Saturday, April 25, 2015

"Experience" as a Differentiator: Economic Musings of a Novice

“One of history’s few iron laws is that luxuries tend to become necessities and to spawn new obligations. Once people get used to a certain luxury, they take it for granted. Then they begin to count on it. Finally they reach a point where they can’t live without it. Over the past few decades, we have invented countless time saving machines that are supposed to make life more relaxed - washing machines, vacuum cleaners, dishwashers, telephones, mobile phones, computers, email. We thought we were saving time; instead we revved up the treadmill of life to ten times its former speed and made our days more anxious and agitated.”
Yuval Noah Harari. Sapiens: A Brief History of Humankind.

“He attacked everything in life with a mixture of extraordinary genius and naive incompetence and it was often difficult to tell which was which.”
Douglas Adams. Hitchhiker’s Guide to the Galaxy.

“I mean I don't really know what you're talking about. I mean I know what you're talking about, but I don't really know what you're talking about.”
Wallace Shawn. My Dinner with Andre.
These observations are probably obvious to an economist. I'm not an economist (and I don't even play one on TV). Please excuse the naivete.

I believe we are at an inflection point in the history of computing. We have commoditized computing to the point that it has become ubiquitous. That means we need to look for a different kind of differentiator than just TCO (Total Cost of Ownership). Thanks to commoditization, many items that were once considered luxuries have become “cheap enough”. We need to find something else to get customers excited; that something is often a better experience.

This pattern is not unique to computing. If I were to plot the history of many industries as a graph, it would be an inverted bell curve starting as expensive and niche initially, becoming cheap and abundant over time. Once this happens, margins erode and industry leaders look to offering a “better experience” at a higher cost, thus resulting in the inverted bell curve.

Computing and the web have literally changed every aspect of our lives over the past twenty years, making our lives dramatically easier, richer, and more connected. Each of us has unlimited computing capacity at our fingertips. Look around you and I bet you’ll find dozens of "computers” around you: your phone, your iPad, your MP3 player, your laptop, the microwave oven, your DVR, the GPS in your car, not to mention the computer that controls the brakes and the other one that controls the radio or the one that controls the parking sensors. Even your home thermostat has a tiny processor and a primitive user interface. Not only that, but all of these devices are increasingly connected to the web, offering a new streamlined experience for everything from photography to mail to travel reservation to banking to social interactions to business transactions.

The world is becoming increasingly digitized and available to the masses - regardless of whether you are sitting at an Internet cafe in Botswana or typing away on your iPad at 30,000 feet. At this rate, even your toothbrush will soon have an IP address and a WiFi connection to the internet so your dentist can keep tabs on your brushing and commend or chastise you during your next visit - dentistry as a service through the cloud. The “Internet of Things” will be upon us sooner than most people realize. I would argue it is already here.

Now that processing power has become ubiquitous, we need some other differentiator to keep technology fueled industries growing. I claim that differentiator is "experience", in its broadest sense. Steve Jobs so brilliantly realized this - as simplicity, as usability, as "luxury", as natural interfaces like touch and speech - that he basically took over several industries in a few short years - not just laptops but also phones, music, and movies.

There is a second force at play here. In 2010, a record breaking ten million people around the world were millionaires. Compare that number to about three thousand millionaires a century ago.  As the world gets richer by the year, more and more people have disposable income that they are willing to spend on a little bit of luxury. You might argue that a million dollars today is not worth a fraction of a million dollars in 1900, but I hope you agree that the majority of the world population has a much better standard of living fueled by technology and commoditization.

I've used computing to illustrate my point but the same rules apply to many other industries: You can commoditize only so far and then you have to differentiate by offering a better experience in order to win:
  • Airline travel was insanely expensive for many decades, then it became so ridiculously cheap that airlines are now making money by catering to the rich, "the one percent", with ever more glamorous business and first class offerings. We (or our corporations in many cases) don't mind paying a little more for a better experience.
  • Light bulbs were once a rarity, then they became so cheap that the Earth now shines when viewed from outer space. So now that you can get a light bulb for ten cents, we don't mind splurging for the luxury of halogen lamps with $30 bulbs.
  • Cars were once viewed as a luxury, but are now so cheap that we can afford to splurge on luxuries like $2000 Bi-Xenon headlamps or seats that give us a massage.
  • Computing was once outrageously expensive. Microsoft and Intel made it so cheap that you can buy a laptop for $299. But now we've turned the corner and many people choose to pay $1499 for a MacBook Air that offers a better experience.
  • Headphones used to be a luxury, then they became so cheap that you get one for free every time you fly. Suddenly, high end headphones are a fad and we’re willing to pay $400 for a pair of headphones.
  • Internet access was once upon a time slow, unreliable, and expensive. It is now so cheap and ubiquitous that we are willing to pay more for higher bandwidth rates and Fiber and LTE: basically a better "experience".
  • Refrigeration was once so expensive that only the rich had refrigerators a century ago. Then, through technology and commoditization, it became so cheap that anyone could buy one for $200. Suddenly, now we are paying $5000 for a top of the line Sub-Zero.
  • Televisions were once a luxury. It was only forty years ago that most of the world had to huddle together as a family or village to watch Ali defeat Frazer. Ten years ago, TV’s were so commoditized that even a top of the line one was no more than a few hundred dollars. Today, we have hit the knee of the curve and are on the upswing. Now we pay $2000 for 3D 70-inch super ultra-thin luxury plasma TVs and expect to have one in every room.
  • Photography was once an exclusive and expensive hobby for the rich. Today, cameras are so cheap and abundant that you have not just one, but two, in your smart phone and you can get a $5 disposable one at the neighborhood pharmacy. Suddenly, digital SLR’s costing $1000+ are a fad - because they offer superior quality.
  • Nespresso sells their espresso capsules, containing roughly five grams of coffee, for about 75 cents. That means you get to pay $75 for one pound of coffee! Of course, those capsules are useless to you unless you also buy their espresso maker for roughly $400. Compare that to the prices we used to pay for a pound of top notch coffee ($15) or a coffee maker ($30) just a few years ago. And you thought the coffee industry had been commoditized decades ago.
  • Restoration Hardware vs. IKEA.
  • Whole Foods vs. Safeway.
  • Starbucks vs. Dunkin' Donuts.
  • Tesla vs. Toyota.
  • iOS vs. Windows.
  • Robert Mondavi (or your favorite winery) vs. Two Buck Chuck.

Enough said.

Note that there is more to this than "quality". Toyota has great quality. So does IKEA.

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