Chapter 4: Reshaping the Landscape

You cannot plan out a new form of society in advance, then set it up and expect it to function as it was designed to—the Unabomber Manifesto

As long as you depend on the statistical aggregates we now call information, you'll know a good deal about your product, a good deal about your services, and not a blessed thing about your customers—Peter Drucker

Relationships with the outside environment, or in other words, your business partners, are already under profound pressure from the new forces. The most obvious symptom of this pressure is the shifting definition of what is inside and what is outside of the firm. As the new forces drive down transaction costs, you must continually revisit your own operational model and decide which functions are more efficiently handled by the market—then move them there as quickly as possible. As you do, the remarkable property of information to increase in value the more it is used will lead you to more surprising changes. It turns out, for example, that customers are not only lower-cost providers of many activities we think of today as "customer service," but customers perceive and realize added benefit from doing these tasks themselves.

The disruptive power of technology, on the other hand, exposes you to new and unfamiliar competitors. The decline in technology costs and the value generated by the effects of Metcalfe's Law unintentionally destroy barriers to entry even in markets and industries long thought impenetrable, including traditional "natural" monopolies like telecommunications and other utilities. These and other industries now find themselves being redefined by information brokers who stand to capture a healthy share of the profit margin using the new forces as leverage. To avoid the resulting killer apps you must adopt them yourself, trading off your existing brand and other information assets to ward off the newcomers even as you accelerate the destruction of your own business model.

Lower information costs, moreover, make it possible to think of and measure your daily operations as a series of unique transactions rather than broad categories like products and customer segments. As transaction costs approach zero, in fact, the Law of Diminishing Firms reveals that standard products are nothing more than a brute force approach to reducing the transaction costs of collecting and responding to the needs of individual business partners, an approach that is now unnecessary. As consultant and author Joe Pine puts it, "Anything you can digitize, you can customize."

The migration from atoms to bits is also creating a new importance for relationships that generate value through information exchange. Even as you outsource uneconomical functions to business partners, making the relationship with the outsourced functions more casual, the diversity and bandwidth of other interactions increase dramatically. As we approach (but never reach) the world of truly frictionless transactions, an organization's relationships are optimized by treating them as a community rather than a series of contracts.

Oddly enough, what most enhances your network of relationships is to improve the connections between business partners, who have much to say to each other but no forum in which to communicate. Organizations are used to working hard to keep business partners apart, and find it difficult to understand how bringing them together generates new value, much of which they can capture through creative brand management. For organizations that begin life digitally, building themselves by building communities is as natural as breathing.

These first four design principles are examined in this chapter:

1. Outsource to the customer.
2. Cannibalize your markets.
3. Treat each customer as a market segment of one.
4. Create communities of value.

These principles can be used to design killer apps that develop new markets, to form new relationships with customers and other business partners, and to apply digital technology to change the nature of the goods and services you currently offer. Companies that have employed them have found new ways of collecting, consolidating, and valuing information, much of which is freely available and, indeed, may already be resident in their own databases. Customers and others, it turns out, are more than happy to provide the rest.

4.2: Outsource to the Customer

Most organizations are already familiar with the concept of outsourcing, which we described in Chapter 2 as an expression of Coasean economics at work: as digital technologies make the market more efficient, companies can and indeed must turn over uneconomic functions, including some or all data processing and other office management tasks, to stay competitive. In cyberspace, the economics of information flow create a related opportunity. Data collection and customer service functions can now be outsourced, not to other firms, but directly to the customer. Customers take on these tasks willingly, extracting value of their own by doing them.

You outsource to customers by building an interface into your information sources and then giving customers the tools they need to navigate and customize them. The data is generally already digital and using the Web and its toolset makes it cheap to build, deploy, and operate that interface. The customer connects to your systems using his or her own equipment, phone lines, office space, and even electricity, which means you don't need to provide it any longer.

For a small investment, you can have the customer perform many of the expensive activities you do today, including basic customer service, order entry and tracking, training, purchase order management, product configuration, and even product development. The data you collect has far fewer errors because it has been handled only once, and then by the originating source. Cost savings on your end can come quickly and they are significant.

Computer and network equipment sellers like Dell and Cisco Systems already use digital technology to let business customers handle most of the basic service functions themselves. But this rule applies to the least experienced customer just as much as it does to the sophisticated customer. Holiday Inn's Web-based worldwide reservation system smoothly guides users through the process of locating the hotel nearest their destination, checking availability, taking a virtual tour of the hotel, and completing the reservation. The system even recommends the next closest Holiday Inn if the first choice is full. The process is entirely customer driven, and doesn't require an 800 number or operators at the other end of it.

As these examples suggest, the use of standard-based technology like the Internet can greatly simplify your operation. But how can you convince the customer to do your work? It's easy. For one thing, customers also reduce transaction costs by performing these services themselves. One-time entry of information, as in purchase orders, avoids review, correction, and undetected discrepancies for buyers and sellers, reducing the costs associated with negotiation, policing, and enforcement. Customers who can review product material presale or postsale on an everywhere-everytime basis can also save substantially on search and decision-making costs. The result is the creation of better and more useful data for future uses, including market research, product development, and, not incidentally, richer relationships with your customers.

4.2.1: The Customer Is the Best Customer Service Representative

Consider examples from other industries. In 1995, FedEx built a simple interface into its package-tracking database and made it available to any customer with access to the Internet. The response was overwhelming. Customers had instantaneous access to a detailed history of their package's travels on their own computers. The specificity of the data, which included the exact time packages arrive at interim locations, given in its entirety rather than summarized by an operator, amazed customers and actually enhanced their belief in FedEx's core value proposition of dependable and reliable delivery service. Despite the sometimes erratic performance of the early Web, customers found working on-line easier than calling FedEx, waiting on hold, and then speaking to an operator who was doing little more than reading the contents of a database.

