‘Leeching’ and the Strategy of Compatibility
From ‘low-end’ disruption to ‘inside-out’ disruption
Much has been made of Microsoft’s transition to a primarily horizontal business model under the leadership of Satya Nadella. Although the company still operates a vertical model with the existence of the Surface devices division, the core of Microsoft’s strategy rests in the vast distribution of its services – Windows, Azure, Dynamics, and Office, among others.
As we know, a horizontal model hinges on compatibility: services becomes more valuable due to network effects when they are available in more places and on more platforms. The ‘coming out’ of Microsoft’s services focus was the decision to offer Office on iOS, putting the stops to Ballmer’s flawed strategy of leveraging Office as a differentiator to sell both Lumia, and the Windows Phone platform.
It’s easy, particularly in retrospect, to recognise the clear flaws in Steve Ballmer’s Microsoft – namely, that the co-existence of a vertical and a horizontal business model is in theory, impossible. One cannot aim to differentiate (vertical) and be ubiquitous (horizontal) at the same time (clear exceptions being monopoly or near-monopoly markets). However, anyone could be forgiven for attempting to replicate Apple’s wildly successful vertically integrated business model. The remarkable success of Apple’s shielded ecosystem which began with the iPod and iTunes Music Store in 2001, has become something of a blueprint for success: control the platforms, encourage developers and content suppliers to fuel the platform, and let network effects do the rest of the work. It is a strategy that built iPhone, the most successful product ever made.
Importantly, controlling platforms remains the first and foundational basis of Apple’s vertical strategy, explaining why Steve Ballmer was happy for Microsoft to compromise the ubiquity of its service layer temporarily as leverage to control the platforms first. Obviously, Microsoft didn’t succeed, Windows Phone is but a flash in the pan in the mobile landscape dominated by Apple and Google. Despite this, I’m not convinced the fundamental logic of Ballmer’s strategy was naturally flawed. What is certainly true though is that Microsoft overestimated the leverage that its services such as Xbox and Office had, particularly on mobile where the value propositions of both services was (is) significantly compromised.
The failure of Steve Ballmer’s Microsoft paved the way for Nadella’s Microsoft: where services rule, and devices are niche. Interestingly, free from the tiresome pursuit of controlling platform ecosystems, Microsoft’s service-focussed horizontal strategy has brought to light an interesting form of competitive strategy, something I call ‘leeching’.
A leech, in computing jargon, is any entity that benefits from the information or efforts of others, whilst offering nothing in return. Multi-platform services – such as social media – are leeches by this definition, as they exploit device platforms as a means of delivering services to customers, but as a result of their universal compatibility, offer nothing to enhance the defensibility of the individual platforms they utilise.
To explain it very succinctly, leeching reveals the possibility that services of any kind can leverage or exploit the existence of platforms and platform-dependent devices as a means of eventually developing their own defensible ecosystems. In essence, a disruption isn’t occurring from the ‘low-end’, whereby an ‘inferior’ competitor displaces an over-serving incumbent, but from within, where a service hosted by a platform may in fact grow to compete in some ways with the initial host platform. In this sense, to utilise the parlance of disruption theory, its something that might be called ‘inside-out’ disruption.
Leechers exercise unique capabilities derived from their multi-platform strategies to compete against the firms they initially exploited. For example, Snapchat which uses mobile operating systems to deliver its services, is now positioning itself as a competitor against digital imaging devices and native smartphone cameras by introducing features such as a permanent camera roll and hardware products like Snapchat Spectacles.
In this analysis, a platform can be any sort of entity in which another component in the product stack is reliant on; a platform can therefore include hardware. Hardware sits at the bottom of the stack as the most foundational element; operating systems, applications and ‘soft’ components such as cloud, sit atop the stack. Hardware is the platform for operating systems, and operating systems are platforms for apps, and apps can be platforms for various specific things such as social networking, or multi-media production and consumption.
Consider the diagram below of the technology platform stack for the mobile devices industry.
