Strategic competitive advantages and value net organisation: conceptual considerations and organisational recommendations for two- or multi-sided service markets.

Dietl, Helmut ; Franck, Egon ; Royer, Susanne 等

Introduction: Competition in service markets

Products and services both fulfil human needs. However, a number of characteristics distinguish services from tangible products. The main difference is the immaterial character of services. Patenting service innovations is difficult due to this immaterial nature of service concepts. Based on ideas, information, and skills, such concepts are almost impossible to patent and also hard to protect against imitation. Long-term, sustainable competitive advantage, therefore, is difficult to achieve. Service firms do not only have to develop unique service concepts but also protect these with the help of isolating mechanisms. Rumelt calls such resource characteristics isolating mechanisms that prevent an imitation by competitors and defines them as 'phenomena that limit the ex post equilibration of rents among individual firms' (Rumelt 1984: 567). Mahoney and Pandian (1992: 371) add that 'isolating mechanisms explain (ex post) a stable stream of rents and provide a rationale for intra-industry differences among firms'. Establishing isolating mechanisms is a particular challenge regarding services because of their immaterial nature.

In general it is not possible to store services. It is thus not possible to decouple supply and demand but a coordination is necessary which requires a sophisticated supply and demand management. Production takes place at the same time as consumption. Therefore, the consumer is virtually integrated into the value-adding process. On the one hand, this means that consumers, as external factors, introduce additional variability and instability to the production process. On the other hand, consumers relieve service firms by placing productive capacity at its disposal. Due to the integration of the customer into the value-adding process of service organizations, customers influence value creation to a high degree. This becomes clear when looking at self-service. For value creation, the Google search engine, for example, not only depends on its technical properties, but exceedingly upon the skill and ability of the user to formulate his or her query.

Integrating the customer into the value-adding process as co-producer seriously influences service firms (e.g. Royer 2005). This is even more relevant when customers not only extensively influence their own transactions' value but also the value-adding process of other customers. Concerts and sports events are typical examples for this. The quality of the audience of concerts or sports events is equally relevant as the quality of the artists or athletes. A pop concert or soccer game in an empty or half-empty stadium generates substantially less value than a sold-out event. Many service providers depend not only on customers but also on complements. For example, eBay depends on electronic payment transactions, Amazon.com on logistic services and Yahoo! on news and entertainment topics.

It becomes obvious that such so-called two- and multi-sided markets have certain specificities (e.g. Rochet and Tirole 2001; Amstrong 2006). Each customer on one market side influences the value creation of customers on other market sides. For this reason competitive advantages here are not only based on firm specificities but rather on the efficient and effective organization of value creation processes and activities around a certain service. These processes and activities often transcend far beyond firm boundaries and also include customers and producers of complements. Therefore, in this paper a new perspective on value creation and competitive advantage realization is taken that is neither a market-based (e.g. Porter 1985) nor a resource-based (e.g. Peteraf 1993) approach. Rather the focus is on the process of value creation and the underlying value-adding processes and activities. Around a product or service different value-adding activities undertaken by various actors lead to a certain form of value net organization (see Dietl, Royer and Stratmann 2007). In many market environments nets of various actors transcending firm boundaries are competing. This leads to a two-level competition on the intra-net level as well as the inter-net level. Both levels have to be taken into account when analysing competitive advantage.

This paper aims at elaborating the relationship between value net organization and competitive advantage in two- and multi-sided service markets and, based on this, at developing contingent organizational recommendations for firms competing in such markets. It follows a description of the characteristics of two- and multi-sided service markets. This forms the basis for an analysis of the strategic potential of horizontal, vertical, and lateral forms of value net organization in two- and multi-sided service markets. In a concluding summary the findings are summed up and critically reflected.

Two- or multi-sided services

For two-sided services, the integration of customers into the value-adding process is crucial to success. Those customers on one side of the market no longer solely contribute to their own value-adding process and the value-adding process of their co-customers on the same side, but primarily create value for those customers on the other market side. Monster.com is a typical example for a two-sided service. Monster.com operates a job exchange platform on the Internet. Employers can post their vacancies on the Internet portal and job seekers may search the job portal applying various criteria as well as make an application. The value-adding process of Monster.com consists mainly of transaction cost economies, especially saving search costs for both market sides, i.e. for employers and for job seekers. Compared to traditional job markets in newspapers, the digitalization of job offers facilitates searching and, therefore, reduces searching costs for potential employees. As job seekers are likely to be more successful the more job offers are launched by the portal, the more are the value creation for job seekers.

