Battle of the Buzzwords

With the dot.com craze came a new language for Internet-based selling. The big concepts to watch were "disintermediation" and "transparency." One of my favorites was "eTailing." Suddenly everyone was using these terms and I remember feeling somewhat bothered that these words didn't roll off my toungue with the tenor of confidence projected by others.

• Disintermediation refers to the notion that Internet-based selling was going to displace pre-existing distributors or conventional retailers (where applicable) due to certain operating attributes innate to the Internet world rendering intermediaries less than necessary. Some manufacturers would go direct to end-users of products. Disintermediation was supposed to help manufacturers.
  

• Transparency referred to the notion that the Internet would empower consumers to easily compare prices of sellers for like items. Transparency would make price the focus of consumers for many types of products they wished to purchase at the best possible prices. Transparency was supposed to help customers.
  

We have an investment in an Internet-based retailer. It sells products manufactured and branded by others. Many of these products are available at your local Home Depot. This company has several Internet-based competitors.

I had the opportunity to get a glimpse of a close competitor ("Competitor A") and compare it to our portfolio company. This company is substantially larger (3X in revenues) than "portfolio company" and has been around a lot longer. This company carries very many of the same products from the same manufacturers.

A close comparison of the two companies reveals something pretty interesting. Our portfolio company realizes gross margins in the 33% range (plus) while those of Competitor A are right at 20%.....This is an exceptionally large difference in gross margin between two competitors selling nearly identical products provided by the same manufacturers.... This would suggest that portfolio company is selling its products at prices substantially higher than those of Competitor A. The premise of "Transparency" would suggest that the Competitor A would run us out of business...BUT just the opposite is happening............ HOW CAN THIS BE?

A review of the posted selling prices of Competitor A suggests that customers can buy from them at prices approximately 10% lower than from our portfolio company. At our average product selling price of $150, the 10% price differential accounts for 8 points of the 13 point margin differential (33% - 20%). So if price were otherwise held equal, portfolio company would still have a 5 point gross margin advantage over Competitor A . Why?

We have spun thus around many different ways and there is only one conclusion we were able to draw. Portfolio Company's gross margins are significantly better because it is buying product at a cheaper price..How does it do this if it is so much smaller than Competitor A?

Secret Sauce

Portfolio company's investment thesis is that it helps manufacturers solve specific types of problems (can't reveal these problems and solutions exactly but they deal channel issues and other sellers of the products - perhaps like Home Depot or Competitor A) In a way Portfolio Company is "disintermediating" these other sellers with purposeful benefit to the manufacturer). I believe that Competitor A's investment thesis is that it provides products to customers at low prices with wide selection. This is sort of like Amazon's focus. Competitor A is sort of a customer to the manufacturer more than a problem solver for the manufacturer and its principal aim is those who buy its products. Competitor A thus has a model built around "transparency."

So...it may not be a perfect conclusion but a plausible one that disintermediation plays result in more profitable companies than transparency plays. In other words...helping the supply side -manufacturers appears to result in higher profitability than helping the demand side-customers (which may result in more volume as thus more profits but at lower margin levels). This may be countered by the notion that suppliers may be more anxious to help problems solvers and thus provide more supply to them. Thus would result in lower volumes to Competitor A. Ironic...that the high volume strategy could result in lower volume...

I suspect my conclusions here are lightyears behind...but at least they provide some empirical context for issues thrown out there years ago...

iPods, Networks, and Instant Gratification

I am a parent. I am a parent of two children (and one on the way). Parenting today seems to involve a steady flow of advice from the daily local TV news, Dr. Phil, my local newspaper, any number of "Better Parenting" books, People magazine, etc.

While I can't absorb all that is broadcast at me I do try and listen keeping some and discarding some. Some of this information is not only good for guiding children it is, in my judgment, good for the reader - me and others in my position. One thing I contemplate regularly (that is discussed in the "Better Parenting" literature is the notion of adolescent development and instant gratification). Based on my readings it seems fair to say that parenting pundits believe that instant gratification experienced regularly may have long-term negative consequences (see the famous "Marshmellow Experiments" (http://en.wikipedia.org/wiki/Deferred_gratification. ) Common sense seems to support this.

