Blown to Bits

Richness or reach? The trade-off used to be simple but absolute: your business strategy could either focus on “rich” information-customized products and services tailored to a niche audience or reach out to a larger market, but with watered-down information that sacrifices richness in favor of a broad, general appeal. Much of business strategy as we know it today rests on this fundamental trade-off.

The new economics of information eliminates the trade-off between richness and reach, blowing apart the foundations of traditional business strategy. In this excerpted book, BCG reveals how the spread of connectivity and common standards is redefining the information channels that link businesses with their customers, suppliers, and employees. Examples span the spectrum of industries from financial services to health care, consumer to industrial goods, and from media to retailing.

Blown to Bits shows how to build new strategies that reflect a world in which richness and reach go hand in hand and how to make the most of the new forces shaping competitive advantage.

A Cautionary Tale

In 1768, three Scottish printers began publishing an integrated compendium of knowledge—the earliest and most famous encyclopedia in the English-speaking world. They called it Encyclopaedia Britannica. Since then, Britannica has evolved through fifteen editions, and to this day it is generally regarded as the world’s most comprehensive and authoritative encyclopedia.

In 1920, Sears, Roebuck and Company, an American mail-order retailer, acquired Britannica and moved its headquarters from Edinburgh to Chicago. Ownership passed to William Benton in 1941, who then willed the company in the early 1970s to the Benton Foundation, a charitable organization whose income supports communications programs at the University of Chicago. Britannica grew under its American owners into a serious commercial enterprise while sustaining its reputation as the world’s most prestigious and comprehensive encyclopedia. The content was revised every four or five years. Brand extensions, such as atlases and yearbooks, were added. The company built one of the most aggressive and successful direct sales forces in the world. By targeting middle-income families and focusing on their aspirations for their children, the company developed a marketing proposition as compelling as the intellectual content of the product itself.

By 1990, sales of Britannica’s multivolume sets had reached an all-time peak of about $650 million.¹ 1 Richard A. Melcher, “Dusting Off the Britannica,” BusinessWeek, 20 October 1997, 143. Notes: 1 Richard A. Melcher, “Dusting Off the Britannica,” BusinessWeek, 20 October 1997, 143. Dominant market share, steady if unspectacular growth, generous margins, and a two-hundred-year history all testified to an extraordinarily compelling and stable brand. Since 1990, however, sales of Britannica, and of all printed encyclopedias in the United States, have collapsed by over 80 percent.² 2 Ibid. Notes: 2 Ibid. Britannica was blown away by a product of the late-twentieth-century information revolution: the CD-ROM.

The CD-ROM came from nowhere and destroyed the printed encyclopedia business. Whereas Britannica sells for $1,500 to $2,200 per set (depending on the quality of the binding), CD-ROM encyclopedias, such as Encarta, Grolier, and Compton, list for $50 to $70. But hardly anybody pays even that: the vast majority of copies are given away to promote the sale of computers and peripherals. With a marginal manufacturing cost of $1.50 per copy, the CD-ROM as freebie makes good economic sense. The marginal cost of Britannica, in contrast, is about $250 for production plus about $500 to $600 for the salesperson’s commission.

Judging from their inaction, Britannica’s executives at first seemed to have viewed the CD-ROM encyclopedia as an irrelevance: a child’s toy, one step above video games. This perception was entirely reasonable. Microsoft had licensed the text for its encyclopedia from Funk & Wagnalls, whose third-rate, nearly defunct product, surviving as a periodic promotional item in the aisles of supermarkets, was perceived to be a brand so pathetic that Microsoft dropped its name in favor of the ad agency coinage Encarta. The addition of public-domain illustrations and scratchy sound recordings too old to bear a copyright (and therefore available at no cost) hardly made for a serious rival to the Britannica—or so it seemed.