Two forms of cost benefits result for the employer. Firstly, the costs placing a job offer with Monster.com are much lower than the costs for corresponding advertisements in newspapers. Secondly, but much more important: Compared to the costs which result from having a vacancy, the costs for advertising are negligibly low. Internet recruitment has led to a reduction of the recruitment period from an average of three months to one month (Hallowell and Reavis 2002: 5). Monster. com, therefore, reduces the vacancy period of a position by an average of two months. The cost advantages associated are the lion's share of (additional) value creation for the employer. All in all, the extent of cost reduction by the employer is dependent on the likelihood of finding a suitable employee. This likelihood grows with the number of job seekers, i.e. the size of the other market side. Each additional participant on one market side, therefore, increases the value-adding possibilities for the participants on the other market side.

The complexity of a value-adding process increases further where multi-sided services are concerned. Another market side for these services appears. Such multi-sided service markets are found when a two-sided market generates attention, which can be sold to advertisers as a side product. For example, Internet portals, newspapers and magazines, and sports and cultural events show the characteristics of multi-sided service markets.

Value net organization and competitiveness

The consideration of value net organization transcends firm boundaries and, in addition to vertically linked value-adding activities, integrates further relevant actors on horizontal and lateral levels into the analysis; yet it does not focus on the industry as a whole but on a system of value-adding processes and activities around a product or service that belong together. Value net organization in two- and multi-sided service markets affects efficiency as well as strategy of actors participating in a system and is, therefore, a highly relevant competitive factor within the context of different value adding systems.

The service platform is at the centre of value net organization in two- and multi-sided service industries. It is understood to be the (technological) connection between individual market sides. For telecommunications, for example, this connection is a fibreglass and copper network. For postal services, the platform is composed of mail boxes, receiving offices and delivery networks. eBay's platform is the electronic auctioning portal.

In this context, the so-called network effects play a relevant role (e.g. Katz and Shapiro 1986). If such network effects are in existence the average willingness to pay increases with a growing number of customers. This is, for example, the case for e-mail or telephone systems or for auction platforms. Only if there is a sufficient number of users a product can stay in a market characterized by network effects. At first products with network effects do only have a few users resulting in a relatively low willingness to pay. If a supplier survives this phase, for example, by selling at a loss, the willingness to pay increases as a consequence of the network effects, and the critical mass of users is reached. Network effects in two- and multi-sided service markets lead to a value-adding spiral, which spans both market sides. Therefore, we in these markets call such effects network cross-effects. Figure 1 exemplarily demonstrates this value-adding spiral for the electronic auctioning platform eBay as a typical example for a double-sided market (Dietl and Schieke 2007).

[FIGURE 1 OMITTED]

Regarding value net organization, platform operators have to address issues of horizontal, vertical, and lateral integration strategically. Moving in a horizontal direction, for example, the platform operator has to make a decision if to integrate, cooperate with, or differentiate from rival platforms. For the vertical dimension the integration or coordination of market sides is in the focus while the lateral dimension is mainly concerned with the coordination of complements. It follows an investigation of strategic direction regarding these three issues.

Horizontal organization

Based on the value-adding spiral between market sides, a platform operator, in order to remain competitive, has to achieve a critical mass of customers on all sides of the market as soon as possible. The respective size of this critical mass depends on the trade-off between network cross-effects and potential differentiation advantages. In the extreme case no potentials for differentiation exist. This would apply to a totally homogeneous service. Due to network cross-effects only one platform operator can survive in such a market in the long run.

Critical mass size is further dependent on the scalability of the service range. The most extreme here would be zero marginal costs, meaning that the service only generates fixed costs and is, therefore, arbitrarily scaleable. In practice however, the criteria for such a 'natural' monopoly are rarely fulfilled. Especially within the service sector, there is constant differentiation potential. Any service business can, on principle, differentiate itself from competitors by utilizing additional services. Admittedly, effective differentiation potentials are more limited as most additional services are relatively easy to imitate. Differentiation efforts in the service sector can, therefore, quickly lead to a ruinous race with respect to offering additional services. The higher the extent of genuine differentiation possibilities, the smaller the critical mass tends to be, since smaller service platforms can compensate for the disadvantages of network effects with differentiation advantages.