The package-tracking application was launched as an experiment, and a cheap one at that. FedEx bar codes all packages and scans them at every stage of delivery, so the data was already in digital form. By using the World Wide Web and its open standards for text and graphics interfaces, FedEx did not need to invest in expensive software or build a large private network for its customers.

FedEx recognized the killer app potential of its experiment, and went through several quick rewrites of the system, adding features like the digitized signature of the recipient and order entry software that allowed customers to schedule pickups and generate and print airbills (on their own equipment), complete with the bar code. For high-volume users, FedEx created versions of the software that could be downloaded from its site to the customer's computer. With this version, customers perform all these functions off-line and then send the data over the Internet back to FedEx.

For FedEx, the enhancements mean there is only one data entry point, and the customer is responsible for it. For customers, it means never having to type another airbill by hand or run out to a FedEx drop box to pick up any of the various forms. FedEx has already realized savings in the tens of millions of dollars in customer service costs. The customer service representatives, meanwhile, are now free to focus on value-adding interactions with the customer.

Outsourcing the customer service function is also proceeding with breakneck speed in the travel industry, much to the chagrin of travel agents who rely on limited access to rate and package information to justify their commissions from airlines, hotels, and rental car companies. These service providers already compete with agents by offering direct order through 800 numbers, and there has been tension in the industry for years. In 1995 Delta announced it was placing a $50 cap on commissions for most domestic tickets issued by travel agents, and the rest of the airlines soon followed. Travel agents protested, but they no longer had the leverage of exclusive access to customers they once did. Technology has lowered the transaction cost of traveler and carrier finding each other. The commission cut generated $1 billion in revenues during its first year, plenty to be shared between airlines and their customers.

Now, travel reservation and ticketing services in cyberspace are springing up every day. The SABRE Group, one of the leading providers of airline reservation software, launched the Travelocity Web site in 1996, only to find that the immediate response was so great that it had to go through several hardware upgrades just to handle the transaction volume. Using Travelocity, customers have full access to the fare database of all major international airlines. This system's search tools find and rank the best reservation options depending on whether customers prioritize for price, desire for nonstop flight, or maximization of frequent flyer miles. The system eliminates the need for a travel agent for most transactions, reducing customer search costs. In addition, it gives more complete access than calling an individual airline directly, further reducing information costs. On-line self-ticketing already accounts for 4 million tickets a year, largely by the treasured business traveler.

Outsourcing to the customer works as well for manufacturers as it does for service providers. Dell Computers, now the world's leading direct marketer of computer systems, has almost completely shifted its sales and support functions to customer-driven applications and is now selling over $3 million worth of its goods and services a day over the Internet. According to the company, its largest corporate, government, and education customers have self-customized Web sites that already know which products customers own when they sign on. The system also provides daily order and manufacturing status. Customers can use the system to configure hardware, choose from a variety of lease/purchase options, and order directly without the need for purchase orders. Customers claim savings in the millions of dollars on technical support and reduced order-processing costs alone.

Those are just the savings on the customer side. For Dell, direct data exchange with customers in cyberspace means speed and reduced costs as well. In the market for desktop computing these advantages are critical. By selling through the Web, Dell doesn't have to wait for dealers to pass the orders on, greatly reducing inventories. Because electronic commerce allows the company to take customer payments directly and immediately, Dell can convert the average order to cash in twenty-four hours. Compare this with the modus operandi of rival Compaq, which continues to operate through dealers. Inventories there are higher, and, more striking, the average order takes 35 days to convert.

4.2.2: The Customer Is the Best Product Developer

Why stop at outsourcing customer service? Why not go further, as some companies have, and outsource the development of future products to customers as well? In many cases customers know best what they need and which features and functions they are willing to pay for. Since they are the end users of these goods and services, they are also experts in how products can and should work. Customers will help you on their own time, when doing so is easy and the rewards—specialized or customized products, faster turnaround times, and even the sense of participation—are tangible.

In the specialized chemicals industry, customer participation in product design is already significant, but the transaction costs for both parties are high. Phone calls, faxes, mailings, and meetings are expensive and erratic. In the filtering of information that goes on between sales and marketing representatives who work with customers, and the product designers who create new products, valuable information is often lost.

To reduce these costs and improve the quality of the information flow, Hüls AG, a leading specialty chemicals manufacturer based in Germany, has begun construction of a virtual design lab. The structure of the lab is simple, using the Web and increasingly cheap high-speed communications to minimize the investment necessary for infrastructure. Hüls plans to use group collaboration tools already available for the Web (such as Livelink), which help distributed project teams organize discussions, share digital work product, and coordinate activities.

In the virtual lab, the worst features of the current process are eliminated. The design process and interaction take place continuously, and communications between customers and developers are direct, avoiding the problem of "helpful" editing. The company believes this environment will support rapid prototyping for new products. In theory, the lower transaction cost environment of the virtual design lab will facilitate a natural movement of the functions involved in design to the participant who has the best information and the most incentive to provide it. That might be Hüls, its subsidiaries, its suppliers, or its customers.

A more extreme example of using digital technology to outsource product development is Firefly, a fast-growing start-up that began life as a project at the MIT Media Lab. MIT professor Pattie Maes had developed some powerful pattern-matching algorithms and decided to let them loose on the Web in the form of a game whose goal was to recommend music that visitors to the site might enjoy. Players ranked their preferences for hundreds of different musical groups and composers, from extreme devotion to "never heard of it." Firefly then told them what other music they might like based on the rankings of other players with similar interests. The more rankings a user gave, the better Firefly did at predicting what he or she would like. The more people who played, the better the predictions got. We had never heard of "The Cowboy Junkies" until Firefly told us that we might like them, and now we're hooked.

Users got to play this fun and possibly eye-opening game for free. Firefly got a product and a company. The popularity of the game quickly created for Firefly a brand name in an exploding market for software "agents," software that learns user preferences and then helps them perform tasks, like shopping, that would otherwise take repetition and time. The company has now licensed its product-selection agents to others, including the Yahoo! search engine and the Barnes & Noble on-line bookstore. The database of music preference profiles, meanwhile, has some of the richest and most credible marketing data on individual musical tastes ever collected.

