technology monopoly explained
What does a company with large cash flows far into the future look like? Every
monopoly is unique, but they usually share some combination of the following
characteristics: proprietary technology, network effects, economies of scale, and
branding.
This isn’t a list of boxes to check as you build your business—there’s no shortcut to
monopoly. However, analyzing your business according to these characteristics can
help you think about how to make it durable.
1. Proprietary Technology
Proprietary technology is the most substantive advantage a company can have
because it makes your product difficult or impossible to replicate. Google’s search
algorithms, for example, return results better than anyone else’s. Proprietary
technologies for extremely short page load times and highly accurate query
auto completion add to the core search product’s robustness and defensibility. It
would be very hard for anyone to do to Google what Google did to all the other
search engine companies in the early 2000s.
As a good rule of thumb, proprietary technology must be at least 10 times better
than its closest substitute in some important dimension to lead to a real monopolistic
advantage. Anything less than an order of magnitude better will probably be
perceived as a marginal improvement and will be hard to sell, especially in an
already crowded market.
The clearest way to make a 10x improvement is to invent something completely
new. If you build something valuable where there was nothing before, the increase
in value is theoretically infinite. A drug to safely eliminate the need for sleep, or a
cure for baldness, for example, would certainly support a monopoly business.
Or you can radically improve an existing solution: once you’re 10x better, you
escape competition. PayPal, for instance, made buying and selling on eBay at least 10
times better. Instead of mailing a check that would take 7 to 10 days to arrive,
PayPal let buyers pay as soon as an auction ended. Sellers received their proceeds
right away, and unlike with a check, they knew the funds were good.Amazon made its first 10x improvement in a particularly visible way: they offered
at least 10 times as many books as any other bookstore. When it launched in 1995,
Amazon could claim to be “Earth’s largest bookstore” because, unlike a retail
bookstore that might stock 100,000 books, Amazon didn’t need to physically store
any inventory—it simply requested the title from its supplier whenever a customer
made an order. This quantum improvement was so effective that a very unhappy
Barnes & Noble filed a lawsuit three days before Amazon’s IPO, claiming that
Amazon was unfairly calling itself a “bookstore” when really it was a “book broker.”
You can also make a 10x improvement through superior integrated design. Before
2010, tablet computing was so poor that for all practical purposes the market didn’t
even exist. “Microsoft Windows XP Tablet PC Edition” products first shipped in
2002, and Nokia released its own “Internet Tablet” in 2005, but they were a pain to
use. Then Apple released the iPad. Design improvements are hard to measure, but it
seems clear that Apple improved on anything that had come before by at least an
order of magnitude: tablets went from unusable to useful.
2. Network Effects
Network effects make a product more useful as more people use it. For example, if
all your friends are on Facebook, it makes sense for you to join Facebook, too.
Unilaterally choosing a different social network would only make you an eccentric.
Network effects can be powerful, but you’ll never reap them unless your product is
valuable to its very first users when the network is necessarily small. For example, in
1960 a quixotic company called Xanadu set out to build a two-way communication
network between all computers—a sort of early, synchronous version of the World
Wide Web. After more than three decades of futile effort, Xanadu folded just as the
web was becoming commonplace. Their technology probably would have worked at
scale, but it could have worked only at scale: it required every computer to join the
network at the same time, and that was never going to happen.
Paradoxically, then, network effects businesses must start with especially small
markets. Facebook started with just Harvard students—Mark Zuckerberg’s first
product was designed to get all his classmates signed up, not to attract all people of
Earth. This is why successful network businesses rarely get started by MBA types:
the initial markets are so small that they often don’t even appear to be business
opportunities at all.
monopoly is unique, but they usually share some combination of the following
characteristics: proprietary technology, network effects, economies of scale, and
branding.
This isn’t a list of boxes to check as you build your business—there’s no shortcut to
monopoly. However, analyzing your business according to these characteristics can
help you think about how to make it durable.
1. Proprietary Technology
Proprietary technology is the most substantive advantage a company can have
because it makes your product difficult or impossible to replicate. Google’s search
algorithms, for example, return results better than anyone else’s. Proprietary
technologies for extremely short page load times and highly accurate query
auto completion add to the core search product’s robustness and defensibility. It
would be very hard for anyone to do to Google what Google did to all the other
search engine companies in the early 2000s.
As a good rule of thumb, proprietary technology must be at least 10 times better
than its closest substitute in some important dimension to lead to a real monopolistic
advantage. Anything less than an order of magnitude better will probably be
perceived as a marginal improvement and will be hard to sell, especially in an
already crowded market.