Customer support as well as physical logistic services largely represents variable cost elements. Growing importance of these two components leads to gradually declining scalability degrees. Like genuine differentiation possibilities, a lower degree of scalability poses an impediment to growth for service platforms. A low degree of scalability usually results in a relatively small critical mass, because utilizing network cross-effects is then limited and will be more than compensated for by cost disadvantages relatively quickly. Digital services requiring neither extensive customer support nor physical logistics attain the highest degree of scalability. Figure 2 summarizes these considerations and shows a continuum of scalability.

[FIGURE 2 OMITTED]

Besides an efficient size of critical mass, the time dimension of competition regarding horizontal coordination of service platforms is strategically relevant. Due to network effects, platform competition is always path-dependent. The larger the critical mass and the longer the head start of the first mover, the more difficult it becomes for new competitors to gain market shares. In the best case, a platform operator has first-mover advantages in a winner-take-all industry, i.e. a sector with high scalability of service range and no genuine differentiation possibilities. In such a constellation a first mover can preserve the horizontal autonomy of a platform. There is no need for acquisition or cooperation. The danger, however, lies in the fact that the platform operator gains too much market power and thus provokes state regulation in the industry. Under such conditions it is better if at least a second (usually smaller) platform operator can survive in the market.

An example for such a scenario currently can be found in the US market for digital satellite radio. As the service is digitalized, scalability is enormously high. Marginal costs are negligibly low and since a multiplicity of programme contents can be broadcast at the same time, genuine differentiation possibilities are also limited. In this winner-take-all industry XM Satellite Radio possesses a clear advantage compared to its smaller competitor Sirius. Yet, it would be strategically counterproductive to push the competitor out of business or acquire it as this would certainly activate the US Anti-Trust Commission.

Late movers in such constellations due to network cross-effects and limited differentiation possibilities have a substantial competitive disadvantage in such situations. The only opportunity to overcome this lies in cooperating with multiple platforms. This, however, does not mean that multiple platforms should be operated in direct competition to the first mover. This would not make sense due to limited differentiation possibilities. It would be better to combine at least two types of platform. A typical example for this is the cooperative project Careerbuilder. com founded by newspaper publishing companies to be able to survive in competition with Monster.com. In addition to classic job advertisements in weekend issues of their respective newspapers, the publishers are able to offer additional Internet ads to their customers. This means that on one hand the differentiation possibilities of the newspaper business remain intact while on the other, Monster.com's first-mover advantages are compensated for by the Internet platform. This strategy is especially suitable where several platform technologies with diverse differentiation possibilities (e.g. press, Internet) compete with each other.

Due to U-shaped cost curves or genuine differentiation possibilities a 'natural' platform monopoly may not exist. In such cases it is advantageous for first movers to take market segments that are most profitable first. Late movers may then gradually take the next profitable segments. Moreover, this situation offers platform operators a strong incentive to overcome scalability limits, for example, by digitalizing services. This strategy, however, is successful only, when all scalability obstacles can actually be dispelled. A partial transcending of scalability limits is not sufficient as, for example, 'sothebys.com' shows. With its Internet platform Sotheby's was able to design a highly scalable auctioneering process. However, this did not work for the adherent physical logistics. As sotheby's.com, unlike eBay, is not able to source out logistics to transaction partners, the attempt at achieving a profitable platform monopoly failed.

Figure 3 summarizes the outlined recommendations regarding horizontal value net organization.

Vertical organization

Operators of multi-sided service platforms face a so-called Chicken--egg problem with regard to pricing at the time of market launch (e.g. Caillaud and Jullien 2003). Value is primarily created by the different market sides. For eBay, for example, the value of platform usage for sellers grows if as many buyers as possible use the platform. In order for a buyer to use the platform, however, various sellers and their offers must in turn already exist. In short, no sellers will come if buyers do not exist and without sellers the platform cannot attract buyers. It is, however, not possible to integrate the market side inside a business. Other coordination mechanisms thus have to be found.