Customer profiling and targeted marketing are not new, but the ability of an unfunded company to collect high-quality data on a global scale and at almost no cost could only be possible in a world operating under the new forces. Since development of the "product" was outsourced to customers, Firefly could afford to wait and see what kind of revenue models would emerge from its killer app. The company is now pursuing several, including selling ads on its own site, licensing the psychographic data it collects, licensing the agent technology, and selling the items it recommends. One analyst estimated the company's value in 1997 at $100 million.

As all these examples demonstrate, outsourcing to the customer differs significantly from long-standing efforts at cost cutting. In banking, significant cost savings have been realized by shifting customer transactions from branches to telephone and from telephone banking to ATM. But in the shift from ATM to Internet banking, the bank-customer channel is no longer one-way; it is interactive. Internet banking not only reduces costs (replacing the ATM and network with the customer's equipment, for example) but opens up the possibility of expanding, customizing, and cross-selling other goods and services. Given the chance, customers are more than happy to tell you what they want.

4.3: Cannibalize Your Markets

In traditional planning, managers are justifiably frightened of launching a new good or service that gains market share at the expense of an existing offering. GM's Saturn division has been successful by nearly any measurement, except that it succeeded in large part by siphoning off customers from other GM units. The Saturn story may be more cautionary still, since the company introduced not only a new line of cars that competed with existing brands but also a way of manufacturing, selling, and maintaining cars that may undermine the core assumptions of the entire auto industry. Good for Saturn, but what about for GM?

Executives in our recent survey agreed that technology is redefining the marketplace, upsetting current plans, and allowing unknown, global competitors to spring up overnight, but many seemed paralyzed by a fear that taking action today may cannibalize current operations. Instead, they are trying to hedge their bets with cautious strategies, moving slowly toward cyberspace, and then only with low-risk offerings. A bank executive told us he was using a hybrid telephone/Internet strategy-betting on the Internet in the long term as a major conduit for customer service, betting on the telephone in the short term, and trying to give customers enhanced service using either option.

Hybrid strategies make sense when they are designed for the sake of the customer, but often they are the cover for a hope that a company's past investments can be fully depreciated, a hope that cannot be fulfilled. There is considerable wishful thinking on the part of those, like the CEO of a large retail chain in our survey, who don't think customers are ready to do business with us in cyberspace. Some customers may never want to move. But that group is already smaller than you think.

Cyberspace cannibalism is already rife. Securities broker Charles Schwab offers a 20 percent commission discount and a wide range of software tools to its Internet customers. The New York Times, San Jose Mercury News, and others publish their entire daily newspapers on-line, and give away most of the content. The Wall Street Journal charges $49 for a full year of unlimited access to its on-line edition, including many services that readers of the printed version don't get for their $150. Even top-drawer management consulting firm Ernst & Young offers a Web-based question and answer service called Ernie" for $6,000 a year, a price that ought to make its partners blanch.

Are all these companies crazy? Clearly these information-heavy goods and services can be offered at low or no prices because the economics of production and distribution in cyberspace are so dramatically reduced. On-line newspapers don't need to be printed or distributed, on-line brokerage customers don't require the overhead of physical offices, and consultants who can serve clients without getting on airplanes can do so at a greatly reduced price. But what about the current clients and markets? Why don't they immediately shift to the new, lower-priced sales and distribution channel, stranding our current assets, and effectively killing us with our own success?

Part of the answer is that what appears to be cannibalism is no such thing. Ernie is not a replacement for the on-site services of an Ernst & Young consulting team, but a clever way for the firm to leverage its knowledge base of client and industry expertise. It is also a cheap point of entry for new clients who, as they become more successful, can be groomed for the consulting firm's higher-priced services. Many on-line newspapers and Web-based information providers, similarly, are unlikely to be competing with their own print businesses. The San Jose Mercury News has few subscribers outside the Bay Area, so offering its news for a greatly reduced price on the Web is largely selling a new product to a new customer base.

Still, some of these examples are genuinely cannibalistic. The Wall Street Journal and New York Times are national publications, and may limit the sale of their print editions with their impressive on-line offerings. The Dallas Morning News made news itself recently by posting a story on its Web site about a supposed confession from Oklahoma City bomber Timothy McVeigh several hours before its print edition was available, in effect scooping itself. If Charles Schwab and other retail product and service companies are successful in their on-line strategies, they will genuinely threaten their own physical businesses.

There is one obvious reason why these organizations are breaking taboos. If they don't, someone else will. Schwab had to offer lower prices over the Web because start-up competitor E*Trade, which operates solely in cyberspace, was already doing so. Hewlett-Packard recently announced plans to accelerate its promotion of digital cameras in order to grow its $1 billion printer supply business. Doing so puts added pressure on companies like Kodak who are hoping to develop the digital market at their own pace. For news organizations, much of the content comes from wire services anyway, and they know there's nothing that would stop you or anyone else from creating a new business that delivered news solely in electronic form, operating at a drastically lower cost than companies stuck with printing presses and distribution networks.

These cannibals understand that the present value of current channels needs to be balanced against the unrealized power of other information assets they can exploit in cyberspace. Chief among them is brand. New competitors have to build awareness from scratch, but you can jump-start new digital markets with the credibility and goodwill already associated with your organization. Cannibalizing your markets recognizes that the old channels will mature or disappear on their own soon enough, but by taking steps that may hasten that end you can get into the new channel early. The cannibals lead with brand, an information asset that gives them competitive advantage in cyberspace. But only if it is used in time.

