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, 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:
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:
- 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.
- 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.
- 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.