Subject: October 2001 ECMgt.com: The New Face of Marketing
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October 1, 2001 *4,300 subscribers* Volume 3, Issue 10
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Shaping the Future with a Portfolio of Real Options
By Ash Vasudevan
Director, CommerceNet Investment Initiatives

A recent news item titled "Biochips Go Big Time: Microelectronic and communications firms turn to life sciences" reflects a growing trend among companies to invest in markets with uncertain potential and outcomes. In anticipation of a booming $10 billion growth in the biochip business, companies like Corning, Hitachi, and Motorola are attempting to expand into this space by forging alliances and making investments in start-up companies. A further testament to this trend is the proliferation of corporate venture capital in recent times. In 1999 alone, the value funds dedicated to corporate venture capital went up to $6.3 billion dollars.

In other words, underpinning any company's strategy for the future is a bevy of forecasts. A series of, "if A occurs, then B is likely to happen" scenarios are at the heart of their strategic planning cycles. Large subsets of these scenarios are those that involve the decision to invest and expand into markets characterized by uncertain demand and market potential. The problem is further exacerbated when the market is distantly related to the scope and scale of its current activities. Viewed differently, a firm's initial investment in new markets can be envisioned as buying the right to expand into the future.

Consider the following scenario. The CEO of an eBusiness company is faced with a difficult decision. Her company has the opportunity to forge a strategic alliance (technology sharing and investment) with a small high-tech company with considerable expertise in a potentially important emerging technology. The technology's impact on eBusiness is little unclear, but current trends and analyst reports seem to suggest that the future impact is likely to be profound and could offer significant potential for the eBusiness company to move into new markets. However, as with any new technology, its potential and future is uncertain. The decision the CEO faces isnot only whether to invest $5 million in the venture, but also whether to commit her company's non-financial resources (engineers, marketing personnel, etc.) to the alliance. Future investments are also likely to be required. Traditional discounted cash flow analysis often overlooks the intangible aspects of such an investment - namely the range of options this investment would create for the company.

In financial parlance this is an example of a real option. What is an option? It is the right, but not the obligation, to buy (call option) or sell (put option) a specific amount of a given stock, commodity, currency, index, or debt at a specified price (strike price) during a specified period of time. An option is an investment to maximize the chance of successfully responding and minimize the chance of being left stranded in uncertain environments of unfolding trends and changing competitive dynamics. It is about investing now to exercise the right to develop a portfolio of technological and market competencies in the future. Why is it a real option? It is real because it is an investment in operating instead of financial capital and it is an option because it is an investment in the right but not the obligation. Take the case of Intel. Their venture capital group is managing a fund worth $6.3 billion - that includes seed round investment in 60 of the 350 companies in their total portfolio. Most of their investments are focused on Internet infrastructure and Internet content/service space. Consider Intel's real option activity in the P2P (peer-to-peer) space. Aside from investing in companies (Groove Networks, etc.), they are also the founding members of the Peer-to-Peer Working Group2, established to foster the development of standards and protocols for peer-to-peer computing in business environments. So in addition to financial capital, they are dedicating real resources (managerial time, salary, etc.) to the development of a nascent technology.

Why is this critical? It is hard to imagine another time, when being at the forefront of the flow of innovations was such a competitive imperative. A portfolio of options enables a company to create a platform for generating killer applications. "Unleash the killer app", instead of "be unleashed by the killer app", is the mantra that spells the difference between competitive success and market failure. Critical innovation opportunities often involve navigating through the unarticulated and unmet needs of customers. Underpinning the concept of unarticulated and unmet need is an environment characterized by uncertainty. It could be technological uncertainty (Which technology is likely to dominate the market?), demand uncertainty (How and when is consumption likely to change?) and/or competitive uncertainty (From whom and from where is our next competitive threat likely to emerge?). In such environments, firms may find it prudent to invest in options that will increase their chances of securing their current and future competitive positions. A recent article in Red Herring alludes to IBM's changing chip strategy, which now involves a series of investments in start-up companies in exchange for equity3. Or, consider Intel's recent acquisition of VxTel, a voice-over-optical-networks company for $550 million. After an initial investment in VxTel's early round (buying an option), Intel decided to acquire VxTel (exercising the option). This is an example of taking real options. The business press is rife with such examples.