Brand must also be used wisely. Cannibalizing markets does not mean cannibalizing the brand itself—that must be kept sacred. Investment bank Hambrecht & Quist may have violated this principle in its launch of a brokerless electronic division whose charter is to sell financial instruments at the same price to consumers as the bank offers to important high-volume institutional customers. According to CEO Donald H. Case III, the company can make up for the cost of smaller transactions with the reduced operating costs of cyberspace and through higher overall volumes. "We'll be the Price Club of electronic financial services," Case said in announcing the service. Institutional buyers might not object too strongly to paying the same price for Hambrecht's services as individuals (assuming they get more individual attention and customized offerings as well), but they might very well object to their prestigious partner repositioning itself as a cheap retailer.

4.3.1: The Stumbling Information Business

The need to cannibalize today's business is particularly acute not just for the newspapers we mentioned earlier but for information providers generally. A closer look at that industry suggests the kind of trauma that is in store for everyone else as the killer apps spread. The news business is already a bits business, and many traditional suppliers of those bits, like wire services, television networks, and newspapers, are resisting the move to digital distribution. Despite its lower cost, digital publishing directly threatens not only existing markets but many time-honored principles of how information providers make and spend their money. Subscription-based newsletters can operate much more cheaply on the Web and reach a much wider audience with minimal additional marketing or operating cost. But once information is released as bits, its natural tendency is to flow, and today's valuable information can be reproduced millions of times with the click of a mouse—legally (the ideas) or illegally (the actual text or broadcast)—by anyone who has access to it. Information providers fear a loss of control over their copyrighted content, and have spent considerable time and money trying to develop digital controls like electronic watermarking. Meanwhile, they are doing little to experiment with the enabling technology itself.

The key for publishers is to recognize that digital media are not simply extensions of current channels any more than TV was a new form of radio. New media require new goods and services, and new attitudes about how to exploit them. The Wall Street Journal's on-line edition signed up 650,000 subscribers during its free trial period. The buzz generated encouraged the paying subscribers after the trial. These subscribers made the experiment profitable in its first year of operation. The free trial demonstrated that the Journal on-line was not just a cheaper version of the printed paper but something much more suitable to the capabilities of the Web. The site links stories to more detailed and archival information, hosts discussion forums between readers (not just between the paper and the readers, as does today's print op-ed page), and lets subscribers loose on a vast database of up-to-the-minute financial, stock, and company filings, data, and news releases, neatly organized into "briefing books." The site moved from being a cannibalization of the print edition to something that resembles the next generation of product and service the Journal will offer, the company's real killer app.

The real lesson of the on-line Wall Street Journal is that cannibalization is a healthy symptom of an organization's transformation to a form better able to survive in the new environment. It is a lesson few information providers have learned. Most Web sites associated with TV news services are poorly implemented, and most have failed to win much admiration from their audience in cyberspace. Newspapers haven't done much better. Both are losing out to start-up specialty news providers, most notably C|Net, a technology-oriented media company founded in 1992. C|Net develops content centrally, then distributes it over a variety of media, including the Web, cable TV, daily E-mail dispatches, and Internet radio. C|Net had no market to cannibalize, and its freedom of movement and ingenuity have paid off. Almost half a million subscribers receive the daily bulletins, and the site is one of the most heavily visited on the Web, contacted by up to 3 million users a day.

4.3.2: A Wholesale Cannibal

Wholesalers, as we suggested in Chapter 2, have much to lose from digital technologies' power to reduce transaction costs. Wholesalers manage the interactions of buyer and seller, reducing the search, information, and negotiating costs that would exist in their absence. Their margin, usually a commission, is based on superior information. As orders-of-magnitude-more information becomes digitized and more easily navigated, markets become transparent, meaning buyers and sellers can find and communicate with each other at far less cost. What, then, is there for a wholesaler to do?

In electronics, wholesaler Marshall Industries understands the threat of the digital killer apps and is trying hard to tame them for its own advantage. Marshall is a $1.2 billion distributor of electronic components and systems for such manufacturers as Siemens, Hewlett-Packard, and Advanced Micro Devices. Before launching itself as an electronic provider, Marshall serviced its 30,000 retailer customers through 37 sales offices located throughout the United States. The company's competitive advantage had been its relationship with major manufacturers and access to a conveniently large inventory.

In 1995, Marshall opened a new channel using the World Wide Web. Technically, the site was a trivial application to develop. Marshall already had a mainframe-based system that was connected over a private network to its sales offices and remotely to the laptops used by its sales force. In effect, the Web site simply offered a new front-end, one based on the Web's multimedia standards. The new interface allowed customers and potential customers from all over the world to search the catalog, place orders, and arrange shipments in a multimedia environment that included audio, video, and foreign language versions.

From the standpoint of Marshall's current business model, the application looks like the corporate equivalent of suicide. Marshall not only lets customers see its price list but provides them with direct links to all of its manufacturing partners, allowing customers to check price and inventory and order directly every item in its catalog. The interface is so easy to use that even current customers might be tempted to switch, cutting off the sales office. In fact, Marshall went further. In regular updates to its site, it has made the Web-based order process even more convenient than its traditional sales channel. All orders are shipped via UPS, for example, and Marshall provides a direct link that allows customers to track their orders using the UPS Web-based system.

What would make a profitable, publicly traded company expend so much energy and enthusiasm on an application that has the potential to wipe out its profit margin? The answer, in part, was recognition by Marshall that even if it didn't open its strategic information to customers, someone else—perhaps the manufacturers—would, and it was better to cannibalize itself than to be eaten. Moreover, this trivial application allowed Marshall to transform itself from a national to a global supplier at almost no cost. The potential loss in one channel is offset by increased volume in another. Marshall receives more than 2,000 inquires a day from 52 countries via its Web site.

