McKinsey Report:
Increasingly the ranks of top players in TMT (technology, media, and telecommunications ) are populated by companies that have managed to create and scale successful platforms that benefit from network effects. These can be technology platforms (for example, Apple’s iOS), marketplaces (for example, Apple’s app store), or platforms of another type—but in each case these winning platforms increasingly exploit “network effects,” which means the value of the product, service, or the underlying technology increases when more people use it. The more you use Facebook, for instance, the more your friends will use it. There are also indirect network effects, which involve the creation of complementary products or services—the app markets that have grown up around smartphones and tablets, for example, or social gaming that is enabled by social networks.
Despite the network economies of size, success is short-lived:
Taking our data set as a whole, across all industries, nearly 60 percent of companies that were in the top quintile in terms of economic profit in 2000 were still in the top quintile 15 years later. In TMT industries, though, only 45 percent of top players from 2000 remained in the top quintile in 2015. The flip side is that over the same period 25 percent more companies that started at the bottom ended up in the top quintile (Exhibit 6).
When looking at Chapter 7 of Managerial Economics, economies of scale and focus were covered. The book conveyed that if your average costs are constant with respect to output, then you have constant returns to scale. If average costs rise with output, you have decreasing returns to scale or diseconomies of scale. When the tech firms of Silicon Valley were forming, they experienced great success not only in their output product but their bloated IPOS. Why do companies such as Fitbit or GoPro have stock at less than half of the value that they entered the market with. Some of these companies are experiencing diminishing marginal returns due to difficulty of monitoring and motivating a larger workforce and overall the running of a more complex operation.
ReplyDeleteThese tech organizations are also having trouble predicting the business cycle while at the same time devoting any surplus of funds to their product development. If the leadership believes they are the expert in the market or are inflating their current position to competitors, they will ultimately face a dried up market and revenue depletion.
“Too often, a tech company starts based on one bright idea by one founder. After that, there is little innovation within. Technology is all about innovation, and founders who fail to make their organizations innovation factories will soon face saturated markets and have no new products to offer.” (Zinn, 2017)
Most tech firm leaders will never see their company reach profitability or adulthood due to undisciplined leadership, for expel, Uber. Tech firms need to not lose focus on profitability, innovation, sound management and design. When firms experience immense growth so quickly, they may fall for certain biases such as loss aversion, paying more to avoid loss instead of focusing on gains. Or confirmation bias, gathering information that rationalizes the current path they are on is the right one because it has worked in the past. Firms such as Google and Facebook are perfect examples of organizations that choose to never slow down, perpetually innovating and growing.
Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2015). Managerial economics a problem solving approach. Boston, MA: Cengage Learning.
Zinn, R. (2017, September 21). Why So Many Tech Companies Are Having Difficulty Surviving. Retrieved September 23, 2017, from https://www.forbes.com/sites/forbestechcouncil/2017/08/11/why-so-many-tech-companies-are-having-difficulty-surviving/2/#bef307277930
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