The clearest way to make a 10x improvement is to invent something completely
new. If you build something valuable where there was nothing before, the increase
in value is theoretically infinite. A drug to safely eliminate the need for sleep, or a
cure for baldness, for example, would certainly support a monopoly business.
Or you can radically improve an existing solution: once you’re 10x better, you
escape competition. PayPal, for instance, made buying and selling on eBay at least 10
times better. Instead of mailing a check that would take 7 to 10 days to arrive,
PayPal let buyers pay as soon as an auction ended. Sellers received their proceeds
right away, and unlike with a check, they knew the funds were good.Amazon made its first 10x improvement in a particularly visible way: they offered
at least 10 times as many books as any other bookstore. When it launched in 1995,
Amazon could claim to be “Earth’s largest bookstore” because, unlike a retail
bookstore that might stock 100,000 books, Amazon didn’t need to physically store
any inventory—it simply requested the title from its supplier whenever a customer
made an order. This quantum improvement was so effective that a very unhappy
Barnes & Noble filed a lawsuit three days before Amazon’s IPO, claiming that
Amazon was unfairly calling itself a “bookstore” when really it was a “book broker.”
You can also make a 10x improvement through superior integrated design. Before
2010, tablet computing was so poor that for all practical purposes the market didn’t
even exist. “Microsoft Windows XP Tablet PC Edition” products first shipped in
2002, and Nokia released its own “Internet Tablet” in 2005, but they were a pain to
use. Then Apple released the iPad. Design improvements are hard to measure, but it
seems clear that Apple improved on anything that had come before by at least an
order of magnitude: tablets went from unusable to useful.
2. Network Effects
Network effects make a product more useful as more people use it. For example, if
all your friends are on Facebook, it makes sense for you to join Facebook, too.
Unilaterally choosing a different social network would only make you an eccentric.
Network effects can be powerful, but you’ll never reap them unless your product is
valuable to its very first users when the network is necessarily small. For example, in
1960 a quixotic company called Xanadu set out to build a two-way communication
network between all computers—a sort of early, synchronous version of the World
Wide Web. After more than three decades of futile effort, Xanadu folded just as the
web was becoming commonplace. Their technology probably would have worked at
scale, but it could have worked only at scale: it required every computer to join the
network at the same time, and that was never going to happen.
Paradoxically, then, network effects businesses must start with especially small
markets. Facebook started with just Harvard students—Mark Zuckerberg’s first
product was designed to get all his classmates signed up, not to attract all people of
Earth. This is why successful network businesses rarely get started by MBA types:
the initial markets are so small that they often don’t even appear to be business
opportunities at all.
3. Economies of Scale
A monopoly business gets stronger as it gets bigger: the fixed costs of creating a
product (engineering, management, office space) can be spread out over ever greater
quantities of sales. Software startups can enjoy especially dramatic economies of scale
because the marginal cost of producing another copy of the product is close to zero.
Many businesses gain only limited advantages as they grow to large scale. Service
businesses especially are difficult to make monopolies. If you own a yoga studio, for
example, you’ll only be able to serve a certain number of customers. You can hire
more instructors and expand to more locations, but your margins will remain fairly
low and you’ll never reach a point where a core group of talented people can provide
something of value to millions of separate clients, as software engineers are able to
do.
A good startup should have the potential for great scale built into its first design.
Twitter already has more than 250 million users today. It doesn’t need to add too
many customized features in order to acquire more, and there’s no inherent reason
why it should ever stop growing.
4. Branding
A company has a monopoly on its own brand by definition, so creating a strong
brand is a powerful way to claim a monopoly. Today’s strongest tech brand is Apple:
the attractive looks and carefully chosen materials of products like the iPhone and
MacBook, the Apple Stores’ sleek minimalist design and close control over the
consumer experience, the omnipresent advertising campaigns, the price positioning
as a maker of premium goods, and the lingering nimbus of Steve Jobs’s personal
charisma all contribute to a perception that Apple offers products so good as to
constitute a category of their own.