Marshall's fearlessness was based on recognition that it had something to offer that went far beyond its role as a manufacturer's representative. Marshall's sales staff has developed significant expertise in product selection, configuration, installation, and postsales support. The company intends to relocate that expertise from the world of atoms to the world of bits; it plans not only to maintain but to expand its market presence by leading with the value it adds to the products it represents. Marshall is well on its way. Its Web site offers on-line seminars, video- and audio-training programs, a twenty-four hour chat room for help, and a collaborative design lab in which customers and Marshall engineers configure custom products. Marshall plans to create extranets with its key accounts, giving manufacturers and customers direct, high-bandwidth and customized access. In effect, Marshall hopes to become the focal point of an electronic marketplace, the organization that can do whatever is necessary not only to bring buyers and sellers together but to ensure quick, successful completion of their transactions.

If the electronic market ultimately replaces your existing business, it's better to be a player in the new channels than an extinct dinosaur remembered for its lack of foresight. Cannibalizing with digital technology can be a low-cost way to find out how soon the change will come, a manageable risk to today's operation. In the end, companies may find that operating as bits-based businesses extends their reach, expands their ability to offer additional goods and services, and even makes them more profitable.

4.4: Treat Each Customer as a Market Segment of One

A 1997 Business Week cover story proclaimed the advent of something it called two-tier marketing-positioning products either to premium buyers (an example would be organic foods) or to value-oriented shoppers (bulk foods). And cable television, we are constantly told, is becoming increasingly specialized as the number of channels increases, a trend known as narrowcasting.

The real killer app in marketing is the more dramatic multiplication of product lines that can happen in cyberspace. When goods and services take the form of bits, or even if they just get advertised, wrapped, or shipped with them, the dramatic reductions in transaction costs make it possible for merchants to connect with each customer without the usual set of expensive external and internal intermediaries. Technology makes it possible to create, cheaply and consistently, a customer offering that is unique; not just one time, but every time. Author Stan Davis calls this approach "mass customization," and nowhere is it more viable than in cyberspace.

4.4.1: The Appearance of Personal

Technology-mediated customization is already the rule in bit-intensive information services. Traditional and untraditional news agents are using the Web to unveil increasingly sophisticated tools that let their readers design personal information engines and watch them churn out custom products every day or even every hour. Pointcast has turned the formerly frivolous concept of a "screen saver" into a killer app, delivering content the user wants, from business news to stock reports to sports to gossip, whenever the computer isn't otherwise being used. Excite, another information "push" company, lets its users define their own newspaper front page, including the comics they like, the news that interests them most, a listing of movies playing in their area, and their own personal daily TV schedule, right down to the order of the channels.

Subscribers to the Wall Street Journal 's on-line edition can design their own "Personal Journal" and receive dozens of stories from the vast resources of the Dow Jones News Service that otherwise never see print. The system today is simple but effective. Subscribers enter the names of companies and key words of interest to them, and when they sign on each day they are presented with articles that match, organized in an easy-to-use index.

Intuit's Quicken Financial Network goes further, giving users an easy-to-use data entry form to enter their current stock holdings. When subscribers access the site (subscriptions are free, since the site is supported by advertising and is itself an advertisement for Quicken software products), they get an up-to-the-minute report of their portfolio performance, including the current day, overall gains and losses, and a wealth of background information on each of the companies. The reports can be customized by the user or downloaded directly into spreadsheets or Quicken databases. As Intuit expands into other financial services, the company is bringing its customization approach with it. The site now offers tools to create a personal insurance portfolio and a Retirement Planner, which calculates your retirement income before your eyes.

These are simple applications, with considerable room to expand as new media and new technologies, following Moore and Metcalfe, make their way through the Internet incubator (including audio, video, 3D, and real-time chat). Even these early experiments have been exceptionally well received, and have high killer app potential. The Journal may be creating a new generation of newspaper, what Professor Negroponte calls "The Daily Me." Quicken is already leveraging its current interface in a move to offer a host of investor, portfolio, and other financial management services.

The power of these applications comes from the fact that customers like the appearance of a personalized product, especially when they have done the personalizing themselves. Modifying the customer-seller equation lowers the transaction costs for customers to get what they actually want (and they may not even know what that is until they begin playing with the free tools). They also become personally vested in the system, often becoming vocal marketers of these services. Think of the religious fervor that has long been the trademark of Apple Computer customers. Imagine tools that create that feeling for your products by offering customers the opportunity to define them or at least choose their packaging.

Treating each customer, if not each transaction, as a unique entity is inexpensive when you use existing (and inexhaustible) digital content and the expanding global computing network. Digital technology creates the miracle of mass customization for a nominal initial cost and then a marginal cost that approaches zero, even on a global scale. There's also a profoundly valuable side effect for you. Customers, in addition to doing their own product design, willingly part with marketing information that most organizations would kill (or even worse, pay) to get their hands on.

The emerging rule in this barter economy is that customers are willing to give away private data in proportion to the direct value they receive in return. Give Travelocity a detailed profile of your travel needs and preferences, and in response you get a selection of itineraries optimized for price and convenience, something beyond the capabilities of your travel agent. Tell Hallmark's Reminder Service the important anniversaries in your life, and they'll E-mail you when it's time to select and send the appropriate greeting. Tell Firefly everything you can about the music you like, and its pattern-matching software tells you what music you're going to like. This is a far cry from the warranty cards and direct mail surveys that nearly everyone ignores. When customers see a direct, immediate benefit from cooperating, they're happy to do so, to everyone's advantage.

4.4.2: An Emerging Model in Public Utilities: The Gateway Proposition

Perhaps no industry seems less likely to follow the rule of treating each transaction as a unique event than public utilities like electric, gas, and local telephone providers. These providers rarely seem to recognize, even today, that they have customers in the first place. As long as these markets remain regulated monopolies, where customers have little or no choice, there's really no reason why utilities should care what kind of service they give. Even at rate hike time, the only customers utilities know about are the regulatory agencies, not the "households," "meters," "accounts," or other euphemisms utilities use to refer to their paying subscribers.

