Before the Strategic Inflection Point
The computer industry used to be vertically aligned. As shown in the diagram that follows, this means that an old-style computer company would have its own semiconductor chip implementation, build its own computer around these chips according to its own design and in its own factories, develop its own operating system software (the software that is fundamental to the workings of all computers) and market its own applications software (the software that does things like accounts payable or airline ticketing or department store inventory control). This combination of a company’s own chips, own computers, own operating systems and own applications software would then be sold as a package by the company’s own salespeople. This is what we mean by a vertical alignment. Note how often the word “own” occurs in this description. In fact, we might as well say “proprietary,” which, in fact, was the byword of the old computer industry.
The Old Vertical Computer Industry—
Circa 1980
A company competed in this industry as one vertical proprietary block against all other computer companies’ vertical proprietary blocks. Salesmen would show up and offer their vertical combination of things, and the company they were selling to would decide to buy one proprietary line and not the others.
This arrangement had its pluses and minuses. The pluses were that, when a company developed its own chips, its own hardware and its own software, sold and serviced by its own people, all the parts would be made to work together as a seamless total. The minuses were that, once you bought into this proprietary arrangement, you were stuck with it. If there was a problem, you couldn’t throw out just one part of the vertical stack; you would have to abandon the entire stack, and that was a big deal. So customers of vertical computer companies tended to stay for a long time with the solution they chose in the first place. Needless to say, competition for the first sale was ferocious in the extreme, because whoever won that sale had the long-term advantage. This was how business was done for decades.
Then the microprocessor appeared, followed by the “10X” force of the personal computer built on it. The “10X” force came about because technology now permitted putting what before had been many chips on one single chip and because the same microprocessor could be used to produce all kinds of personal computers. As the microprocessor became the basic building block of the industry, the economics of mass production kicked in and manufacturing computers became extremely cost-effective, making the PC an enormously attractive tool in both home and business settings.
Over time, this changed the entire structure of the industry and a new horizontal industry emerged. In this new model, no one company had its own stack. A consumer could pick a chip from the horizontal chip bar, pick a computer manufacturer from the computer bar, choose an operating system out of the operating system bar, grab one of several ready-to-use applications off the shelf at a retail store or at a computer superstore and take the collection of these things home. Then he or she fired them up and hoped that they would all work together. He might have trouble making them work but he put up with that trouble and worked a bit harder because for $2,000 he had just bought a computer system that the old way couldn’t deliver for less than ten times the cost. This was such a compelling proposition that he put up with the weaknesses in order to avail himself of the power of this new way of doing business. Over time, this changed the entire structure of the computer industry, and a new horizontal industry, depicted below, emerged.
The New Horizontal Computer Industry—
Circa 1995
(not to scale)
In this diagram, we have horizontal bars representing fields of both competence and competition. In chips, suppliers of microprocessors using the Intel microprocessor architecture compete with companies such as Motorola and others who supply different types of microprocessors. In computers, a basic computer design is supplied by a variety of computer manufacturers, such as Compaq, IBM, Packard Bell, Dell and many others. These computers are fundamentally similar even if the computer company engineers improve the basic machine as they compete with each other.
In operating systems, again, there are a few well-established types. Over most of the decade of the eighties, Microsoft’s early operating system, DOS, prevailed. In the nineties, this was modified to become easier to use and Windows emerged, which competes with IBM’s OS/2, Apple’s Mac OS and a number of UNIX-based operating systems.
A visit to a neighborhood computer store shows all sorts of applications software competing for shelf space as well as for customers: spreadsheets, word processing, database packages, calendar software and the like. Sales and distribution of computer products have also become enormously eclectic. Retail stores compete with dealers who compete with superstores. Each of these carries a number of manufacturers’ computers and software vendors’ products, just as many grocery stores carry different brands of toothpaste.
So, throughout the decade of the eighties, the way computing was done changed, from the old vertical way to the new horizontal way. First individuals using computers changed to PCs, then big-time computing increasingly started to be done this way. Over time, the entire structure of the industry metamorphosed to a horizontal structure, as shown on the next page.
Even in retrospect, I can’t put my finger on exactly where the inflection point took place in the computer industry. Was it in the early eighties, when PCs started to emerge? Was it in the second half of the decade, when networks based on PC technology started to grow in number? It’s hard to say. But some facts are clear: Going into the eighties, the old computer companies were strong, vital and growing. IBM projected that they would be a $100 billion company by the end of the decade. But by the end of the 1980s, many large vertical computer companies were in the midst of layoffs and restructuring, and a whole new set of players emerged. I keep thinking of a computer-generated image of a person “morphing” from one face to another, one face imperceptibly dissolving and another simultaneously taking shape. You can’t tell the precise point when the first face disappears and the new face replaces it. You only know that at the beginning of the process you have one face and at the end of the process you have another face, but you can’t identify any point where the image is any more one than the other. So it was here, even in retrospect.