As revenues plunged, it became obvious that whether they ought to be or not, CD-ROM encyclopedias were serious competition. Britannica executives reluctantly considered creating their own CD-ROM product, only to encounter a technology constraint: the content of Britannica was too big for the medium. Encarta, with its seven million words, could fit easily onto a CD-ROM, with plenty of room for illustrations and interactivity. Britannica, however, had more than forty million words. It was impossible to create an interactive version within the capacity limits of a CD-ROM. The technology was not ready for the content, so the company’s executives decided to wait.

Months passed. Sales continued to plummet. In response, the company put together a text-only CD-ROM version of Britannica, only to encounter another crisis: a revolt by the sales force. Even if priced at a significant premium over Encarta, a CD-ROM version of Britannica could not possibly generate the $500 to $600 sales commission of the printed product, from which it would so obviously take sales. Indeed, a CD-ROM product would have to be sold through a completely different channel. To avert a revolt by the sales force, Britannica executives decided to bundle the CD-ROM as a free bonus for buyers of the multivolume set. Anyone who wanted to buy the CD-ROM alone would have to pay $1,000.

This decision appeased the sales force briefly, but did nothing to stem the continuing collapse of sales. Losses mounted. There was no apparent strategy. In May of 1995, the Benton Foundation finally put the company up for sale.³ 3 “Slow-to-Adapt Encyclopedia Britannica Is for Sale,” New York Times, 16 May 1995, 1. Notes: 3 “Slow-to-Adapt Encyclopedia Britannica Is for Sale,” New York Times, 16 May 1995, 1. For nearly eighteen months, investment bankers tried to find a buyer. Microsoft said no. Technology, media, and information companies all declined. Finally, in 1996, financier Jacob Safra agreed to buy the company, paying less than half of book value.

Morals

The decline and fall of Encyclopaedia Britannica is more than a parable about the dangers of complacency. It illustrates what we will call the new economics of information: how the evolving technological capabilities for sharing and using information can transform business definitions, industry definitions, and competitive advantage. It illustrates how the most stable of industries, the most focused of business models, and the strongest of brands can be blown to bits by new information technology.

The Britannica story contains morals for all businesses. The first is obvious: the most venerable can prove the most vulnerable. New information technologies can come from nowhere and demolish brands and businesses that have been established for decades, even centuries. One of the greatest brand names in the English-speaking world was nearly destroyed—in just five years—by a cheap, shiny disc.

The second point is a bit less obvious: the history, the myths, the shared values, and the unreflective presuppositions that define a strong corporate culture can blind business leaders to events that do not fit into their collective mental framework.

Britannica’s executives initially scoffed at Encarta because its content was based on a promotional item sold in supermarkets. But their own market research told them that the typical encyclopedia is opened less than once a year, once the initial pride in ownership fades. Their own salespeople knew full well that the way to sell an encyclopedia is to play on anxieties: parents trying to “do something” for their kids. The fact that the kid never uses the product is beside the point; parental guilt has been duly assuaged.

But today, when parents are anxious about their children’s performance in school, when they feel guilty about not doing enough to help, they buy a computer. The new PC may never be used for anything other than chat rooms and video games, but parental guilt has again been duly salved. It just so happens that the computer costs about the same amount as Britannica. And along with that computer comes a CD-ROM drive. And along with the CD-ROM drive come several free CD-ROMs, one of which is a promotional copy of Encarta.

In other words, if the fundamental value proposition is assuaging parental guilt, then the fundamental competitor is not Encarta, it is the PC. Encarta is merely the icing on the cake. Supermarket brands and intellectual content have precious little to do with it. But within the mindset of executives in the business, steeped in a culture of scholarly values and self-confident from a history of unbroken success, it is extraordinarily hard to understand early enough that conventional industry definitions are obsolete.