But in the United States and Europe, we are seeing just such a revolution in public utilities, one of the chief effects of which is that many are enthusiastically embracing digital technology to customize their offerings to commercial and residential customers. Motivated by rapid deregulation in the United States and the imminent deregulation in Europe as part of its move to a borderless economy, utilities have been scrambling to build bridges and establish meaningful links to their customers as quickly and cheaply as possible. Their hope in doing so is to build brand loyalty before customers get the opportunity to choose their suppliers. Like companies in information businesses, utilities are finding that the fastest way to make that connection is by offering digitally-customized goods and services.

A new model for the utility industry, sometimes referred to as the gateway proposition, is now emerging. In the United States, companies like Utilicorp are already using digital technology to customize offerings around a broad array of services that go beyond basic energy. These include time-of-use or even real-time pricing (based on best available prices in the growing energy commodities markets), remote control of appliances and other equipment, customized billing for corporate customers, and, amazingly, other utility services like telephone, home security, and entertainment. These leading utilities recognize that the electrical connection is just one of many pipelines that serve a home or business.

Ultimately, customers want the option of a single gateway to manage all these pipes—a complete shift that will create opportunity as well as risk for today's providers. Deregulation and an information marketplace make it easy to buy and sell the basic service units, and access to the customer is now seen as the primary objective in an industry with a long history of ignoring that customer's very existence. Companies like Glasgow Electric in Kentucky, which already provides cable television and telephone service as well as electricity, are hoping to be such providers. Just as electricity suppliers are moving into home and commercial services, cable and telephone companies, as well as new asset-free information companies, are moving to control the gateway themselves.

The gateway proposition is a mass-customization strategy based on clever handling of information. As Moore's Law makes it possible to put intelligence into every device (soon down to every lightbulb), Metcalfe's Law spreads out data network standards for communicating with these devices. Homes and businesses will increasingly look like miniature Internets, with the ability to monitor and measure power usage and performance, and adjust devices and rate options to optimize their use of outside services such as power. The goal is nothing less than treating each power usage event, like turning on or off a light switch, as a unique, customized transaction.

Today, enormous quantities of data aren't even captured. But collecting and mining these bits would create significant value for both customer and supplier. Customers would save money and receive precisely the package of energy and related services they want, while utilities could collect information with far more precision than today concerning loads, usage, and other key indicators affecting generation and balancing. Utilities, in real time, could buy and sell excess power on a global market. Consumers and manufacturers could be given or sold performance data on individual appliances that indicate when parts need replacement.

Much of this information, as experiments in the United States and Europe have demonstrated, can be exchanged over the power lines themselves, avoiding today's reliance on the phone network for data communications. It is entirely plausible that the data network inside your home or business will use the existing wiring for infrastructure and follow the open standards of the Internet to communicate both inside and outside.

In our work with German electricity giant PreussenElektra (PE), the progress U.S. utilities have already made with the gateway proposition sounded a wake-up call for management. After our initial presentation, a senior member of its management board confessed that he was "deeply moved" by what he had seen. German power is still highly regulated, but PE knows that significant change is imminent. It also knows that today's complex operating model has left them ill-prepared to treat customers—even its large industrial users like Deutsche Bahn (the German Railway) and Volkswagen—as a market at all, let alone markets of one. Through a network of regional and municipal utilities, PE's power ultimately serves 7 million customers, but today the company has little or no communications with most of them.

The response of the PE management team was swift and definitive. Senior executives began frank discussions with PE's distribution partners, including more than 900 municipal power companies, regarding the development of an "information grid." Teams were dispatched to the United States to visit gateway leaders and to see others, like Sydkraft in Sweden, that are experimenting with high-speed data transport using the electrical network. PE also began production of its first Web-based customer interface, hoping to begin, before deregulation, a dialogue that will help them expand their information partnership to as many of today's 7 million customers as possible.

As these examples suggest, technology can be employed to create unique goods and services, turning each transaction into an event. The model is already working in news services, travel, retail, and entertainment. It's coming soon, very soon, to everything else, including insurance (design your own policy without an agent), education (where companies like Digital Knowledge Assets and schools like the University of Phoenix are creating tools for virtual institutions), and even public utilities, as we have just seen.

4.5: Create Communities of Value

For the last several years, we have taken trips organized and hosted by a company called Backroads. Backroads offers what it calls "active travel." Guests are taken to the most beautiful places in the world and put on bicycles, cross-country skis, or their own two feet and given the opportunity to experience these places from a different vantage point than conventional touring allows. Backroads supplies the tents, cooks the food, and follows discreetly behind in comfortable vans, sending energetic young "hosts" along to ensure everything runs smoothly.

The real value of a Backroads experience, however, is the quality of the other guests. We take such trips because we know that the company attracts like-minded individuals and we know we'll make some new friends by the end of the trip. The Backroads brand stands largely for the quality of its network of customers, who pay, in part, for the opportunity to interact with and be entertained by each other.

The success of Backroads, which has grown dramatically to become the leader in active travel, is a Metcalfe magic act. We mention it here to make the point that networks and their distinctly dystrophic economics exist not just in cyberspace. We can hardly think of a more undigital example than Backroads; yet Backroads president Tom Hale has hit on a formula in the physical world that organizations of any size can and should be applying to digital space: creating communities of value by valuing community.

This principle applies with even greater force in cyberspace, since cyberspace is ruled by network economics. Brands rise and fall quickly, communities create their own value as they grow, and low entry and exit costs change many of the rules of competition, disaggregating and reaggregating long-standing industry models. The real power of the new channel is that its architecture allows for high-bandwidth information exchange between merchants and their customers. Even more important, the channel enables powerful communications between the customers themselves. This N-way interaction, and the value it creates, is what makes electronic commerce a true killer app.

Exploiting the power of communities in cyberspace can be liberating for the company as well as the customer. Mobil Oil built a Web site that attracts visitors interested in Mobil's involvement in Formula One racing. The site cleverly channels its visitors to information about environmental issues important to Mobil. After reading Mobil's side of the story, you're invited to E-mail your elected representatives (which Mobil easily determines based on your zip code) and tell them what you think. If you don't object, Mobil keeps a copy for themselves.

