Non-linearity of technology adoption

2009-09-10

When I was in business school I remember a class where a partner from a big consulting firm was talking about how they had done extensive research and concluded that broadband would never gain significant traction in the US without government subsidies.  His primary evidence was a survey of consumers they had done asking them if they were willing to pay for broadband access at various price points.

Of course the flaw in this reasoning is that, at the time, there weren’t many websites or apps that made good use of broadband.   This was 2002 – before YouTube, Skype, Ajax-enabled web apps and so on.  In the language of economics, broadband and broadband apps are complementary goods – the existence of one makes the other more valuable.  Broadband didn’t have complements yet so it wasn’t that valuable.

Complement effects are one of the main reasons that technology adoption is non-linear. There are other reasons, including network effects, viral product features, and plain old faddishness.

Twitter has network effects – it is more valuable to me when more people use it.  By opening up the API they also gained complement effects – there are tons of interesting Twitter-related products that make it more useful.  Facebook also has network effects and with its app program and Facebook Connect gets complement effects.

You can understand a large portion of technology business strategy by understanding strategies around complements.  One major point:  companies generally try to reduce the price of their products complements (Joel Spolsky has an excellent discussion of the topic here).   If you think of the consumer as having a willingness to pay a fixed N for product A plus complementary product B, then each side is fighting for a bigger piece of the pie. This is why, for example, cable companies and content companies are constantly battling.  It is also why Google wants open source operating systems to win, and for broadband to be cheap and ubiquitous.

Clay Christensen has a really interesting theory about how technology “value chains” evolve over time.  Basically they typically start out with a single company creating the whole thing, or most of it.  (Think of mobile phones or the PC).  This is because early products require tight integration to squeeze out maximum performance and usability.  Over time, standard “APIs” start to develop between layers, and the whole product gains performance/usability to spare.   Thus the chain begins to stratify and adjacent sections start fighting to commoditize one another.   In the early days it’s not at all obvious which segments of the chain will win.  That is why, for example, IBM let Microsoft own DOS.  They bet on the hardware.   One of Christensen’s interesting observations is, in the steady state, you usually end up with alternating commoditized and non-commoditized segments of the chain.

Microsoft Windows & Office was the big non-commoditized winner of the PC. Dell did very well precisely because they saw early on that hardware was becoming commodotized.  In a commoditized market you can still make money but your strategy should be based on lowering costs.

Be wary of analysts and consultants who draw lines to extrapolate technology trends.  You are much better off thinking about complements, network effects, and studying how technology markets have evolved in the past.

Next post: Google and newspapers: the false choice of opting out
Previous post: Getting a job in venture capital

Views expressed in “content” (including posts, podcasts, videos) linked on this website or posted in social media and other platforms (collectively, “content distribution outlets”) are my own and are not the views of AH Capital Management, L.L.C. (“a16z”) or its respective affiliates. AH Capital Management is an investment adviser registered with the Securities and Exchange Commission. Registration as an investment adviser does not imply any special skill or training. The posts are not directed to any investors or potential investors, and do not constitute an offer to sell -- or a solicitation of an offer to buy -- any securities, and may not be used or relied upon in evaluating the merits of any investment.

The content should not be construed as or relied upon in any manner as investment, legal, tax, or other advice. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment. Any projections, estimates, forecasts, targets, prospects and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Any charts provided here are for informational purposes only, and should not be relied upon when making any investment decision. Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, I have not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. The content speaks only as of the date indicated.

Under no circumstances should any posts or other information provided on this website -- or on associated content distribution outlets -- be construed as an offer soliciting the purchase or sale of any security or interest in any pooled investment vehicle sponsored, discussed, or mentioned by a16z personnel. Nor should it be construed as an offer to provide investment advisory services; an offer to invest in an a16z-managed pooled investment vehicle will be made separately and only by means of the confidential offering documents of the specific pooled investment vehicles -- which should be read in their entirety, and only to those who, among other requirements, meet certain qualifications under federal securities laws. Such investors, defined as accredited investors and qualified purchasers, are generally deemed capable of evaluating the merits and risks of prospective investments and financial matters. There can be no assurances that a16z’s investment objectives will be achieved or investment strategies will be successful. Any investment in a vehicle managed by a16z involves a high degree of risk including the risk that the entire amount invested is lost. Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by a16z is available at https://a16z.com/investments/. Excluded from this list are investments for which the issuer has not provided permission for a16z to disclose publicly as well as unannounced investments in publicly traded digital assets. Past results of Andreessen Horowitz’s investments, pooled investment vehicles, or investment strategies are not necessarily indicative of future results. Please see https://a16z.com/disclosures for additional important information.