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the Software View: Software market dynamics (Part II)

Welcome back, gentle reader. I just returned from a business trip in the Philippines. I am helping to create a software company there. There is an incredible amount of opportunity there and the countryside is a paradise. After swimming on the ocean beach in Bongabong, Oriental Mindoro, listening to the strains of Jessa Zaragoza's "Bakit Pa?" and "Pa'no Kaya?", I began to reflect upon the events that transpired during the previous months.

One event, that happened during my trip, really opened my eyes to the power of this upcoming Internet software economy age and coming networked era. To make a long story short, my wife and I attempted to leave the Philippines on August 27, earlier than we had scheduled. Our travel agent issued tickets to my wife using her maiden name, rather than our married name. This created an identity crisis for Northwest Airlines and they refused to allow us to leave the country, just in case we were trying to use "Mrs. Kuharich's" ticket. I expect to see the overthrow of old world, bureaucratic companies like Northwest Airlines in my lifetime. The Internet is a global phenomenon on a scale we've never witnessed. These are the forces that will make companies like Northwest Airlines irrelevant. We used the Internet to overcome any obstacles that Northwest Airlines attempted to throw in our path. We sent an e-mail describing the situation to our sister-in-law here in the United States. She created a JPEG image by scanning our marriage certificate. Our sister-in-law then e-mailed the JPEG image to us. And we printed it out using the Manila hotel's printer.

On August 31, 1998, the Dow Jones Industrial average dropped over 500 points, and the NASDAQ dropped over 140 points. For both stock market exchanges, it was the largest single day market loss in history. That day, Microsoft's Bill Gates lost over $5 billion in a single day.

As for the media's attention, Microsoft sure is sheepish when it comes to the United States Justice Department's depositions involving Bill Gates and other executives. The depositions, which were supposed to happen this week, have been put off until decisions can be reached about how to conduct the antitrust interrogation with reporters in the room. Consequently, the trial itself, which was originally scheduled for September 8, will likely be pushed back as well.

This all started when a lawyer representing the New York Times, Ziff Davis, and the Seattle Times cited a 1913 law that requires depositions for federal antitrust cases to be open to the public. Right now Redmond is appealing United States District Court Judge Thomas Penfield Jackson's decision, which was based on the obscure law, to make the depositions public.

David Coursey writes, "Windows NT - A matter of life and death? Here's a snippet of one of the most recent news stories highlighted on Microsoft's Web site, taken from the Rocky Mountain News in Colorado:

"Denver and Adams counties last week showed off an enhanced 911 trial that allows dispatchers to identify the location of people calling from a wireless phone ... Denver was the first major implementation of San Diego-based American TriTech's VisiCAD for Fire/EMS. Unlike older dispatch systems, which tend to use big mainframe computers, it runs on Microsoft Windows NT, using SQL Server."

Though the technology that article talks about sounds cool, it worries me that many places - especially life and death systems like 911 operations - are bending to the Microsoft marketing machine and using NT because they feel like there is no other choice.

Microsoft has been so successful in promoting NT that all sorts of things - perhaps things that don't need to - are migrating to it before the operating system is really ready. I base this on the conversations I've had with developers and others who actually are in positions to decide what kind of hardware and software goes into supporting 911 systems.

The question I like to ask them regarding this is: "Would you bet your life, or someone else's, on a computer system that's running on NT?" The long silence when I ask this is very telling. Nearly none of them feel that NT is stable enough to perform truly critical, life-or-death applications.

Do you want to be on the other end of the phone while the 911 operator waits for NT to reboot? Ask the sailors on the Navy ship that had to be towed back into port after its NT-based control systems died the big death.

I mention this because I have a regular correspondence going with a 911 systems vendor who is really concerned about NT stability in truly mission-critical apps. Indeed, stability can be a life and death matter."

For those of you with Internet and World Wide Web access and a Netscape Navigator web browser, please point your browser to:
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Now, dear readers, on with this week's episode of the Software View!

With this issue, I continue a multi-part exploration of the dynamics of software markets.

CAPITALISM IS WAR

Ted Lewis writes, "One rule that can help compete in a frictionless economy is the New Lanchester Strategy. It provides guidance by suggesting market share targets and useful mergers and acquisitions patterns. This theory can propel a FutureBusiness down the learning curve at high speed, beating out slower rivals.