In viewing the current and future competitive landscape from an options perspective, two critical decisions emerge to the forefront. First is the decision to identify the next generation killer applications that are likely to render the current business models obsolete. Are they out there? If so, how quickly and in what sequence will they diffuse and how are they likely to impact us? This would make it a survival imperative for companies to hold options in those technologies that would have a disruptive impact on their competitive success. Second is the timing decision. When is it desirable to exercise the option and what influences the exercise choice?

While in the past, companies would dedicate themselves to unleashing a single killer app, today's intensely competitive environment demands that they unleash more than one killer app to sustain their competitive edge. What are the next killer apps in eBusiness? Are there any innovations threatening to shift the center of gravity of eBusiness? What are the confluences of events or trends that are threatening to unleash new rules of the game and in the process generate new wealth creation models and opportunities? What are the weak signals today that have the potential to dramatically change our experiences of Internet and eCommerce tomorrow?

Wireless Applications
First is wireless. Will mobile Internet outstrip conventional Internet and the business use of Internet as we know and understand it today? In the next two years, it is projected that wireless use of the Internet will grow beyond a billion users worldwide. Companies in this space are betting that more and more computing power and services will be accessed using airwaves through a myriad of wireless devices that link personal computers, hand-held devices and other gadgets to the Internet and to corporate networks, as well as to each other. Expectations are that wireless connections will herald a new era of ubiquitous and pervasive computing. With wireless appliances, the goal is to enable the customer to access information on a 24x7x365 basis without any constraints on location. As we all get intertwined in a mobile-centric world, a new strategy incorporating the wireless applications is likely to unfold, gradually progressing from the periphery to the very core of a firm's competitive effort. We have already seen the early stages of what is to come: new wireless applications are likely to make obsolete such things such as credit cards, traveler's checks, trips to the bank, checkbooks, passports, foreign exchange, remote controls and even cash. IDC estimates the number of wireless subscribers will skyrocket from fewer than a thousand in 1999 to more than 29 million in 2004. Meanwhile, the value of their transactions will go from being too small to count to close to $21 billion during the same time frame. It is their ubiquity (anytime, anywhere, anyhow) that makes the range of wireless communication devices and their potential to conduct transactions (B2B/B2C) with just the push of a few buttons extremely powerful and appealing, and consequently, their diffusion widespread.

While the explosion of wireless applications in B2C space is well documented, wireless in B2B is still a weak signal that needs amplification. There is some activity though. IBM has allocated $300 million of its $500 million commitment to building an intelligent infrastructure including chips, databases, mainframes, servers and protocols, to position itself at the forefront of the data-rich mobile future. In Asia, Korea Telecom, Freetel, Broadvision and 28 other companies have formed a wireless Internet B2B group to develop products for corporate clients. Consider the recent alliance between Siebel and Sprint that has them developing wireless solutions for verticals, including the financial services, high technology and communications industries. In Asia, B2B transactions are expected to be conducted mainly through wireless communications. Other companies are building solutions around Asia's wireless boom. Taking advantage of China's burgeoning wireless infrastructure, MeetChina.com is working with companies like Motorola Inc. and China Wireless Information Network to alert executives to online requests from supply-chain partners via their cell phones. This is the first step toward eventually building real-time electronic marketplaces, involving interactions between overseas buyers and Chinese suppliers. Not to be left behind, i2 Technologies recently formed an alliance with JP systems Inc., a mobile ASP, to offer services such as auction and remote order management services to i2's tradematrix customers.

So the following questions need to be posed: Is your strategy (corporate and business) and business model WAP enabled? Can your ecosytem (suppliers, business partners, customers) access and transact with you and each other more efficiently through wireless networks? How are eBusiness applications going to link seamlessly to the plethora of hand-held, mobile devices? Will wireless transactions mirror their B2B exchange counterparts and migrate from simple to complex business transactions? Will wireless middleware, application servers, EAI (enterprise application integration) technologies, and others migrate and converge onto a common platform? Is your product/service conducive to ubiquitous transaction now? What level of your product (core, actual or augmented) has the greatest opportunity and is most likely to be impacted by wireless applications? What about the future? What wireless applications can be used to transform the customer's perception and usage pattern of your product/service? Can you strengthen your relationship with your stakeholders through wireless applications?

