How Ecosystems Can Defend Against Technological Disruption

How Ecosystems Can Defend Against Technological Disruption

Technological disruption versus incumbent firms explained for fundamental investors in 2017 and CEOs of dominant brands by Bryan Hong

  • “With today’s unprecedented rate of technological disruption, here’s one way that today’s technology giants are defending against being disrupted themselves
  • The rise of ecosystems throughout the world’s economies such as those created by Alibaba, Amazon, Facebook and Google create competitive advantages that help these firms to shield against the threat of technological disruption
  • As these ecosystems continue to grow and become more valuable to consumers, new entrants with disruptive innovations will be more likely to sell to incumbent firms controlling the ecosystem instead of competing directly with them over the long run, increasing the chances that these incumbent firms will maintain their dominant positions

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In the late 1990s, a pioneering technology company became one of the world’s most innovative communications device manufacturers, selling a revolutionary small handheld wireless device with a patented miniature keyboard that could send and receive e-mail.  In 2002, the company introduced a line of phones that integrated the same capabilities.  In just a few years, the firm possessed every company’s dream--strong brand recognition with a loyal base of customers that were addicted to its product.  The company’s stock price would ultimately peak in June of 2008 at $144 per share, rewarding its earliest investors with an extraordinary 1000% return on their investment.  However, the stock price would ultimately fall over 95 percent in the following years, as its major competitors enjoyed dramatic market share growth at the company’s expense.

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The company, as many readers might recognize, is Blackberry (NASDAQ: BBRY), a story of both extraordinary success and downfall of one the more famous (former) incumbent firms.

While unfortunate for the company and its shareholders, Blackberry’s fall from dominance is far from surprising in the context of history.  As I’ve mentioned in a previous article (link here), technological disruption is a natural part of how innovation works in a capitalist system with firm competition, which constantly reshuffles the way industries are organized, and who its dominant firms are.[1]  Over a long enough time horizon, successful incumbent firms face an increasing risk of being disrupted by new entrants, which often then become the incumbents themselves.  Then, these incumbents face their own risk of ultimately being disrupted.  These are simply the forces of nature at work.[2]

Following this logic, one might think that today’s high-flying technology giants, including Alibaba (NYSE: BABA), Amazon (NASDAQ: AMZN), Facebook (NASDAQ: FB) and Google (NASDAQ: GOOG), will eventually be disrupted themselves, the same way they are affecting incumbents across a range of industries today.

The problem with this reasoning, however, is that it misses the dramatic rise of ecosystems controlled by each of these firms.  By controlling an entire ecosystem instead of a single product or service, successful technological disruption becomes substantially much less likely.

This is one of the most important lessons from the Blackberry story.  Its lack of a valuable ecosystem left it much more vulnerable from a competitive standpoint than investors realized.  This might seem like a simple observation at first (especially in hindsight), but its implications are incredibly profound, and require a good understanding of how and why ecosystems can create their own competitive advantages.  For all of the talk of “durable competitive advantage” and “economic moats” that is used to justify stock investments, much of the discussion about ecosystems misses much of what they are able to accomplish in this regard.

Why ecosystems matter

First, let’s try to more clearly define an ecosystem.  The term is used in a variety of different ways, but for the purposes of this article let’s consider an ecosystem as a group of complementary products and services.  And, by complementary, it’s a group of products or services that are more valuable when they are offered together, as opposed to separately.  While these products and services don’t necessarily have to be owned by the same firm, let’s begin with a simple case where this is true.  Take Google’s own product offering, for example.  You might use Gmail for your e-mail, video chat with your friends and family over Google Hangout, share documents with your colleagues with Google Docs, and save your photos on Google Photos.  Each of these products is distinct, but offering them in an easy to access bundle with a single login means that the value proposition of Google becomes more about the value of the entire bundle to you than any individual product or service.

The additional value of the bundle doesn’t have to be enormous.  It only needs to be just valuable enough that you wouldn’t bother switching to something else.  In the context of competing firms in an industry, it means you are much less likely to switch to competitors, as long as the bundle offers you almost everything you want.

To understand how powerful this is in creating competitive advantage over rival firms, let’s do the following thought experiment.  Let’s say there’s a new startup that offers free e-mail accounts that’s clearly superior to Gmail.  It has an easier interface, blocks spam e-mail more effectively, and can organize your e-mail more efficiently and with less effort.  Would you switch?  I would bet probably not, unless it was something revolutionary (e.g. it would automatically answer your e-mails for you the same way you would).  The reason is because Gmail likely works just fine for your needs.  And, your Google account isn’t just about Gmail, it’s about everything else you use Google for as well, which may be an awful lot of things.  Thanks to the ecosystem, Gmail doesn’t have to be the best e-mail service.  It only has to be good enough.  And, the more valuable the other products and services in the ecosystem are to you, the burden for how good it needs to be relative to the competition decreases that much more.