A few months ago I bought an iPod. Over these few months I have noticed a change in my alertness regarding music. I used to hear a song and perhaps think (I like this song and if I can remember - I might go to the record store and purchase the CD). I would then abruptly forget about it. With an iPod...I operate differently. I hear a song that I would like to own and don't forget about it. I burn the notion of buying that song in my mind because I know I can go on-line and buy it though iTunes. I know that if I just hang on long enough to get in front of my computer...I am going to get that song. iPod has thus changed my behavior. I can, relatively speaking, receive a form of instant gratification. So the possibility of instant gratification has changed how I occupy my time and use my brain cells. As a side note...I haven't seen a record store in two years.

A Closer Examination of Instant Gratification

Pursuit of instant gratification is more prevalent than ever. The world can get you things and tell you things real fast. There are many examples in the information technology world.

A Positive Example - Some types of instant gratification certainly are good. Web MD (www.wedmd.com) helps you diagnose your symptoms without the anxious process of going to see a doctor (please do this at your own risk).

A Negative Example - Some types of instant gratification are addictive and bad. YouTube (www.youtube.com) is conceivably such an example. This is a website where one can conveniently posts homemade videos. It works sort of like this...I put videos up myself on YouTube (as millions of others have)...I then wait to see how many views I have had and then use this as a measure of my self worth. Google just decided this social/emotional feedback loop was worth about $1.6 billion. It is bad in my judgment because I perceive it to place the power of determining one's self-image into the hands of others and away from the self. "My opinion of me is based on what I perceive others may think of me......"

Yes...... we are a culture of instant gratification...the addictive character of instant gratification is why we talk too often on our cellphones, try out on American Idol, do a double take on advertisements that promise a graduate degree in 9 months, and otherwise quit so frequently when things get too hard to complete.


What Does This Mean?

Yes...I have noticed above...there are good and bad forms of gratification. While I can't mathematically weigh whether or not higher speed gratification is, on the whole, good or bad...I do believe that instant gratification drives a greater appetite for more instant gratification. It goes faster and faster. A result of this is that obtaining and using the tools for instant gratification occupy more of my focus...as a result of feeding my addiction...I spend more time doing and less time thinking...

Believe it or not...this has ramifications on, among other things, the products and services we demand and on the way software is designed and networks utilized (I had to work this in). Some basic beliefs of mine:

• By virtue of our cultural changes....software and networking systems that provide more instant gratification will be more attractive to potential buyers and win market share. This can come in the form of better visualization, faster visualization and analysis (real-time), and ease of deployment. It seems obvious that the faster the information...the more demand for the information technology.
  

• End Users will be more into self provisioned software...in other words...they will do a search on the web..find what they think they need that provides requisite business functionality...download and start using it (credit Tyson Weihs) . This is happening all around you.
  

• Customization will have to wait. End Users will end up trading functionality for immediacy. If a software package does 60% of what I need but is available today vs. next year (as might be the case if run through IT)...then so be it. Greater functionality will be built later.

• As a result of the point immediately above...software will become more disposable. 60% capable software will survive for awhile then be trashed while a more competent system is procured/deployed. Think of this...software will become more disposable...this is starting to sound like service oriented architecture (SOA)...use the service...dispense with the service.
  

• Some of this will mean that software will be broken down into smaller pieces contrary to the huge monoliths such as SAP and Oracle. So we are sort of going back to best of breed.
  

These statements reflect a necessary change in product architecture and philosophy, marketing message, pricing strategy, and requisite product functionality.

Self Check

Nonetheless....I am sure that more and more of my time and braincells will be directed toward the pursuit of instant gratification...I need to make sure I stop and breath to make sure that I do things like calculate and reason. Someone please contact George Orwell.