Broadband and Peer-to-Peer Technologies
The second weak signal is the emergence of high-speed, "broadband" networks and applications. One of the primary, and perhaps most important, benefits of the Internet was the potential for it to make information available to those who needed it instantaneously. While the first generation Internet made possible the sharing of simple documents (formatted text and graphics), the future Internet will involve the sharing of all kinds of information ranging from data, voice, audio, and video. We won't just send words, or even still images, to each other. We'll send huge amounts of data, including audio and video. Among other things, broadband will accelerate the move toward "peer-to-peer" uses of the Internet, allowing users to connect to computers over the Internet and share data and digital files. What does it mean?

Webopedia4 defines peer-to-peer architecture as "a type of network in which each workstation has equivalent capabilities and responsibilities. This differs from client/server architectures, in which some computers are dedicated to serving the others. Peer-to-peer networks are generally simpler and less expensive, but they usually do not offer the same performance under heavy loads." Additionally, peer-to-peer goes beyond simply sharing files - it also encompasses the usage of spare processing cycles of idle networked and desktop computers. For some others, it is about taking advantage of idle resources at the edges of the network called Internet. Just like wireless, P2P applications seek to dramatically transform the "connectivity" and "communicability" dimensions of the network.

"Is your business 'Napsterized?'" is the new mantra, having supplanted the old, "Has your business been Amazoned yet?" What is this hoopla all about? Fundamentally, it is about a decentralized architecture (hybrid or pure) that enables a network of clients to share information, and donate unused processing power to run complex, computational - intensive applications. Instead of information being held at one central location, peer-to-peer technologies makes it possible to access information (files, data etc.) residing on every client connected to the network thereby blurring the distinction between client and server. In its purest form, each node in the network is simultaneously the client and the server. Unlike the centralized architecture that is underpinning and driving much of the content, community and commerce in the Web today, P2P has set in process the creation of a decentralized architecture that drives much of the same flow using the Internet. Consider GridTalk, a B2P (business-to-peer) solution that allows vendors and clients to engage in real-time serverless communications by exchanging documents over the Internet in a seamless, secure, and instantaneous manner. Imagine a P2P network that offers real-time information about the availability and price of materials flowing into the manufacturing of a car. Instead of searching a central database that is always delayed by 24-48 hours, users (buyers and sellers) have the option of transacting in real-time. This is exactly what Infrasearch5, a P2P network company, is creating.

Will this eventually lead to the emergence of decentralized marketplaces6? Similar to what is happening in the wireless world, will we see a plethora of P2P middleware adapters linking eBusiness applications and P2P? Can P2P software handle complex business transactions? How will to "peer-to-peer" trading mechanisms affect the volume and quality (interacting with bots) of transactions conducted today? Again, how will eBusiness applications be linked to the peer-to-peer platform? Will they be primarily enterprise-based solutions? While the volume of possible transactions is an obvious benefit7 of peer-to-peer, the quality of transactions is a less-obvious benefit. Consider Kalepa, a P2P start-up that is integrating the file sharing technology of P2P, with the need for companies to access and scale applications over the network on a real-time basis for close enterprise systems. Aside from this, we are also beginning to see P2P applications to facilitate collaborative planning and forecasting, risk sharing and contingency contracting among supply chain partners. Finally, is there a potential for P2P applications to merge with wireless devices? Using Bluetooth technology, Swedish software maker Pocit Labs has created the first file sharing application for mobile devices enabling 54 peers to share files, play games or use wireless software applications8.

Optimizing Your Option Portfolio
So how do you know if you have created the right portfolio of options for the future? How do you know that you are in a position to actively influence the future rather than passively succumb to it? Depending on your industry, product, and position in the value chain, the threat wireless applications or P2P pose to your competitive advantage may range from imminent to weak. All else being equal, the threat is more imminent if your product is 100% information intensive. On the other hand, if your product is a mix of bits and atoms, the threat is weak, yet credible.

