The Commoditization of Complexity

I just returned from a business trip to Europe. As I reviewed the global service business of this TSIA member I was visiting, I came to the realization of a brutal reality facing so many of our TSIA members:

The Commoditization of Complexity

What do I mean? Let me explain

Definition of a Commodity

A commodity is some good for which there is demand, but which is supplied without qualitative differentiation across a market. In other words, customers can’t really tell the difference from one offering to another—they are interchangeable.

Traditionally the term commodity was applied to the following types of categories: (Coote, 2000)

  • Food products and fisheries (e.g. grains, tea, meat, fish);
  • Agricultural non-food products (e.g. cotton, rubber, tobacco);
  • Ferrous metals (iron, steel, etc.);
  • Non-ferrous metals (tin, gold, etc);
  • Industrial raw materials (e.g. non-metallic chemicals); and
  • Energy (e.g. coal, oil)

These categories fit our concept of a commodity because, regardless of where you buy these items, they are the same product. Regardless of where I buy a piece of corn, I am still buying this known product called “corn.” We can debate if corn grown in one location is way better than corn grown in another location, but you get the general idea.

In a commodity market, many companies compete and none enjoys a competitive advantage. This reality typically leads to smaller and smaller profit margins for companies that provide the offering. Also, the importance of any factor other than price (such as brand name) diminishes.

Complex Offerings

Complex offerings, by definition, “consist of interconnected or interwoven parts.” This is the opposite of a commodity—where we are typically referring to items like corn, or silver. A PC is a complex offering because it involves the integration of a host of hardware and software technology in a rather tight physical footprint.

In the past, technology companies have emphasized complexity to justify premium pricing. “Hey, if everyone could get this complex solution to work, it wouldn’t cost so much. But this technology is complex.”

The Commoditization of Complexity

In today’s technology market, I am seeing the commoditization of complexity. There are companies that deliver very complex technology solutions to the marketplace but are now being treated by the marketplace as a commodity. Beyond the poor PC manufacturers, there are a host of examples:

  • Complex document management solutions from companies like Xerox and Ricoh
  • Complex network technologies from companies like Alcatel-Lucent and Ericsson
  • Scalable, reliable storage technologies from companies like EMC and IBM.

You can see the commoditization of these solutions reflected in the downward trends on product margins. These are incredible, innovative, complex technologies—but customers are treating them like a commodity. To put an exclamation point on this trend, check out this headline that appeared in CNET this past summer:

Analyst: Expect tablet market to commoditize

Didn’t Apple just create this market?

The Rule of Three

Customers are smart. As they drive vendors to commodity pricing, they will make sure that at least three vendors stay viable in the marketplace. This guarantees ugly price wars as each vendor vies to buy the business. No vendor will be allowed to dominate. More than one vendor will be kept alive to prevent monopoly pricing. Great book by the same title: The Rule of Three

The Path Forward

The commoditization of complexity is already creating all kinds of consternation for technology companies. How will tech companies navigate this ugly twist in the road? I predict technology companies will land on one of three economic engines:

  1. Commodity Engines: These will be tech companies that will be forced to compete on price and volume. Think Acer PCs. But also think of the standard CRM offering from salesforce. A vast majority of tech companies will end up on this square.
  2. Differentiated Engines: These will be tech companies that provide differentiated technology and or service capabilities.  The differentiation will have to be very compelling. Today, this is someone like a VMware. But this is an every shrinking number of tech companies.
  3. Consumption Engines: These will be tech companies that provide the technology at commodity prices but learn how to commoditize revenues based on actual customer consumption. Think Apple and their MP3 players. Think LinkedIn. Think XBOX.

The commoditization of complexity is painful. If you are a tech company, your business model will need to land on one of the above three squares. But please keep in mind that the “differentiated engine” square is rapidly shrinking, and the “consumption engine” square is rapidly growing. You might want to consider playing the probabilities on this one.

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2 Responses to “The Commoditization of Complexity”

  1. Chuck Brown Says:

    Hello Thomas,

    In my own private world of software, PC’s, and networks what you have postulated hold true. My desire to buy only what i need when I want drives my consumption of these technologies. No longer do i need to be on the bleeding edge.

    However in my professional life, I don’t see the “Differentiation” engine completely disappearing, especially when the customer uses that solution or technology to differentiate themselves from their competition. I would like to know what your thoughts are on this. I would also like to know if TSIA will use these newly defined economic engines in further defining their Benchmarking and Diagnostics tools.

    • Thomas Lah Says:

      Chuck:

      You and I aren’t Spring chickens anymore, so I agree with your statement that the “Differentiation” engine will not completely disappear in our professional lifetime. Having said that, I do see more companies being forced off of that engine–especially if they are only differentiating with a product offering. For product companies, the play over the past decade has been to slow that migration from “Differentiation” to “Commodity” by adding more value with technology solution bundles and value added services. This is still a viable play to create differentiation. But I believe the high growth game will be played by companies that master a “Consumption” based engine.

      To your final question: Will we benchmark the service performance of technology companies based on these three economic engines? The short answer is yes. I believe the practices and performance metrics for the service organizations in these three models will vary widely:
      If you are in a “Commoditized” engine, services will be focused on volume and cost control. Look at amazon.com’s support services for their S3 platform.
      If you are in a “Differentiated” engine, services will be focused on building unique expertise and offerings and monetizing that differentiation. Think IBM.
      If you are in a “Consumption” engine, services will be focused on customer analytics and creating offerings that drive consumption. You were at TSW last month, think Taleo.

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