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How to create a new market

28 April 2010

A striking example of the ubiquity of obliquity is that scarcely anybody sets out deliberately to create a new market, yet that is what nearly all of my subjects in Winners and Losers did. One exception is eBay – Pierre Omidyar’s idea was always to create ‘a perfect market’, a level-playing field for part-time traders. Its genesis however was largely serendipitous – he did not originally think of it as a business at all, but more of a communitarian utility.

Does it make sense to plan to create a new market? Until recently I would have said no – far better to concentrate on building a robust business. Now that we understand much more about how the networked economy works, not least from eBay’s history, that judgement needs qualifying. Where there are powerful network effects and positive feedback loops, a race often develops for who can reach critical mass first, and the winner can expect to hold onto his prize for a long time. Here fortune favours the prepared mind and those with a head start.

Let’s consider first the conditions that always apply. All successful market creators, from Apple and Sony to Amazon and Google, spot ‘competitive white space’, where nobody else is looking or doing anything effective. This is not normally an analytical process, Amazon being a notable exception. It would be more accurate to say that market creators discover white space in their pursuit of an idea: for Apple, ‘insanely great’ products; for Sony, ‘an ideal workplace, free, dynamic and joyous’; and for Google, ‘organising the world’s information’. They all judged, correctly, that many customers would share their enthusiasms; most innovators are less fortunate. Finding a space that is not yet swarming with competitors, that the pioneer can mark out as its own, is something most entrepreneurs should aim for. The prize, whether it’s an enormous mass market or a nice little niche, is competitive advantage so great that it comes close to being a monopoly for a while.

The starting point for getting to this enviable position is a radical idea that meets a large, unsatisfied customer need. Good ideas are comparatively common and most never get beyond the drawing board. What are really crucial are organisational capabilities that nobody else yet has. It is these that enable the business to make compelling propositions to large numbers of customers. The other two essential attributes are a balance between entrepreneurial spirit and management discipline and an original business model that others find it difficult to replicate.

This rare combination of qualities would normally be enough to help the pioneer hold onto its prize for a while, but most are eventually dislodged by competitors who can match their innovations and may have other weapons in their armoury. Strong network dynamics can change the rules of engagement dramatically, making it virtually impossible for competitors to get a look-in. EBay was blissfully unaware of them in its early days, as its astronomical growth took Pierre Omidyar by surprise as much as everyone else. This was a market nobody had dreamed could be so large, but by the time that competitors had spotted it, eBay had acquired unstoppable momentum: it always offered sellers more buyers, and buyers more sellers, than any other auction site.

Peter Thiel and the other founders of PayPal had noted this extraordinary phenomenon and understood how network effects and feedback loops work. They had not however anticipated that the main customers for their online payments service would be eBay traders. Settling payments at the conclusion of auctions were then a serious problem for small traders who could not afford to offer credit card facilities. Thiel was always aware that this market would be a race where one winner would take pretty much all and he quickly switched strategy to concentrate almost exclusively on these early adopters. To build critical mass as quickly as possible, PayPal offered new customers an account with $10 already in it and a $10 inducement for every other member signed up. This might sound a lot, but Amazon was spending $35 to acquire each new customer in 1999, and the value of PayPal’s early customers was much greater. It was of course already very much in their interests of eBay traders to recruit others, and in those days eBay was still an evangelical community.

The other main runner in the payments race eventually became eBay itself. At the end of 1999, it announced its own payments service, Billpoint, charging a hefty 4.75% on all payments, on top of its other charges. Not surprisingly, most traders preferred Paypal’s much cheaper and simpler service. Despite eBay’s rather heavy-handed attempts to pressurise traders into using Billpoint, PayPal’s growth barely faltered, reaching 100,000 members in January 2000 and a million by March. By 2002 it had 15 million members and eBay bowed to the inevitable, acquiring the upstart for $1.5 billion. That proved a much better buy than the $2.6 billion it paid for Skype in 2005: PayPal now accounts for more than a third of eBay’s net revenues.

PayPal like eBay is itself a network, as of course is Facebook, which came to dominate social media as quickly as Microsoft did the desktop through similar network dynamics. We can expect to see many more businesses like these emerge in the next few years. They may not all be Internet-based, though it does offer the greatest scope for penetrating mass markets quickly. The growing importance of smart phones and other mobile devices will almost certainly lead to a new wave of networked businesses.

It seems unlikely that any of the new giants to emerge will be quite as innocent, or fortunate, as Pierre Omidyar. You can be sure that thousands of would-be entrepreneurs are presently poring over plans to jump-start new networked markets. They cannot afford to neglect the essential qualities of all market creators, particularly distinctive capabilities, but their priority will probably be strategies similar to PayPal’s for winning those first crucial customers and building momentum and critical mass.

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