In 1916, Frederick William Lanchester (1868-1946) wrote a book called Aircraft in Warfare: The Dawn of the Fourth Arm. It was about air battles, not high-tech battles. In 1952, however, Japan was introduced to his work by quality guru Edward Deming, and Dr. Nobuo Taoka, a well-known author there, applied Lanchester's theories to sales and marketing. Since those early days, the Lanchester model has evolved into the New Lanchester Strategy with help from a number of Japanese strategists.

The New Lanchester Strategy is essentially a recipe for business-as-war. It gives details - with mathematical precision - on how to muscle your product or company into the mainstream.

The first question it addresses is how much market share is really necessary to achieve dominance. Companies with market share in excess of 73 percent are said to hold a monopoly share. A monopoly ends the game of business-as-war.

It is not necessary, then, to try and increase market share beyond this point. In fact, it may be dangerous. According to the New Lanchester Strategy, several things happen when a company's market share exceeds 73 percent: It becomes difficult to stimulate more demand; the company invites competition from other industries or specialty companies; and the correlation between market share and profitability disappears.

So what is the ideal market share? When a company's goal is to dominate, it usually attempts to gain at least 50 percent of the market. The New Lanchester Strategy, however, suggests that only a 41 percent market share is necessary. The gap in profitability between the leader and its rivals widens when the leader's market share exceeds 41 percent but is less than 73.9 percent.

McAfee Associates Incorporated, Santa Clara, California, recently achieved a 41 percent share of the PC network management suite market by merging with Saber Software Corporation. This illustrates the use of mergers as a mainstreaming strategy.

A company that has more than 26 percent of a market, but less than 41 percent, is considered a player. Such a company must stay above the 26 percent minimum, even though it is not a leader, to maintain its position as a competitor. Smaller share percentages cannot support the marketing costs.

All manufacturers in the desktop personal computer industry fall below the 26 percent minimum. They are called unstable players, because a company's position can be easily reversed. It is not surprising then, that the positions of leadership among personal computer vendors is in constant flux.

How does a company move up the marketing food chain? By sliding down the learning curve, thus climbing the mainstreaming curve, faster than its competitors. For example, Novell's IPX/SPX networking protocol standard formerly held a leadership position. But the TCP/IP standard is now racing along the learning curve. When I plug the learning curve of TCP/IP into my mainstreaming model, it predicts that by about the year 2000, TCP/IP is likely to achieve a monopoly market share and end the game.

Now, a caveat: The New Lanchester Strategy assumes a constant market size. In reality, most computer industry markets are rapidly expanding. For example, although the personal computer vendors are all unstable players by virtue of their low market shares, they are less threatened than they might be, because they are in a rapidly expanding business. Shipping product is more important than competition.

Still, when the market expansion slows or stops, the unstable players will have to either leave their competitors in the dust or merge with one another to reach the 26 percent threshold. Therefore, the personal computer companies are well advised to continue speeding down their learning curves as quickly as possible.

IN SHOOTING RANGE

The New Lanchester Strategy gives a prescription for mainstreaming. It is called the "shooting range theory," and has been refined by a number of scholars. Finding and targeting a weakness in an opponent is called "finding the shooting range."

The relative market shares of companies determines if they are within shooting range of each other. In a two company battle, for example, if one company has three times the market share of the other, the position is irreversible. But if the market share of one is less than three times that of the other, their market shares could be reversed.

What if there are more than two companies battling it out? Any company whose market share size is within about 1.7 (or the square root of three) times the size of a second company's market share is within shooting range of that company.

Shooting range theory is a kind of game theory. When real "players" and "unstable players" within shooting range are present in a market, it is interesting to follow the rules to help evaluate a certain strategy, such as whether a merger would significantly boost its chances of success. The personal computer industry is ripe for reversals because nobody has more than about 10 percent of the global market. But until one or more of the personal computer vendors pulls ahead of the pack, application of shooting range theory is not very interesting.

THE BODY ELECTRONIC

There is little doubt that the coming software economy coincides with the rise of the Internet. The numbers may change every day, but they still add up to a sea change in the computing industry. Future Internet sales estimates by the year 2000 range from Forrester Research's $45 billion to Hambrecht & Quist LLP's $73 billion. Compare this to the size of the total current content market (software, books, movies, videos, video games and magazines) of $90 billion.