The chicken--egg problem is often intensified by the so-called penguin effect (Farrell and Saloner 1987). The first customers on each market side contribute most to value creation. They virtually get the ball rolling. However, these first customers also bear the highest risk as they do not yet know which platform will prevail in competition. Jumping on the wrong platform leads to sunk cost, i.e. their investment is lost. This risk increases with the specificity of the investments. This situation can be compared to the decision problem hungry penguins face. Freezing and standing on an ice floe, they would very much like feeding on the many fish swimming by, but they hesitate to jump in and hunt because predators are lurking in the cold water. These in turn would very much like to feed on the penguins. As the first penguins to jump are at the highest risk of being eaten, each penguin waits for the other to jump. As soon as a number of penguins have jumped into the water the danger of one individual being eaten by a predator is negligibly low and each penguin is able to calmly hunt the substantially available fish. It is this penguin phase that platform operators must overcome in order to be successful. One possibility is to subsidize or at least to grant price advantages to first platform users. In the beginning, it is often advisable to offer the platform free of charge. A further strategy is winning attractive reference customers as first customers.

After the penguin starting phase, i.e. during the swimming and feeding phase, the selection of price structure remains an important success factor. An orientation based on marginal costs and price sensibility of customers is insufficient. In addition, the value-adding contributions of each market side to respective other market sides have to be considered. If one market side accomplishes very high value creation for the other market side(s), this must be considered with regard to pricing. In this case it is beneficial to subsidize this market side and to price only the other market side(s). Adobe, for example, prices only the Adobe Creator while offering the Reader free of charge. This way Adobe tries to ensure that an adequately large installed basis of potential readers exists. By selling the Adobe Reader, additional income would be possible on this market side, but, as a consequence of the high price sensibility on this market side, a substantial cutback of demand would have to be expected at the same time. This decrease of demand would again lessen the Adobe Creator's value creation. All in all, more income would be lost on the author's market side than would be gained on the reader's side. In some cases it can even be rational to request a negative price on one market side. However, this is often associated with serious free-rider problems. A possible solution is subsidization by means of personal additional services which cannot be sold to third parties. Mobile telephone services, for example, often offer free minutes.

Value creation in many multi-sided service industries is not only related to the quantity of platform users. Often their quality plays a relevant role for competitive advantage realization. For a participant on one market side it may be important which types of customers use the platform, so that customer selection plays a strategically relevant role. Value here again is created by other customers. Within a chat room for example, value creation is primarily achieved by the quality of the communicating partners. In such a case, platform operators must mainly focus on the characteristics of the platform user. In doing so, self-selection mechanisms are most suitable besides signalling and other selection strategies. Self-selection mechanisms should be designed in such a way that each platform attracts only those users actually possessing the desired qualities.

Looking again at those cases for which value creation is mainly determined by the quantity of platform users, self-service plays a crucial role. Platform operators in this context usually face the following dilemma: Due to network cross-effects a fast-growing number of customers on all market sides is advantageous, yet each additional customer not only increases value creation. Since customers of service industries are co-producers at the same time, they also inevitably bring additional variability into the production process (e.g. Larrson and Bowen 1989). This variability, which manifests itself in differing needs, abilities, and attitudes, as well as individual motivation, willingness, and acceptance of customers, influences production efficiency. In principle, this problem can be evaded in two ways. Either the platform operator caters to this variability and allows for the individual characteristics of each platform user, which, as a general rule, deteriorates cost structure and in turn endangers scalability of the service concept. Or, the platform operator ignores the individual characteristics of each platform user in order to guarantee cost efficiency and scalability. This, however, impairs the service experience of platform users.

One possible way out of this dilemma is to outsource production steps to the customer. Self-service allows customers to match a service to their respective individual specifics. Self-service, therefore, resolves the original dilemma and cost efficiency and scalability are preserved without diminishing the service experience of the customer.

Figure 4 recapitulates the fundamental organization recommendations in respect of vertical value net organization.

Lateral organization

Often operators of two- or multi-sided service platforms are dependent on complements in order to activate the value-adding spiral. E-commerce suppliers need payment systems, credit card portals need banks, Internet portals need DSL connections, etc. As previously discussed, the question if complements possess market power or not comes up only in those cases in which complements are available in sufficient numbers. If they do possess market power, the complement providers are able to appropriate a large amount of value creation at the expense of the platform operator. When, on the other hand, complements are not yet available, a further chicken-egg problem emerges: Companies will only be willing to invest in supplying necessary complements, if the platform already offers a large amount of users. The platform will be utilized intensely, however, only if the necessary complements are already available in adequate numbers.