A Web site that appears to be about car racing turns out to be a bold effort to cultivate grassroots political support. Mobil could further enhance the site to allow like-minded visitors to share their views with each other, perhaps in a moderated network discussion hosted by a famous Formula One driver. On-line "cafés" of this sort are already highly evolved on both the World Wide Web (powered by free bulletin board and messaging software from companies like ICQ and The Palace) and on-line services like CompuServe and AOL. The trick will be to direct the tremendous energy being unleashed.

4.5.1: On-Line Services Enable, but Do Not Create, Communities

On-line services and others on the Web have already learned that in building digital community centers, the closer you can get to activities about which the community feels passionate, the greater the potential value you can capture. The computer gaming community has forced its way onto the Internet, building communities even as the technologies they need are being developed. Enthusiasts who have conquered the different levels of the games themselves look to competitive play with others to extend the fun. Game companies are rapidly developing multiuser versions of their programs that can be played by ad hoc collections of players in cyberspace. Meanwhile the gamers are using all the chat and discussion software the Internet has to offer to reduce the transaction costs of finding each other.

Millions of dollars of venture capital are being spent on new businesses that will furnish the environments to connect games and players and serve as independent sources of statistics, rankings, and other information. Winning companies will be those that create the most appealing places to visit, riding the Metcalfe wave in what some analysts project will be a $1 billion market by the year 2002.

The real value in a digital community comes from its participants. Starwave, a start-up company founded by Microsoft cofounder Paul Allen (Disney acquired a significant stake in the company in 1997), built the most successful example of a community of value, the subscription-based ESPN SportsZone service. SportsZone, which leverages the brand value of the all-sports cable TV giant ESPN, is the sports lover's heaven, a virtual locker room attracting millions of visitors a day. In addition to up-to-the-minute sports information, play-by-plays of games in progress, and discussion forums that give Monday morning quarterbacks a high bandwidth channel for self-expression, SportsZone also manages fantasy leagues in which players can draft teams and play against others based on the changing statistics of the real-life players. The more people who sign up for SportsZone, the more additional people who sign up-as pure an example of Metcalfe's Law as we've seen so far.

Even more powerful than the competitive spirit motivating gamers and sports fanatics are matters of the heart. Richard Posner wrote in his provocative economic analysis of human relations, Sex and Reason, that modern urban life has dramatically increased the transaction costs for finding suitable spouses, friends, and sexual partners. Walk into any singles bar and you'll see why. The darkness, noise, and altered mental state of the patrons increase, rather than reduce, search and information costs.

Cyberspace provides an alternative. While imperfect, it is still an enormous improvement. Though consultants John Hagel and Arthur Armstrong write extensively about on-line services like America Online (AOL) in Net Gain, their study of virtual communities, they overlook its most valuable feature: the chat rooms, bulletin boards, and "instant message" dialogues. These features enable real-time communication between members of a fast-growing subscriber base, creating the environment for communities of friends and lovers to form with dramatically reduced transaction costs. (It's true that AOL advertises itself largely on the basis of its content, but most of that is available in better form for free on the World Wide Web. Few AOL subscribers we know go anywhere near these areas.)

AOL builds these communities of value simply by attracting as many users as possible. Members are given the tools they need to find and communicate with each other in what AOL calls its "People Connection" service. There, members create their own "rooms" based on personal interests, including location, sexual preference, or even frivolous topics. Other AOL members can access the room and participate in private or room-wide discussions, or create private rooms just for their friends. The system maintains "Buddy Lists" that tell members when their friends sign on and off and where they are, a feature AOL recently extended to users of the entire Internet.

AOL provides a safe context in which users meet, the technology to interact, and, most of all, the membership itself. The communities form, operate, and disband entirely on their own. The popularity of this service—there are hundreds of rooms open all day and night—prefigures dramatic changes even in industries only peripherally involved in human relations (like clothing, entertainment, and alcoholic beverages) as well as patterns in future demographics (such as location).

Compare "People Connection" with Digital City, a service AOL runs in over 20 cities together with local information providers like newspapers, available both within AOL and on the Web. Digital City is an explicit attempt to build digital community centers for urban populations, giving its users one-stop shopping for information about neighborhoods, restaurants, housing, events, and classified ads.

Digital City fails, however, to follow the very rule that has made AOL successful. Content is provided by publishers of newspapers like the Chicago Tribune, and these partners bring an information "broadcast" approach to a medium where broadcast is not only unnecessary but an insult. Digital City Chicago, for example, provides restaurant and movie reviews written by the Tribune's staff critics as well as information about housing and neighborhoods provided exclusively by sellers and landlords. There is, remarkably, no way for users to post their own reviews or otherwise share their expertise about the community, and there is no mechanism for using Digital City to find and exchange information with anyone other than these "official" sources. The design reflects a profound misunderstanding by the media companies about the power of the new media, a further example of the tremendous confusion information businesses are experiencing at the hands of the killer apps.

4.5.2: Communities and Brands

The value of AOL is the value of the network, not the content. The monthly charge is a fee for access to that network. Keeping that fee low brings in more members, increasing the value of the product, which AOL can leverage by selling other goods, services, or advertising. Recognizing this balance, AOL switched from hourly billing to a monthly fee for unlimited access, only to discover that it had vastly underestimated the appeal of its own product. Users spent more time on-line, which encouraged other users to want to do the same, and the company's network infrastructure (the private one, not the Internet, as many newspapers reported) was overwhelmed—a Metcalfe misjudgment. Members suddenly found themselves waiting an hour or more just to get connected.

The ensuing rage of customers spread to other communities, including a forum created by the New York Times at its Web site, and even caught the attention of state attorneys-general, most of whom probably didn't even know what an on-line service was. A similar revolt occurred later when AOL considered leasing the phone numbers of its members to merchants, despite having promised not to do so. CEO Steve Case received so much E-mail that within twenty-four hours he changed course and announced that the phone lists would not be released after all.