The demographics of the Internet are also well known. Find/SVP Inc. found that roughly 3.4 percent (4.4 million) of United States households were wired in 1994. A Georgia Institute of Technology survey zeroed in on the market-of-one statistics: on-line consumers have high incomes, are well-educated, and are mostly male.

There are more than 40,000 Web servers and more than 76,000 domain names ending in ".com." Open Market Commercial Sites Index says 22 percent are profitable, 40 percent expect to be in one to two years, and only 14 percent are disappointed with Internet business.

We know the consumer. Security problems will soon be solved and consumers will have the necessary equipment and access to sustain a vibrant Internet software economy. All indicators are that success is only a log-in away.

LINKER TOYS

The question, however, still lingers. "What is a good business plan for the Nethead market?" I will consider two: The producer/distribution model, and the consumer/push-pull model.

Producer, or distribution, models are currently in vogue among FutureBusinesses "doing business on the Internet." The idea is to produce content and distribute it via the Internet. This is very much a magazine publishing model. First, some form of edutainment is published on the Web; e.g., graphics, data, articles or pure nonsense such as the tele-garden (a robot that remotely plants and waters seeds over the Internet).

Second, a webmeister counts hits - accesses to a Web page - and registers potential clients through CGI (Common Gateway Interface) forms and programs that collect names, addresses and other demographics. These counts are similar to the Business Publisher's Association (BPA) numbers collected by magazine circulation managers. The value of a magazine, and its advertising rates, is proportional to the number of people who read it. The value of a Web page is proportional to the number of hits received per day, week or month.

Third, high-traffic Web pages use mainstreaming techniques to accelerate the rate of hits. These techniques are very similar to the ones described above, with an emphasis on tribalism, narrowcasting and Davidow's Law. That is, the webmeister tries to appeal to a special interest group (such as wine tasting), create a sense of community (anti-freedom of speech laws discussions are a favorite) and rapidly turn over page content to promote repeated visits to the page (hot lists).

Marketing on the Web is fierce but gentle. Webmeisters not only maintain the Web page but, more importantly, they spend a lot of time and effort trading URL links with other webmeisters. They play linker toys with the URL building blocks of the Web. The more links pointing at your Web page, the more hits you get. The more hits you get, the more market share you get. Quick dissemination of links is critical to the Internet's learning curve. Riding that learning curve is what Internet marketing is all about.

The problem with the magazine publishing model is that the consumer must hunt down and access the content. And the cyber-Simpsons of the future are unlikely to spend much time hunkering over an unresponsive browser.

This problem has been solved by traditional publishers of books, magazines, movies and software through aggressive and expensive advertising campaigns. Advertising is expensive and does not guarantee sales. This is as true on the Internet as it is in the magazine business. Expect to see Internet public relations firms and ad agencies and linker-toy specialists rapidly appear in response to this problem.

Within a few years, the cost of doing business on the Internet may rival that of the Machine Age - ads could cost $25,000 per page, and hits will dictate the return on your advertising dollar. Will this kill the Internet or fuel rapid commercialization? It is not clear at this point whether the Web can step out of the simple magazine model. Magazines are Machine Age products, and the Internet is the steam engine of the Information Age.

If the Internet is to become more than a low-cost alternative to magazines, it must evolve toward electronic barter, communal groupware, virtual shopping malls, work-at-home, learn-at-home, bank-at-home and other unfathomable "at-home" products and services. As in the magazine business, compelling content is key. Thus, the static home page of HTML must give way to dynamic edutainment. This is why Sun Microsystems' Java^TM technology is important. It turns static pages into dynamic pages. It turns data into entertainment.

Java is a language and a platform-independent interpreter for running any Java program on any computer. Java applets are small programs attached to home pages. When a home page is accessed, the HTML data is downloaded into the customer's PC or Internet reader along with attached applets. The applets are interpreted under the control of the customer's computer, and then discarded when the customer leaves the Web page.

Combined with the Netscape Communicator Internet browser, Java and JavaScript provide a basis for doing business using the producer/distribution model. The technology is controlled by the producer (i.e., the software developer and marketer), not the consumer. Therefore, Java requires the content producer to "sell" to a consumer using rather traditional methods of marketing.

Attracting customers with linker-toy promotion is the basis for marketing under this model. A good example of this approach is Yahoo! Corporation, Mountain View, California. The students who founded Yahoo! got their start by collecting and evaluating thousands of links. They achieved a certain player position within the Nethead community, which resulted in high hit counts. How does Yahoo make money? They charge other companies $60,000 per quarter to advertise on their Web site.

