers only) through Facebook, if this succeeds. And what do dedicated job sites like Monster.com do?

Facebook surely has big data, small data (or thick data) and even the right data (after my posts of the last two weeks, this HBR post on right data appeared online!). Exciting times ahead.

Cheers.

(c) 2016. Srinivasan R.

Flipkart Ads – Is there a shift in online advertising economics?

Yesterday, I read an interview with Sanjay Ramakrishnan, Senior Director & Head – Business development & Marketing, Flipkart Ads in Advertising Age India (read it here). It set me thinking, why is Flipkart into advertisements? Is it competing with Amazon or with Google, Facebook, and Apple as well?

Though I am tempted to label this development as the advertising market becoming a contestable market, I will refrain from doing so. Let me first explain what is a contestable market (in simple terms, of course, let me try; and in the context of platform business models), and then proceed to analyze if the success of Flipkart Ads is a source of worry for other platforms whose principal business model is based on advertising revenue.

The theory of contestable markets originated from the works of Baumol as early as 1982 in this seminal paper (available through JSTOR here). He (and his co-authors in subsequent papers) defined a contestable market as one with absolutely free entry and costless exit. Which implies that such a market would be vulnerable for a hit-and-run entry, i.e., by any competitor with no need for any specific assets, process capabilities, or differentiation.

A key characteristic of these markets is that the new entrant takes the prices prevailing in the market (of the incumbents) as given, and enters with the same price. In a perfect competition, any new entrant will increase the supply in the market, and should lead to a reduction in prices. Even when the market shares of incumbents and new entrants change, the industry price levels should ideally fall with increase in supply. In contrast, in a contestable market, the new entrant could enter the market with the same price as the incumbents. The justification for this assertion could be based on two arguments, that the new entrant enters the market at such a small scale compared to the incumbents that there is no visible change in the total market supply to warrant a price correction. The second argument is founded on the thesis that the incumbents cannot retaliate with sufficient speed to counter the threat posed by the new entrant, due to their systems and processes that bind them to a particular cost structure and a positioning in the market. In such a case, the new entrant could enter the market with a prior contract, preferably a long-term contract, at least as long-term as it takes for the incumbent to respond. In perfect competition or monopolistic competition, incumbent firms will adopt limit pricing strategies (if profitable for them) to keep new entrants at bay, i.e., as the incumbents sense the threat of new entry, they would reduce the prices to a level where it would be profitable for the incumbents and not for the new entrant. Take for example, when cola firms entered the bottled water market in India, the incumbent, Bisleri International embarked on a strategy of keeping market prices so low that it took a long time for Coca Cola Company, and Pepsico to break even.

The second aspect of contestable markets is the absence of any sunk costs whatsoever for both the incumbent and the new entrant. If any upfront fixed costs were to be incurred by a competitor either prior to entry (including in studying the feasibility of making money in that market) or at entry (like setting up manufacturing and distribution capabilities), the costs of entry will prevent this market from becoming contestable. Let me provide an example. In today’s world, setting up an online store entails no sunk costs for any retailer. The domain registration and hosting, website design, payment gateways, and fulfillment are all functions that are unbundled and offered as independent services (as SaaS) by different vendors, which makes all of them variable costs, rather than fixed costs. Such costs are neither fixed nor specific – one could use the payment gateway for any other online transaction, should this venture fail. Such markets with no sunk costs result in no barriers to entry and exit and therefore, are contestable. Contrast this with our previous example of Coca Cola Company and Pepsico entering the Indian bottled water market – this is a market that requires significant bottling and distribution capabilities. Though the cola firms enter this market with significant synergies from their core business, there were certain unique capabilities that the bottled water market required – sourcing of good quality water and plastic bottles, bottling lines that were specific to water, unique branding, and wider distribution networks.

The third characteristic of contestable markets is that the products are absolutely non-differentiable. That means, the new entrants can enter the market and imitate the products/ services offered by the incumbents at the same costs or even lower, and therefore maintain the same price levels. It is also possible that the new entrants enter with lower prices, and offer the same ‘standard’ products or provide additional features at the same or lower prices. Such standardization is highly visible in the context of platform services, like a C2C marketplace. In the absence of any product differentiation between competitors (any new feature is imitable quickly and is almost costless to do so), Quickr.com and OLX.in entered the market and took market share from incumbents like Sulekha.com or asklaila.com.

In summary, a market can be (or become) contestable when either of these conditions are met – no changes in prices (no limit pricing by incumbents), no fixed sunk costs, and no differentiation in products and services offered.

Is digital advertising becoming a contestable market?

For digital advertising market to become (and be) a contestable market, it has to allow for costless entry and exit, no sunk costs, and no differentiation. In the case of Flipkart Ads, I would argue that it would have cost Flipkart next to nothing to build the platform. The ecommerce store was in any case dealing with sellers, and all that they had to do was to extend the relationship to brands. And remember, in the Indian market, a lot of the brands had their own ecommerce retail operations and some of them were already on Flipkart as sellers. For instance, when I searched for the Prestige brand of pressure cookers on Flipkart, I found about 40-odd sellers including TTK Prestige, the brand owner.

And when Flipkart entered the digital advertising space, did Google and Facebook respond with limit pricing? I am not sure they did. A Feb 2015 LiveMint article that announced Flipkart and SnapDeal’s entry into online advertising space gave Google ad revenues as US$55bn compared to Amazon’s US$1bn (read it here). Given these sizes, it is unlikely Google and Facebook would have felt the need to respond to their entry by lowering prices.

Developing the advertising platform would possibly not involve any sunk costs for Flipkart. There is sufficient traction in terms of relationships with sellers and brands, the technology platform costs next to nothing to build, transaction costs are variable (including cloud storage and payment gateways), and even brand building is costless (as they are extending the same brand – Flipkart Ads).

It is the third condition of contestable markets that protects the online advertising market from becoming a contestable market, i.e., lack of differentiation. In the case of online advertising market, differentiation is created and sustained by superior targeting of advertisements to the right users. Measuring and monitoring engagement of the audience is the key in data collection; deep understanding of the consumer behavior and decision-making process is critical in analyzing this large volume of data; and close relationships with a wide variety of advertisers is imperative to ensure narrowcasting of advertisements to specific audience profiles. Here is where the product differentiation kicks in – the kind of browsing habit data that Google has access to is very different from the ‘buying intent’ that Flipkart can derive out of its customers’ behaviors. And especially in the context of mobile apps, the Flipkart app has access to other information like the person’s location, WiFi/ data connection information, and even his contacts; all of which could be useful to provide targeted narrowcasting (or even unicasting) of advertisements. Such shrinking of segments and the ability to serve what the marketers call ‘the segment of one’ customer can differentiate the new entrant, Flipkart’s services from the incumbent ‘Google’ and ‘Facebook’.

So, what are the implications for entrepreneurs?

First, evaluate if your market is indeed contestable, or is likely to become contestable. If there is a likelihood of your primary market being or becoming contestable, consider one of the following options:

  1. Change your business/ business model (pivoting is a fancy word these days in the startup ecosystem)
  2. Erect barriers to entry and exit – use regulation if you must (see how Airport Taxis in Bangalore are competing with OLA and Uber)
  3. Differentiate – even if it is not the most significant of your product offerings, focus on those value creation opportunities that involve sunk costs
  4. Wait for a new entrant and bleed him to death with limit pricing (you better have easier access to capital than the new entrant)!
  5. Wind up, sell out, and take your family (if you have one) on a holiday to Seychelles! And don’t forget to thank me!

 

 

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