There is a third lesson: even if the executives of established businesses fully grasp the impact of new technologies, and even if they can reason their way beyond their corporate myths and assumptions, they still face a massive competitive disadvantage arising precisely because they are incumbents. Incumbents are saddled with legacy assets—not just clunky mainframe systems, but sales and distribution systems, bricks and mortar, brands and core competencies. Competing in the face of the new economics of information requires cannibalizing those assets, perhaps even destroying them. Incumbents hesitate to do that, especially as long as the business has positive margins. Rather, they do complex financial calculations and get bogged down in internal political debates. Insurgents have no such inhibitions.

Britannica’s sales force had been built over decades. It was a foundation of competitive advantage and the envy of the industry. It was obsolete. An aggressive strategy for the new medium would have required blowing it up. The company hesitated. Microsoft had no reason to hesitate.

This is a real shift. In the vast majority of traditional competitive situations, the defense has the advantage. But when the economics of information are shifting, insurgents are advantaged precisely by their lack of legacy systems, legacy assets, and a legacy mindset. Having nothing to lose becomes an advantage.

The destabilization of competitive advantage is as much an opportunity as it is a threat. It just depends on how strategists choose to look at it. One consequence of the obsolescence of industry and business boundaries is that every incumbent under traditional business definitions is free to play the insurgent under some other definition.

There is a fourth lesson: this is not a zero-sum game. The total value of the players can rise—or fall—dramatically. The game can be a massively positive sum: in book retailing, total shareholder value has gone up significantly. It can be a massively negative sum: in the encyclopedia business, shareholder value collapsed, perhaps by an order of magnitude. Britannica clearly lost. But it is not obvious that Microsoft or anybody else won. In dollar terms, sales of encyclopedias of all kinds are one-tenth of what they were in 1990.⁴ 4 The GDP statistics analyzed by economists would capture neither the drop in price nor any quality changes in the shift from print to electronic encyclopedias over this period. This illustrates the irrelevance of much of the macroeconomic debates over the impact or non-impact of information technology on “productivity.” It also illustrates the peculiar propensity of economists to interpret their inability to measure something as a statement about the world as opposed to a statement about economists (c.f. the “efficient markets hypotheses” in finance). For the purposes of the arguments in this book, however, it does not matter whether the substitution of CD-ROMs for multivolume printed products (or any other manifestation of the new economics of information) is deemed (or measured as) economic progress or not. The substitution has a tremendous effect on competitive advantage, and that, not GDP, is the focus of our argument. Notes: 4 The GDP statistics analyzed by economists would capture neither the drop in price nor any quality changes in the shift from print to electronic encyclopedias over this period. This illustrates the irrelevance of much of the macroeconomic debates over the impact or non-impact of information technology on “productivity.” It also illustrates the peculiar propensity of economists to interpret their inability to measure something as a statement about the world as opposed to a statement about economists (c.f. the “efficient markets hypotheses” in finance). For the purposes of the arguments in this book, however, it does not matter whether the substitution of CD-ROMs for multivolume printed products (or any other manifestation of the new economics of information) is deemed (or measured as) economic progress or not. The substitution has a tremendous effect on competitive advantage, and that, not GDP, is the focus of our argument. Microsoft never succeeded in getting to the price point it expected. Consumers rarely trade up from last year’s promotional version to this year’s fully priced version. Consumers benefit (if they ever use the product), but the industry is essentially destroyed. It is not clear that anybody will ever again write works of scholarship comparable to the greatest editions of Britannica—at least not in the same form.

But there is hope. Britannica, under its new management, has produced a moderately successful CD-ROM product. It goes far beyond its competitors, not only in quality and sheer volume, but in transcending the CD-ROM’s limitations and connecting directly to the World Wide Web. The new Britannica aims to become a—indeed the—portal to a universe of high-quality, objective, scholarly material. The brand guarantees, as do few others, the seriousness and reliability of the content. The hope is to rise above the clutter and mediocrity that have proliferated in the early years of the Internet and build anew something of permanent value. The identity of that something and the challenge of building it under the vagaries of shifting economics of information are the themes of this book.