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What’s striking about this phenomenon is how little it can take in order for a firm controlling an ecosystem to overpower a competitor without an ecosystem.  This can happen even if the competitor has a significant first mover advantage in offering its product or service, and has developed something vastly superior to what is currently available on the market.

Netscape:  An ecosystem battle lost

An example of this is the web browser war between Netscape and Microsoft’s Internet Explorer.  Netscape was the first to develop a mainstream graphical web browser, which fundamentally changed the way content could be delivered across the Internet through the World Wide Web.  Like Blackberry, the stock was initially a Wall Street darling after its IPO in 1995, with a powerful narrative about a new technology that many believed would transform our society.  And, they were right.  The company’s product was already proven to work effectively, and it had over 90 percent market share.  Buying Netscape stock, one could imagine, was to invest in this revolution with good odds.

Unfortunately for Netscape and its shareholders, it was a software company that depended upon an ecosystem it did not control.  In the same year that Netscape became a public company, Microsoft included Internet Explorer, a competing web browser, pre-installed on its Windows 95 operating system.  While there was debate about which browser was superior, the bottom line was that they weren’t different enough to matter.  Users switched to Internet Explorer in droves primarily because of the marginal difference in convenience (it was already on their machines), and by 2001 Netscape’s market share would fall below 10 percent.

While Microsoft had missed being first in the development of the graphical web browser, its control of the operating system that the vast majority of PCs ran on gave it the leverage it needed to overtake Netscape’s dominance and almost completely eliminate it from the market.  And to be clear, it wasn’t just about Microsoft’s operating system—the company also had the world’s most popular productivity software with Microsoft Office, and a close partnership with chipmaker Intel (NASDAQ:  INTC) to ensure that consumers would be offered a complementary bundle of products that would be difficult to walk away from.

Technological disruption - Implications for Incumbent Firms

Of course, technological disruption can still happen, especially if you offer something distinct from what the ecosystems offer.  But the rational move in many of these instances is to sell your firm like WhatsApp did when it sold to Facebook (perhaps taking a lesson from the Netscape story).  While wildly successful, the management team at WhatsApp would likely stand little chance in the long run if it tried to compete directly with the ecosystems controlled by the large technology giants.

Not every firm chooses to sell into an established ecosystem, however, and it’s informative to see what happens in those cases.  Snapchat (NASDAQ: SNAP) is perhaps the most recent high-profile firm to choose not to sell.  The company’s app is clearly an innovative product that has successfully captured the mindshare of millennials.  However, Facebook’s Instagram has adopted many of Snapchat’s most popular features, and as of the date of this article the stock is now substantially below its IPO price.  In the long run, Snapchat really only has two choices.  Either it can try to compete against the technology giants and try to stay one step ahead of them, or it can sell itself to an acquirer.  The road ahead will be challenging if it is the former.

Today’s ecosystems are becoming ever larger and more valuable, making entrants less and less likely to succeed as standalone competitors to them.  They also provide a longer runway for the incumbent firms that control them to invest in future innovations without seeing success.  None of these incumbent firms need to figure out the final version of self-driving cars, virtual reality, or any other technology that will ultimately be what we all use.  Instead, their burden is to quickly adopt, either through imitation, innovation, or both, these new technologies when they reach their final designs and become mainstream.  And this burden, as history tells us, is substantially easier to meet than consistently betting on the winning version of the next big technology.

[1] Here, I define technological disruption in a more general sense than Christensen’s original definition, to mean any type of technological change that leads to the survival of incumbents being challenged.

[2] It is worth mentioning that there are some very notable exceptions, such as IBM.  However, these examples tend to be the exception in history, and not the rule.

About the Author

Bryan Hong is an assistant professor from Ivey Business School in Canada, where he is a member of the Strategy faculty, and is also a visiting assistant professor at the Stern School of Business at New York University.  Before joining Ivey, he completed his PhD in Business Administration at the University of California-Berkeley, and previously worked in investment banking, corporate strategic planning, and strategy consulting.

Professor Hong’s practitioner research examines how firms can deal with strategic uncertainty about the future.  Given the increasing speed of (often very unpredictable) technological disruption today across different sectors of the economy, strategies that can directly address the problem of uncertainty can give firms an advantage over their competition.  More recently, Professor Hong’s work is focused on explaining equity investment returns by providing a clearer understanding of what “economic moats” really mean when selecting companies for investment, and how to evaluate them.

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