The Transformation of the Computer Industry
(not to scale)
As this transformation progressed, companies that had become prosperous in the old vertical computer industry found their lives increasingly difficult. But at the same time, the new order provided an opportunity for a number of new entries to shoot into preeminence. Compaq became the fastest Fortune 500 company to reach $1 billion in revenue. They were a company that understood the dynamics of the new industry and prospered by tailoring their business model to it. So did many others, like Dell and Novell. More about these later.
After the Strategic Inflection Point
Not only had the basis of computing changed, the basis of competition had changed too. Competitors in each horizontal bar of competence and competition now fought for the largest share of that bar. The power of this approach to computing is based on mass production and mass distribution. Those that win inevitably get stronger; those that lose, over time, get weaker.
After 1981, when IBM chose Intel to provide the microprocessor in their PC, Intel grew to become the most widely accepted supplier of microprocessors. After that, industry participants in the layers above, i.e., computer manufacturers and operating systems suppliers, found it more economically advantageous to build their business on Intel architecture microchips than on any other. Why? Because there were a lot more of those being produced every year. If you base your business on the volume leader, you will be going after a larger business yourself.
Developers of applications programs were driven toward volume as well. Their alternatives were to develop a product based on Microsoft’s market-share-leading Windows or on competitive operating systems with a s
maller market share. Over time, they chose to base their work on the former, gradually reinforcing the success of Intel’s microprocessors and Microsoft’s operating systems.
The transformation of the industry from the old model to the new didn’t take place in one instant. It took place over years. It took place in many small steps—as mainframe computers lost new applications to PCs, as programmers shifted their attention, as old software companies shrank and new software companies grew. Over time, thousands of such individual events made up the transformation.
Let’s think about what this transformation from the vertical industry structure to the horizontal must have been like at one of the mainframe computer companies. In particular, let’s look at it from IBM’s standpoint. IBM had been the strongest player in the old industry. What was the impact of this change on IBM?
First of all, IBM’s growth slowed down as much of computing went from mainframes to microprocessor-based personal computers. But that’s not all. IBM was composed of a group of people who had won time and time again, decade after decade, in the battle among vertical computer players. The managers who ran IBM grew up in this world. They got selected for their excellence in developing products and competing in the marketplace within this framework. Their long reign of success deeply reinforced and ingrained the thought processes and instincts that led to winning in the vertical industry. So when the industry changed, they attempted to use the same type of thinking regarding product development and competitiveness that had worked so well in the past.
Even something as simple as the choice of the name “OS/2” showed how IBM missed the significance of the horizontal industry. The idea of OS/2, a new personal computer operating system, was introduced in 1987 at the same time as a new line of IBM personal computers called the “PS/2.” Even though it wasn’t necessarily the case, the inference was that OS/2 worked only on PS/2 computers. That perception alone might have been enough to limit the success of OS/2, since the majority of personal computers were made by IBM’s competitors, not by IBM itself.
But there was, in fact, more to it than just that. It took a long while before IBM actually provided the necessary adaptations to OS/2 to make it work with other manufacturers’ computers and an even longer time before IBM started marketing their operating systems to other computer manufacturers—their competitors—so that those manufacturers could ship OS/2 with their computers as they were accustomed to doing with DOS and Windows.
I happened to be a witness as an IBM manager who was involved with both the PS/2 line of personal computers and the OS/2 operating system tried to persuade another large personal computer manufacturer to adopt OS/2 for the latter’s PC line. It was the oddest marketing meeting ever. These two people thought of themselves, first and foremost, as PC competitors. Even though his primary mission was to popularize OS/2, the IBM person was emotionally hamstrung in his attempt to market to his competitor. At the same time, the representative of the other computer manufacturer was reluctant to rely on IBM—a PC competitor—for such an important piece of technology as the operating system. The conversation was awkward and tense; the deal never materialized. OS/2 still hasn’t gained broad popularity in the industry.
Clearly, the old world was no more. Something had changed. And the more successful the players were in the earlier industry, the harder a time they had to change with it.
Winners and Losers
When an industry goes through a strategic inflection point, the practitioners of the old art may have trouble. On the other hand, the new landscape provides an opportunity for people, some of whom may not even be participants in the industry in question, to join and become part of the action.