In both cases, it seems to make sense to advise the platform operator to integrate the production of complements. Such a lateral integration would, at first sight, solve both value acquisition as well as the coordination and provision problem. On closer inspection, however, the dangers of lateral integration become apparent. If the platform market is a winner-take-all market, meaning it is characterized by high scalability and missing differentiation possibilities, the platform operator is dependent on fast-growing market sides. Precisely this would be prevented, however, if the consumers had to undertake specific investments and if the platform operator also monopolizes the complement market in addition to the platform market (e.g. Dietl and Royer 2003). Consumers would then have to fear being themselves exploited even in the case of utilizing the platform free of charge. In this case the platform operator would not be able to solve the chicken--egg problem or overcome the penguin phase.

In the case where a platform operator strives for platform monopoly and customers do not have to undertake specific investments, lateral integration is possible but not necessary (Figure 5). When platform users have to undertake specific investments, the value-adding spiral will only get under way if there is competition on the complement market (Figure 5). To platform users, competition amongst the complements signalizes that their consumer's rent cannot be taken away by monopoly prices for complement purchases. Finally, if platform competition exists in a situation in which platform users must not transact specific investments, a lateral integration is beneficial since large profits are not attainable on platform markets anyway (Figure 5). Lateral integration allows platform operators to monopolize the complement market and thus clearly improve their value acquisition possibilities. Figure 5 recapitulates the lateral organization recommendations.

Summary and Conclusion

In this paper we analyse the relationship between value net organization and strategic competitive advantage in two-sided and multi-sided service markets. Therefore, the interplay of actors who contribute in a value-adding process is taken into consideration with regard to the strategic analysis instead of focusing on firm internal resources or a particular industry structure. The analysis extends over organizational boundaries and takes not only vertically linked value-adding activities into consideration but integrates other actors on the horizontal and lateral level. In two-sided and multi-sided service markets each customer on one market side influences the value-adding possibilities of the customers on other market sides. Competitive advantages in such markets strongly rely on the ability to organize effectively the complete value creation process stretching over firm boundaries. The paper gives answers to relevant strategic questions of service platform providers with regard to horizontal (integrate competing platforms, cooperate with them, or differentiate from them?), vertical (integration or coordination of the market sides?), and lateral (how does the coordination of complements function?) value net organization. The aim of the paper is to give a conceptual overview of strategic possibilities of platform providers in two-sided and multi-sided service markets. These considerations could be a valuable basis for following in-depth case study research of the suggested types of value net organization.

References

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Helmut Dietl, Institut fur Strategie und Unternehmensokonomik, Lehrstuhl fur Services- und Operationsmanagement, Universitat Zurich, Winterthurer Strasse 92, CH-8006 Zurich

Egon Franck, Institut fur Strategie und Unternehmensokonomik, Lehrstuhl fur Unternehmensfuhrung und -politik, Universitat Zurich, Plattenstrasse 14, CH8032 Zurich

Susanne Royer, Internationales Institut fur Management, Professur fur Allgemeine Betriebswirtschaftslehre, insbes. strategisches und internationales Management, Universitat Flensburg, Munketoft 3, D- 24937 Flensburg

Figure 3: Horizontal Value Net Organization

 No genuine possibilities Genuene possibilities
 of differnetation and of differentation and/or
 high scalability low scalability

First Autonomy Taking the most
Mover profitable market
 segment, possibily
 overcoming borders of
 scalability

Late Platform cooperation Successive taking of
Mover next profitable market
 segments

Figure 4: Vertical Value Net Organization

 Penguin Phase Swimming and
 Feeding Phase

Design Establishing a critical Taking the value
of Price mass by product creation of other
Structure subsidies and/or market side(s) into
 by winning relevant account regarding
 reference customers. the distribution of
 revenues.

Customer Establishing If necessary,
Selection adequate signalling signalling
 and selection and selection
 strategies for the requirements have
 actors that contribute to be increased to
 to value creation improve customer
 combined with a quality continuously if
 high relevance of of strategic relevacne.
 customer quality Outsourcing

Outsourcing Implement self-service concept if possible.
of Value- Otherwise: Trade-off between scalability
adding (no consideration of individual customer
Activities to characteristics from most reasons) and
Customers differentation (development of mechanisms
 to take individual customer specificities into
 account to be different to competitors in the
 eyes of the customers).

Figure 5: Lateral Value Net Organization

 No specific Specific investment
 investment of of customers
 customers

Platform Lateral integration Competition in
monopoly possible but not the market for
 necessary complements

No Lateral integration Competition in
platform advantageous the market for
monopoly complements