There is another, more exotic approach to the coming Internet software economy. It is called the consumer, push-pull or cyberspace model. In this model, the basic economic unit is a transaction. In cyberspace, transactions take us back to the age of barter. The basic mechanism for making money is the transaction fee. Credit card companies have long practiced a sophisticated version of electronic barter. These models have not yet proven successful, but they might be turned into profitable strategies if certain principles of the Internet software economy are followed.

The main difference between this model and the previous one is that business is initiated predominantly by consumers. Someone, somewhere wants to buy information, service or a product. They enter into a community of buyers and sellers, or a market, and obtain the service or product by electronic barter. The intriguing prospect in this model, however, is the idea of a software agent, a program that roams the telesphere looking for buyers and sellers (who are also software agents). Whenever two or more software agents meet in the telesphere, they barter for services and products, and then report back to their human owners.

Mobile software code written in Java and utilizing Sun Microsystems' Jini technology is an example of a technology for implementing the customer or push-pull model. A Java agent can seek out other agents to engage in electronic barter. Agents initiate a consumer "pull" when they are launched by a consumer who wants to buy something. They initiate a market "push" when launched by a producer looking to sell something. This product has already been built. Netbot, a Seattle software company created Jango, an electronic buying software agent written in Java. They were subsequently bought out by Excite, the Internet search engine and Internet portal company.

Excite could implement the push-pull model by launching hordes of Java agents into cyberspace on behalf of its customers and then sitting back and collecting transaction fees. Suppose Excite did this for the real estate industry. Sellers unleash agents that look for buyers, and buyers unleash agents that look for sellers. The buyer agents hold data and instructions for selecting and negotiating the purchase of a house. The seller agents hold data about their houses for sale, along with instructions for negotiating the sale. Third-party agents, such as bankers, lawyers and escrow accountants, may also be involved in the ensuing transactions.

This form of electronic cottage industry requires a new currency, such as electronic cash or electronic credits. Results of a sale may be reported back to their human owners, or forwarded on to the next transaction. Thus, the software economy runs with only minimal human interruption.

The telesphere is a cyberspace with places and "go actions." A Java software agent can go to places in the telesphere. In computer terms, Java software agents and places are both executing processes. A Java software agent is a process that runs inside of a place process. The go action implements process migration, which moves an agent process from one place process to another. Place and agent processes are independent of any machinery, physical location or physical barrier. However, every Java software agent starts within a machine process - inside a customer's computer.

The telesphere of Java software agents can launch agents for doing any kind of business. Agents can be created on a single computer, a LAN, VAN or WAN, and they can roam across networks of any size or duration.

When unleashed on the Web, a global telesphere might consume the entire electronic infrastructure, creating an electronic mall to end all malls. Indeed, the potential for work-at-home, banking, publishing and nearly all other service industries is astounding.

DOES IT HAVE LEGS?

Is the Internet software economy viable or voodoo, science fiction or reality? The Yahoo! home page generates about 600,000 "meaningful transactions" per day, depending on how you define a transaction. Suppose each visit generated a transaction fee of one penny. This translates to $180,000 per month, far more than the $15,000 per month generally charged for a single advertisement. On the surface, it seems that transaction-based barter is far more lucrative than selling advertising pages. (Okay, so this is an unfair comparison because a single site can host thousands of ads. But then, how does an advertiser reach an audience if it must rise above the noise of thousands of ads?)

In reality, both models could flourish in the Internet software economy. Manufacturing and distribution industries that produce a tangible product are more likely to go for the producer/distribution model because it mirrors the Machine Age. Service industries, which add value through transaction processing, may find the consumer/push-pull model more attractive. In fact, as the economy moves toward service instead of manufacturing sectors, the idea of a virtual marketplace with Java software agents could take off.

This indicates that the specific business model may not be as important as an understanding of the principles of FutureBusiness. Any product or service that uses the Internet or other software technology to drive products and services to commodity pricing levels, to personalize and appeal to tribal instincts, has a good chance of becoming a mainstream success. FutureBusinesses that are able to fly down the learning curve to reach mainstream status will, with some luck, achieve a leadership position in the coming Internet software economy."

To be continued ...

Sincerely,
Mark Kuharich

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