Technology & Competition in Voice Disintermediation

While Clayton Christensen is best known for his 1997 book, The Innovator's Dilemma, I've also enjoyed his subsequent observations on value chains, modularity and vertical integration.  A common basis for both his original thesis and many of his subsequent observations is what happens as technological progress outstrips customer demands.

Early in a product's life cycle, technology needs to be optimized to have any prayer of delivering acceptable performance.  At this stage a vertically integrated organization is ideal, as it can manage the entire value chain and deliver the needed optimizations.  This was case in telephony from it's 19th century origins to the 1960s.  But eventually technology performance gets ahead of what's needed.  To quote from the abstract of a November 2001 article by Christensen, Raynor and Verlinden, Skate to Where the Money Will Be:

... as the underlying technology improves to meet the needs of most customers, companies begin to compete on the basis of convenience, customization, price, and flexibility. At that point, vertical integration is no longer an advantage – in fact, it quickly becomes a disadvantage. Different links in the industry value chain become modular, and the chain subsequently fragments.

We saw this in telephony in the 1970s as modular subsystems became available – PBXs, microwave radios systems (the "M" in MCI) and mini-computers – each in turn benefiting from integrated circuit technology.  At every stage,

profitability goes to the companies that own the interdependent links in the value chain--the places where everyone's still vying to satisfy their customers with ever-better product functionality.

That's key.  Standardized modular components, serving multiple verticals, like memory chips, disk drives or computer servers, become commodities.  They can be profitable for companies that focus on process and operations, like Dell.  But the high margins are reserved for areas in the value chain where technology still has to be tweaked.

Of course, Christensen is writing about products in relatively free markets and just assumes there is competition.  In telephony, that's an unwarranted assumption!  Indeed, productivity gains in telephony lagged those of the IT/computer industry by decades.  But there have been a few breakthroughs.

With the breakup of the Bell System in 1983, we entered a period of long distance competition where the service caught up with what technology had already enabled – the death of distance.  Of course this also resulted in the demise of the long distance companies, as the capital investment to duplicate their networks was a small fraction of their sunk costs and the operating cost (of a new network) likewise a small fraction of theirs.

While there was no direct competition in local phone service until the recent advent of cable telephony and consumer VoIP, substitution of (competitive) mobile-only service has been a US trend since 2000.

Now VoIP is poised to do for voice telephony what long distance competition did for distance – kill it, at least as we've understood fixed voice telephony for the past 100+ years.  There will still be a PSTN interconnect business, but if both ends have broadband, the operating costs to connect VoIP phone to VoIP phone are near zero.  Today Skype has set the price point.  Monopoly (or duopoly) broadband providers may be able to sell bundles, but Vonage and other pure VoIP providers will be hard pressed to maintain a business in traditional telephony.

Christensen's model applies to many other areas, for example, layer violations in wireless protocols.  I will discuss the his model and the wireless industry in a subsequent post.

Comments

[Aswath]

How do you say that Skype has set the point of zero cost of VoIP phone to VoIP phone calls? Haven't FWD and SIPPhone and many others done that much earlier?

[brough]

Aswath, Yes, my choice of Skype was a bit arbitrary. VocalTec's Internet Phone software provided VoIP to VoIP calling in 1995 and I've certainly used both FWD and SIPPhone more recently (although not in the past 12 months).

However, Skype has dramatically higher name recognition and higher usage (eBay claims 7% of all international voice traffic) compared to any prior VoIP service.
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