Below excerpt from my story: WeChat and the Mini Program
On top of the hardware are operating systems; here Android powers the hardware of many smartphones from a variety of different companies such as Samsung, Sony, LG, and Google’s own to name a few. In this case, Android leeches off the hardware products which have been reduced to commodities due to their lack of differentiation on the user experience layer. Resting on top of the operating systems are first party apps. This is particularly relevant to the iOS ecosystem given that most of Google’s services — Gmail, Maps, Photos, Search etc. — are available cross-platform. Here, Apple uses its own first-party applications such as iMessage, iCloud, and Photos to differentiate and increase switching costs to users heavily invested in Apple’s ecosystem.
Above the first party app layer however, is where it gets most interesting.
Cross-platform applications such as Facebook and WeChat sit on top of operating systems and thus replace a lot of functionality that is otherwise fragmented at lower levels of the stack. For example, messaging applications such as Facebook Messenger and Facebook-owned WhatsApp have largely superseded first-party alternatives such as iMessage. In addition photo-sharing and social media functions have also largely moved upstream into the application layer, think Google Photos and Facebook albums. Considering network effects, this should be no surprise at all. But it’s important to recognise that Facebook and WeChat are not just apps, but are platforms in their own right, as they host a bevy of applications and utilities.
Facebook the platform is merely a framework, consisting of profiles, the news feed, and identities, all of which facilitate the platform’s utilities. On top of this platform, are the things Facebook actually does: facilitate messaging, online mini games, B2C communication, photo sharing, news aggregation, and many other things. Facebook, to some degree, is starting to sound a lot like an operating system. After all, an operating system is only as good as the applications that can be used on it.
Understanding vertical and horizontal business models
It’s important to recognise the shortcomings of the vertical business model. The main advantage of the vertical business model is clear: it allows the firm to capture most if not all of the value within the vertical chain – for Apple, the company captures the value generated from ownership of the platform (iOS, MacOS etc), and the physical devices (iPhone, iPad, Mac). Horizontal businesses on the other hand only capture value from a specific segment of the value chain, granted they usually do it on great scale. Nonetheless, three key disadvantages of vertical businesses are as follows:
- Vertical businesses are strategically inflexible. This is the case because vertical firms are often so focussed on defending their ecosystems that they ignore competitors who may respond via indirect or flanking strategies. Large and dominant vertical businesses can become immobile and easy to disrupt.
- Vertical businesses are zero-sum competitive. Vertical businesses by nature are engaged in battles to gain market share at the expense of competitors. Multi-platform horizontal businesses on the other hand leverage incumbent platforms, and therefore grow with the market.
- Vertical businesses are difficult to defend. Lastly, by virtue of the zero-sum nature of competition, vertical businesses often struggle to maintain market share. IOS for example, has seen its share fall significantly due to the increased popularity of Android.
Evidently, as powerful as owning ecosystems is, they are distractions just as much as they are blessings. By virtue of their compatibility, horizontal services ride the successes of the platforms that host them. An increase in aggregate device usage, regardless of platform – whether it be Android, iOS, or Windows – is a boon for any horizontal multi-platform app such as Facebook, Snapchat, Office, or Gmail. I’ll briefly examine Facebook, Snapchat, and Microsoft to illustrate how a leeching strategy applies to these horizontal service providers.
Four years ago, I wrote a story on BetaNews in response to news of Facebook considering building its own smartphone. Although the physical device never actually manifested, Facebook at the time had planted the seeds to exploit its own leeching strategy: culminating in Facebook Home, and notably, Facebook Messenger. Facebook Home was a (now defunct) project that enabled users of certain Android handsets to ‘Facebook-ify’ their phones, turning their lock screens into stylised versions of their personal news feeds, and Messenger into the primary messaging application. The aim of the product was to utilise Facebook’s clout to re-appropriate fundamental features of host platforms. Although the entirety of the ambitious Facebook Home project never caught on, Messenger has lived on to become a flag bearer of Facebook’s leeching strategy. Facebook Messenger, by virtue of its vast multi-platform compatibility is, through network effects, one of the most heavily used messaging platforms in the world. As such, Messenger along with other horizontal messaging services, disrupt native messaging applications such as Apple’s iMessage, competing with and displacing this core feature of the host platform.
