Mind Your Value Chain or Else!

Amazon.com is today famous for their relentless re-investment into their operations in the early 2000s, amidst a backdrop of dot-com ruin and with their shareholders demanding distributions.  At some level it is obvious what they were up to – they wanted to seize the opportunity to become the biggest and the baddest e-retailer on the planet.  They were early in the game and wanted to take the opportunity before it past.  And the down market further increased the opportunity they were given, by keeping the competition at bay.

But there is a deeper explanation at work, which can be instructive to other tech entrepreneurs.  If you are truly a technologist then there is a good chance that you have not been exposed a core business concept, the value chain.

Created in 1979 by Michael Porter at the Harvard Business School, the idea is basically that there are multiple layers of your business that go into creating a the entire customer experience, and each layer the product passes through, adds value.  For example, those sourcing connections and preferred pricing structures are worth something, but so are the IT system that enable quick fulfillment and the premium customer support that you provide compared to your competition.  Each of these layers augments the value of the final product to your customer.

What Amazon.com was doing, was taking the opportunity to master its value chain before anyone else did.  They were perfecting their supply chain, the shopping experience and upsell/recommendations engine, and defining an industry-leading returns and customer support process.   The end result was that they had a World class operation which stood for trust and reliability and helped prospects to overcome the fear of entering their credit card number online, before anyone else.

This earned them serious brand value which again feeds back into the value proposition (trust value feedback loop).  This then gave them a serious secondary benefit of being a mega player in retail that could negotiate cheaper sourcing than just about anyone else than Walmart, thus giving them the ability to offer lower prices as well.

And now that Amazon has all of these things, how does one compete with them?  Well, you don’t.  The barriers to entry for creating the infrastructure they now have would be nearly impossible to overcome.  The brand value and sourcing advantages make it nearly impossible for someone to compete head on with them as a volume supplier.    Those are massively defensible positions, and so their future is well known and secure now.  Well played Jeff Bezos.

And what about those who did not make these investments at that critical time?  The products they sell are simply worth less to the end consumer.  Chances are, if they compete directly with Amazon, they’re earning less now which means something else has to give, either infrastructure, return policies, support, or something else. As a result their value diminished over time and will continue to do so, until they are completely marginalized.

This brings me to yet another core concept most tech startups probably aren’t intimately   familiar with – the Law of Marginal Cost !  This is a big one, particularly when dealing with technology.  Over time, the value of a product will become worth only the amount that it cost to product an additional unit of that product.  So after all that money you spent to develop the software, what is the cost to sell one additional subscription?  Its basically just your marketing cost.  According to this law,the market value of your product will inevitably fall to the equivalent of that marketing cost.

Your products and even your business are inevitably headed toward commoditization unless you re-invest in them so that the user is provided additional value when they buy from you.  If you have not re-invested by the time your product are commoditized, then you yourself have become a commodity.  The only way to overcome this, is the focus on the value you provide around that commodity. And yes, it is possible to do after the fact.   Consider that Zappos did this well with their ridiculous customer support.  Starbucks did this with coffee and Pinkberry with yogurt.   Yes, they are an example of what can be done later to overcome commoditization, but then, consider how much easier and more probably their success would have been, had they done it early in the curve as Amazon did. I guess my point here is that Amazon was given an absolutely golden opportunity and to his credit, Jeff Bezos recognized that and seized upon it, while others were more focused on short term profits, at a much higher long term cost.

Bottom line, you need to mind your value chain or you are not investing in your brand and you will be a mere commodity once the temporal winds that are blowing against your back have passed. This is the key difference between direct marketers and brand builders. If your goal is to make a lot of money fast and get out, then sure, no need to consider value chain.  In that case you’re not building a business, you are speculating.  If however, you want to build a brand for the long run, hopefully you now see just how critical it is to take the momentum that you have and use it to transcend temporary market conditions in order to become a proactive market leader, while you still have a chance.  It is not a question of whether you want to lead or follow. Rather, do you want to be huge or nonexistent 10 years from now.

Neal Cabage

Technologist living in Los Angeles, California.