Many have tried to learn from Apple’s success: paid advertising, branded stores,
luxurious materials, playful keynote speeches, high prices, and even minimalist
design are all susceptible to imitation. But these techniques for polishing the surface
don’t work without a strong underlying substance. Apple has a complex suite of
proprietary technologies, both in hardware (like superior touchscreen materials) and
software (like touchscreen interfaces purpose-designed for specific materials). It
manufactures products at a scale large enough to dominate pricing for the materials
it buys. And it enjoys strong network effects from its content ecosystem: thousands of
developers write software for Apple devices because that’s where hundreds of millions of users are, and those users stay on the platform because it’s where the apps
are. These other monopolistic advantages are less obvious than Apple’s sparkling
brand, but they are the fundamentals that let the branding effectively reinforce
Apple’s monopoly.
Beginning with brand rather than substance is dangerous. Ever since Marissa
Mayer became CEO of Yahoo! in mid-2012, she has worked to revive the once-
popular internet giant by making it cool again. In a single tweet, Yahoo! summarized
Mayer’s plan as a chain reaction of “people then products then traffic then revenue.”
The people are supposed to come for the coolness: Yahoo! demonstrated design
awareness by overhauling its logo, it asserted youthful relevance by acquiring hot
startups like Tumblr, and it has gained media attention for Mayer’s own star power.
But the big question is what products Yahoo! will actually create. When Steve Jobs
returned to Apple, he didn’t just make Apple a cool place to work; he slashed product
lines to focus on the handful of opportunities for 10x improvements. No technology
company can be built on branding alone. What does a company with large cash flows far into the future look like? Every monopoly is unique, but they usually share some combination of the following
characteristics: proprietary technology, network effects, economies of scale, and
branding.
A monopoly business gets stronger as it gets bigger: the fixed costs of creating a
product (engineering, management, office space) can be spread out over ever greater
quantities of sales. Software startups can enjoy especially dramatic economies of scale
because the marginal cost of producing another copy of the product is close to zero.
Many businesses gain only limited advantages as they grow to large scale. Service
businesses especially are difficult to make monopolies. If you own a yoga studio, for
example, you’ll only be able to serve a certain number of customers. You can hire
more instructors and expand to more locations, but your margins will remain fairly
low and you’ll never reach a point where a core group of talented people can provide
something of value to millions of separate clients, as software engineers are able to
do.
A good startup should have the potential for great scale built into its first design.
Twitter already has more than 250 million users today. It doesn’t need to add too
many customized features in order to acquire more, and there’s no inherent reason
why it should ever stop growing.
4. Branding
A company has a monopoly on its own brand by definition, so creating a strong
brand is a powerful way to claim a monopoly. Today’s strongest tech brand is Apple:
the attractive looks and carefully chosen materials of products like the iPhone and
MacBook, the Apple Stores’ sleek minimalist design and close control over the
consumer experience, the omnipresent advertising campaigns, the price positioning
as a maker of premium goods, and the lingering nimbus of Steve Jobs’s personal
charisma all contribute to a perception that Apple offers products so good as to
constitute a category of their own.
Many have tried to learn from Apple’s success: paid advertising, branded stores,
luxurious materials, playful keynote speeches, high prices, and even minimalist
design are all susceptible to imitation. But these techniques for polishing the surface
don’t work without a strong underlying substance. Apple has a complex suite of
proprietary technologies, both in hardware (like superior touchscreen materials) and
software (like touchscreen interfaces purpose-designed for specific materials). It
manufactures products at a scale large enough to dominate pricing for the materials
it buys. And it enjoys strong network effects from its content ecosystem: thousands of
developers write software for Apple devices because that’s where hundreds of millions of users are, and those users stay on the platform because it’s where the apps
are. These other monopolistic advantages are less obvious than Apple’s sparkling
brand, but they are the fundamentals that let the branding effectively reinforce
Apple’s monopoly.
Beginning with brand rather than substance is dangerous. Ever since Marissa
Mayer became CEO of Yahoo! in mid-2012, she has worked to revive the once-
popular internet giant by making it cool again. In a single tweet, Yahoo! summarized
Mayer’s plan as a chain reaction of “people then products then traffic then revenue.”
The people are supposed to come for the coolness: Yahoo! demonstrated design
awareness by overhauling its logo, it asserted youthful relevance by acquiring hot
startups like Tumblr, and it has gained media attention for Mayer’s own star power.
But the big question is what products Yahoo! will actually create. When Steve Jobs
returned to Apple, he didn’t just make Apple a cool place to work; he slashed product
lines to focus on the handful of opportunities for 10x improvements. No technology
company can be built on branding alone. What does a company with large cash flows far into the future look like? Every monopoly is unique, but they usually share some combination of the following
characteristics: proprietary technology, network effects, economies of scale, and
branding.
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