AOL is not a stupid or an evil company. As a pioneer in the development of communities of value, it is likely to continue bumping into the Law of Disruption when it makes missteps like these. (Wall Street seems to understand this—during the period when these disasters occurred, AOL's stock climbed from $22 to $70 a share.) The rest of us will learn these lessons, too. As digital technology pursues its Metcalfe invasion of the home and the global computing network becomes a part of day-to-day life, the transaction costs of community organizing are plummeting. For customers, the power to interact is also the power to band together and express collective will on businesses of all kinds, something most companies rarely needed to worry about in the predigital past. In AOL's case, customers were actually provided with the tools that were used to put pressure on the company.

The more general point is that communities of value play a powerful role in developing and managing brand. Brands, as we've said, serve as the shorthand for a company's qualities. On the one hand, digital technology makes it possible to communicate brand to a growing number of constituencies (not only customers but suppliers, shareholders, regulators, and other business partners) at a rapidly decreasing cost. The same technology creates a corresponding risk that deviations from those qualities can also be communicated, quickly and effectively, by customers and competitors (consider the "Untied Airlines" site, which is a rich information source on examples of poor service from United). Consumers long shielded from negative "advertising" may overvalue its importance when it suddenly starts to flow, as airlines learn whenever there is an accident. Good news travels fast, but bad news travels even faster. As Mark Twain once said, "A lie travels halfway around the world while the truth is still putting its shoes on."

Customers who aren't given an official forum in which to express their feelings about branded goods and services may take advantage of Moore's Law and Metcalfe's Law to create their own, with unexpected consequences. Executives at a well-known maker of an international brand of beer asked recently whether it was time to establish a presence in cyberspace. We did a simple search of the Web and discovered that there were already thousands of homepages carrying information about their product, most of them from enthusiastic consumers. Many of them identified themselves as the product's "official" homepage, and several were offering free audio and video clips from the company's advertising—even screen savers based on the company's commercials.

Such displays of product devotion are the dream of every marketer and the point of advertising and promotions in the first place. For our client, however, their ignorance of an intense unofficial ad campaign already taking place on the Internet had the makings of a nightmare. Even if the company wanted to enforce its legal rights to control the use of its brand and intellectual property (the screen savers unquestionably violated copyrights), doing so had become impossible. There were too many customers to stop. Imagine, as well, the response to a lawsuit against a customer who was proclaiming to the world that your product was a defining element of his life. The better solution would have been to start by asking not whether they should have presence but how best to channel it. And to have asked the question before customers took matters into their own hands.

Brand management in cyberspace requires real engagement with customers. You need to ensure that their good experiences become bits that enhance the value of your information assets; you also need to provide a moderated forum to air their bad experiences. Even complaints can become valuable bits. Answering questions or complaints quickly can cement a lifelong relationship with a customer, but responding slowly, inappropriately, or not at all can be extremely damaging to the organization's brands. Worse, it may encourage or even empower customers to find other avenues. Experience so far suggests that this feature of the new business environment is poorly understood. Many organizations confess to being overwhelmed by the level and volume of communication they receive via E-mail, much of which they invite on their homepages.

4.5.3: Business-to-Business Communities

You don't have to sell sports or sex to build valuable communities. Though the stories of SportsZone and AOL are dramatic, most organizations start their community-building activities around more traditional activities, like relationships between buyers and suppliers. These relationships, after all, are limited by transaction costs that make it difficult for business partners to find each other and to share information. Organizations in many industries are experimenting with digital technology to increase the size and scale of their business-to-business networks, finding along the way that doing so not only reduces costs but creates new value.

One of our clients, for example, is a large developer and manager of residential real estate that owns several hundred thousand units of housing. To help it coordinate the assignment of repair work to various craftsmen, the company built a computer system, which it operated over a proprietary data network, that made the repair data electronically available to approved contractors. The text-only system allowed the company to send work orders directly to craftsmen without the need for paperwork, saving time and money.

The company now wants to take advantage of the decreasing cost and improved network possibilities of using the Internet. Compared with their private network, the Internet is open and easily scalable, and using it would allow them to connect to many more service providers at a lower operating cost. The Internet already offers a richer set of interface-building tools than the old system, and promises, through its open standards, the future possibility of videoconferencing and direct access to the devices, such as major appliances, in the rented homes.

The company is building an Internet-based network to replace the private system and in the process has completely changed its understanding of what such an application can do. They now see that their business-to-business connections can be easily changed and expanded, allowing them to add in and switch out not only contractors but also suppliers of building materials, the tenants themselves, and other stakeholders, including banks, local governments, and construction companies.

The new network will allow our client to provide many new and enhanced services. In addition to giving suppliers, craftsmen, the company, and its tenants a common area in which to transact business, the company can consolidate materials orders from the craftsmen, obtain discounts from suppliers, and provide short-term financing for materials. In exchange for guaranteeing volume for the craftsmen, the company can obtain better rates and improve overall quality. Once the company has used the network to remake itself into a service provider, it might even scale up further by offering its expertise to other property management companies.

4.6: Summary

The new economics of cyberspace dramatically alter the ways in which organizations interact with customers, suppliers, and markets, presenting the potential for a wide range of killer apps to be created and used to manage these new relationships. We have presented four design principles for shaping this new environment. Many of them might seem counterintuitive or worse. In the context of the new forces, however, each of these rules makes good business sense. In cyberspace, customers want to do our work for us, cannibalizing markets is necessary to our survival, customizing every product for every customer is possible and inexpensive, and enhancing communities rather than markets will create the best opportunities to extract new margin.

These strategies have already been tested in a variety of industries, often with great success. Companies like FedEx, Firefly, AOL, and even public utilities are creating new competitive landscapes using today's most interesting digital technologies.