Snapchat
MG Siegler wrote an interesting story a few months ago about Snapchat Memories and the smartphone camera. The story’s title: ‘Displacing the Camera that Displaced the Camera’, was an apt metaphor for the leeching phenomenon. Essentially, Snapchat Memories is a new feature that allows users to capture and store permanent photos within albums in Snapchat. Memories act like normal photos in the sense that they don’t self-destruct. Snapchat is now positioned as a competitor to the native camera and camera roll on vertical platforms. With the introduction of Memories, Snapchat’s ‘sticky’ social functionality acts as the application’s pull factor, however its multi-platform compatibility poses a legitimate threat to native camera applications as it allows access to albums through the cloud on any device and not just platform specific devices. Apple’s iCloud Photo Stream is unsurprisingly only available on Apple devices.
Microsoft
Microsoft is probably a strange example to place here, particularly following both Facebook and Snapchat. Despite this, many of its services such as Cortana and Office, which recently have been blessed with multi-platform compatibility are now equipped with the requirements to adopt a leeching strategy. Cortana and Office can disrupt, from the inside-out, platform native digital assistants and productivity applications respectively via the same methods ascribed by Facebook and Snapchat. The strategy blueprint is certainly there, whether or not the company can pull it off is another matter. For example, the success of Cortana hinges on it being better than Google’s horizontal assistant Google Now, which appears to be a tall order.
Leeching Strategy Requirements
What these three examples serve to highlight is that a leeching strategy is essentially subject to three fundamental requirements:
- The prosper of multiple platforms. This is the most foundational qualifier. Horizontal service providers can only adopt leeching strategies if a singular host platform does not hold monopoly or near-monopoly market share. If host platforms do hold exceedingly large market share, native services will in practice have the effect of horizontal services due to their ubiquity. Multiple platforms must exist and be significant in the market. For this reason, Google’s masterful utilisation of Android has acted as a defensive mechanism to support the company’s services layer — Search, Gmail, Maps, Docs etc. — against the dominance of iOS. Android itself is not a core Google product, but rather a decoy. Thus, the verticality of Android does not conflict against the horizontal nature of Google’s services.
- Multi-platform compatibility. As a result of the prosper of multiple platforms, horizontal services must by definition work on all dominant platforms in the market. Therefore, horizontal services have the theoretical possibility of gaining 100% market share which places it at an advantage over the native services on vertical host platforms. As described earlier, the zero-sum competitive limitation immediately precludes vertical services from gaining dominant market share (provided the prosper of multiple platforms holds true). Thus, the leeching strategy is generally unavailable to vertical platform controllers.
- Product relatedness. Finally, this requirement allows leechers to actually exploit and surpass the vertical platforms they are hosted by. Product relatedness refers to whether a leecher’s service is able to replace a service that is native on a platform. This qualifier therefore excludes unimportant non-core services (utilities like calculators and clocks) which gain no necessary benefits through the application of network effects.
I started this story talking about Microsoft, but what’s important is leeching is applicable to almost any kind of cross-platform horizontal service. Different services however have varying levels of desirability, for example messaging services likely represent significantly higher value potential for a leecher than aggregating reminders or to-do lists. This type of inside-out disruption doesn’t necessarily spell doom for vertical businesses, it simply reduces the incentives of vertical businesses to insulate their services as a means of maintaining differential advantage. In fact, being disrupted in such a manner may in fact compel a vertical business to expand the scope of its native services. For example, Spotify’s success has necessarily forced Apple Music to become a multi-platform service. A horizontal strategy if executed correctly, refutes the consensus that owning platforms is the greatest pathway to success.
