Sunday, September 19, 2010

When "a better mousetrap" isn't enough

You've heard the saying "Build a better mousetrap, and the world will beat a path to your door." It's the mantra of many engineering-driven organizations. Unfortunately, it's not true. We all know examples of products that clearly were technologically inferior but that went on to great market success. In the U.S., one of the best examples was Sony's Betamax vs. Panasonic's and JVC's VHS. Most industry observers felt that Betamax was the better product--it certainly had better video quality. However, Betamax had two quality modes that allowed either one or two hours of recording on a single tape. VHS, on the other hand, had three modes that allowed one, two or three, and eventually two, four or six hours of recording. The picture looked better on Betamax, but consumers could purchase many fewer tapes with VHS, so it was seen as a much better value.

Sometimes, the most important innovations from technology companies have little or nothing to do with technology. In my opinion, Microsoft's two greatest innovations, the two things most responsible for its success, were software suites and per-machine pricing.

In the early days of the PC industry, consumers purchased applications one-at-a-time, based on their needs. If you wanted a word processor, WordPerfect and Wordstar were the preferred choices. The most popular spreadsheets by far were initially VisiCalc and then Lotus 1-2-3 and Borland's Quattro Pro. Microsoft had its own word processor, Word, and its own spreadsheet, first Multiplan and then Excel, but neither one was overtaking the market leaders. Then, Microsoft had the brilliant idea of bundling all of its office productivity applications together and selling them at about the same price as a copy of its competitors' single-purpose applications. The result was Microsoft Office.

Consumers immediately saw the value in Office. They might have preferred WordPerfect as a word processor or 1-2-3 as a spreadsheet, but for the same price, they could get a word processor, a spreadsheet and a presentation tool (PowerPoint.) Microsoft Office and its applications quickly dominated the market. Competitors tried to respond by acquiring other products to create their own suites, but Microsoft's market dominance was never challenged.

Microsoft's second innovation was per-machine licensing. Let's say that you were a large PC manufacturer, and you had a choice of a variety of operating systems--in particular, Microsoft's PC-DOS, Digital Research's DR-DOS and IBM's OS/2. Each one of the companies would sell you their operating systems at a price based on the total number of copies that you purchased. However, Microsoft came up with a unique new pricing model based not on the number of copies of PC-DOS that you shipped but rather, the number of computers that could run PC-DOS that you shipped. It cost much less per unit to license PC-DOS under this new model, but you had to buy a copy for every computer you built that could run PC-DOS.

This model almost immediately squeezed Microsoft's competitors out of the business of selling to computer manufacturers. PC-DOS was the "industry standard" and customers expected it. If you also wanted to offer DR-DOS, which many people thought was superior to PC-DOS, you had two choices:  Buy only the copies of PC-DOS that you needed, at a much higher price that you'd have to pass on to consumers, or buy two operating systems--PC-DOS for every machine, plus DR-DOS for some models. Very quickly, manufacturers decided that PC-DOS was good enough, and it wasn't worth raising prices or buying two copies of operating systems and throwing one away in order to offer a choice.

When Microsoft launched Windows, which was originally an add-on to DOS, it did the same thing: Manufacturers who wanted the lowest prices had to license DOS and Windows together for every machine that could run them. Competitive graphic environments such as GEM and Go didn't have a chance. This pricing model, more than anything else, built Microsoft's monopoly in desktop operating systems.

Have you ever wondered why Intel processors have been used by the vast majority of computer manufacturers for years, even when AMD had equivalent (or better) processors at lower prices? One big reason was that Intel was paying computer manufacturers under the table not to use AMD's processors (a fact that was recently admitted by Intel and Dell,) but Intel had another, above-board tool for getting buy-in. That Intel "Bum-bum-bum-bum" sound that you hear at the end of many PC commercials? Those commercials are paid for in large part by Intel. Through the use of co-op agreements and spiffs (sometimes called "sales promotion incentive funds), Intel reviews the commercials, and if they're approved will often pay 50% or more of the cost to air the ads. For the PC manufacturers, it's like doubling their advertising budgets. Intel won't approve payments for any ads that mention any computers using a competing processor, so it's a strong incentive to stick with Intel.

That brings us to a current example: How much is it worth to put the "Google" logo on your smartphones and have access to the Android Market? If you're Motorola or Samsung, it's apparently worth quite a lot. According to a lawsuit filed last week by Skyhook, a geopositioning technology company, Google withheld its approval for usage of the Google logo and access to the Android Market in order to force both companies to drop Skyhook in favor of Google's own positioning services. According to Skyhook, Google operates an "Android Compatibility Program," and products must be approved by this program in order to carry Google trademarks, license Google applications and gain access to the Android Market.

The Android Compatibility Program has two components: The Compatibility Test Suite, a software test suite that tests whether the submitted hardware and software are compatible with published Android specifications, and the Compliance Definition Document, which has additional requirements for what constitutes full compliance with Android specifications. According to Skyhook, the Compatibility Test Suite is an objective test that can be run by manufacturers and gives "go/no-go" answers, while the Compliance Definition Document is an amorphous, subjective document that can be freely interpreted by Google employees.

Skyhook claims that when Motorola submitted a phone that incorporated Skyhook's geolocation system, Google demanded that Skyhook share its geolocation information with Google in order to get approval. When Skyhook refused, Google then demanded that Motorola's phone run Skyhook's and Google's own geolocation systems simultaneously, which would have used far too much power and would have been impractical. Google additionally demanded that whenever the Skyhook system was in use, the phone's user had to be warned that their location data was going over a third-party network and might not be secure. After Skyhook refused to implement this final specification, Google demanded that Motorola remove the Skyhook system completely from its phone in order to get certification, and Motorola complied.

A second company, named "Company X" in Skyhook's lawsuit that is most likely Samsung, also adopted the Skyhook technology, and initially received shipping approval from Google. However, Motorola learned of the decision and requested that it be allowed to reinstate Skyhook's technology, at which point Google withdrew its approval to ship and reinstated it only after Company X removed Skyhook's technology from its phone.

As you can see, it's usually the exception when the better mousetrap wins, not the rule.
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