I have mentioned Compaq as an example of a computer company that skyrocketed by becoming a practitioner of the new horizontal computer industry. Although their original business model consisted of being a follower of IBM as a maker of IBM-compatible personal computers, when the introduction of a new microprocessor in 1985 provided an opportunity to go for a market-share-leading position, they took the chance and got out in front, ahead of IBM. This initiative propelled them to a growing share of the PC bar and eventually they even passed IBM as the world’s largest maker of IBM-compatible PCs.
There were others who, being born into the new order, were unfettered by old concepts or old rules. In the early eighties, Michael Dell started supplying his friends with computers he assembled out of parts in his dorm room at the University of Texas. Basically, he tapped into the desire of customers of the horizontal PC industry for low-cost standard computer systems. Later, Dell built on his experience and started a company based on the premise that people other than his college friends would also be interested in purchasing computers customized to their specific needs and supplied through direct means—in this case, through orders taken over the phone, with computers delivered by parcel post. No member of the old computer industry would have given a chance to a proposition that said that people would buy computers through the mail. It would simply have been seen as an unnatural act: just as dogs don’t fly, people don’t buy mail-order computers. At least, they didn’t in the old world order.
Today, Dell Computer Corporation of Austin, Texas, is doing about $5 billion worth of business a year, still true to its original premise—selling personal computers custom-assembled to the individual buyer’s specifications, through the mail. This could only happen in a world of computers that is characterized by low-cost, mass-produced, mass-consumed items.
Few of the top ten participants in the new horizontal computer industry rose from the ranks of the old vertical computer industry, bearing testimony to the observation that it is truly difficult for a successful industry participant to adapt to a completely different industry structure.
Some members of the old industry managed to renew themselves in a manner that was consistent with the new industry structure but would not have been with the old. NCR, in the early eighties, before the transition gathered speed, was one of the bigger vertical computer players. It was among the first, if not the first, to recognize the forces of change. Over the course of a few years (and before they were acquired by AT&T), NCR moved their entire computer line onto commonly available microprocessors. They abandoned their proprietary chips and hardware design, and made major modifications in their software, so that what was originally designed to run on their proprietary architecture would now run on off-the-shelf microprocessors.
Unisys, a vertical computer company created from the combination of two independent computer companies, Sperry and Burroughs, was another one of the players in the old computer industry, a multibillion-dollar company. They hit hard times as the strategic inflection point wreaked havoc on the vertical companies. In adapting, Unisys, once a proud designer of first-class computers, moved their strategic focus to software and services built around the products of the new horizontal computer industry. In effect, they came to the conclusion that they couldn’t fight this industry-wide change, so they adapted to it.
Sometimes the changes are even more dramatic. In the early eighties, Novell was a small company fashioned along the lines of the old computer industry. They built hardware and developed network software to run on their own hardware. They, too, hit hard times. Novell’s then head, Ray Noorda, often tells the story that it wasn’t very hard to figure out what to do. They simply didn’t have enough money to continue to pay their suppliers, so they abandoned their hardware business and concentrated on software where they didn’t need to worry about supplier bills. Then they moved their software onto inexpensive standard PCs. By moving quickly into a new way of doing business, Novell became a “first mover” in networking in the new horizontal industry and became a billion-dollar software company by the end of the decade.
There is an important lesson to be learned from Novell’s experience. Whereas as a hardware producer Novell had lack of scale working against them, by being the first to popularize networking software that runs on PCs and capturing a large share
of the emerging networking market, they made scale work for them. They turned from losers to winners.
In fact, there are two more lessons here. First, when a strategic inflection point sweeps through the industry, the more successful a participant was in the old industry structure, the more threatened it is by change and the more reluctant it is to adapt to it. Second, whereas the cost to enter a given industry in the face of well-entrenched participants can be very high, when the structure breaks, the cost to enter may become trivially small, giving rise to Compaqs, Dells and Novells, each of which emerged from practically nothing to become major corporations. What’s common among these companies is that they all instinctively followed the rules for success in a horizontal industry.
The New Rules of the Horizontal Industry
Horizontal industries live and die by mass production and mass marketing. They have their own rules. The companies that have done well in the brutally competitive horizontal computer industry have learned these implicit rules. By following them, a company has the opportunity to compete and prosper. By defying them, no matter how good its products are, no matter how well they execute their plans, a company is slogging uphill.
What are these rules? There are three.
One, don’t differentiate without a difference. Don’t introduce improvements whose only purpose is to give you an advantage over your competitor without giving your customer a substantial advantage. The personal computer industry is characterized by well-chronicled failures when manufacturers, ostensibly motivated by a desire to make “a better PC,” departed from the mainstream standard. But goodness in a PC was inseparable from compatibility, so “a better PC” that was different turned out to be a technological oxymoron.
Only the Paranoid Survive Page 4