Consider the above figure for illustration purposes. If recent trends are to be believed, most of the much-touted B2B commerce is likely to flow through supply chains rather than neutral exchanges. Fundamentally, underpinning any supply chain are flows - a flow of information (sales data, inventory status, production schedule, promotion plans, demand forecasts, shipment schedule, and new product introduction plans), a flow of money, and a flow of materials. At the beginning and end of each flow are buyers and sellers. These flows occur at every node of the chain and often not in a sequential manner as delineated above. Each node also represents a network of transactions, intertwining buyers and sellers in a complex network of value creation. Efficacious management of this flow will enable companies to get products to volume and market faster and more efficiently, while reducing inventories.

Depending on the industry, there could be certain nodes that are more conducive to being enabled by wireless and peer-to-peer applications than others. For instance, all else being equal, you are more likely to demand real time information on sourcing, production, distribution and sales rather than research and design where the life-cycles, by choice, are longer. More specifically it is important to evaluate the node in isolation as well as in conjunction with other nodes to better understand the impact of the innovation on the supply chain. How does it facilitate and dramatically improve the flow between nodes? Does it lead to greater visibility into supply chain processes and consequently enable better and faster collaboration? How does it enable participants to better manage their risk? An innovation at one node could lead to the diffusion of new business models and fundamentally new supply chain architectures through the chain. Viewing the supply chain as an ecosystem of value creation and transactions will better position players within and outside the supply chain to create options, forecast the value of their options and exercise them in a timely, efficient fashion. However, both wireless and P2P applications need to move beyond merely improving the accessibility and flow of communication, and address the challenge of building deeper collaborative relationships that underpin most B2B transactions in the real world.

The greatest rewards go to those companies that can create new business models in the context of changing technological and demographic trends. Often times, risk reduction becomes a competitive imperative in response to uncertainty. An options approach, on the other hand, invokes a new perspective - profiting from uncertainty. It gives you a chance to be at the edge of the future. Doing that requires the right combination of breadth and depth. Innovation today is a competitive imperative. The central question facing firms today is "where will the next generation of wealth-creating opportunities come from? Firms have to invest in a portfolio of options if they desire to emerge unscathed in the intensifying battle of innovations. Options represent the best means of hedging against unintended consequences. If you think about it, investing in the right to expand and acquire is better than having no options at all. For instance, following an initial investment, Cisco has acquired approximately 10% of its portfolio companies. Being bold, taking options, and constantly questioning the assumptions of success is going to be the sine qua non of monitoring new business opportunities and conceiving new product and service ideas to stay ahead of the game. It requires viewing the overall competitive landscape from three perspectives:

  • Broadly, what capabilities are going to be needed for us to profitably meet our customers' needs in the future, especially with the advent of peer-to-peer and wireless applications?
  • What potential future markets (geographic, customer or non-user) will it be important to start learning about so that we have the option to serve them in the future?
  • Which customers (or partners) can be recruited to catalyze the rapid adoption and diffusion of the innovation? Successful innovation, as Michael Schrage9 observes, is "the relentless coevolutionary synthesis of the innovator and the adopter", rendering the "brilliant customer at least as important as the brilliant innovator."

We live in a world where the risk of being rendered obsolete by the intrepid interloper is not distant but immediate, and in some instances, day-to-day. Shaping the future is as critical as harnessing the strengths of the present, and this is especially true in the fast-paced world of eBusiness. The recent downfall of B2B companies does not mean that the well-established players can once again be comfortably ensconced in a state of complacency. If anything, this should only serve as a warning of ensuing disruptive technologies and business system innovations in most industries. Wireless and P2P represent two such disruptive technologies in the landscape. The question, then, is one of timing. How quickly and in what sequence will new technological and business innovations strike at the very core of our business, economic and social experience? If recent history involving the Internet and the business use of Internet is any indication, the wait will be over sooner than you expect. Are you prepared? And more importantly, are you protected?

About the Author
Ash Vasudevan is the head of CommerceNet Investment Initiatives - an investment program focused on the creation, development and diffusion of innovative technologies in the Internet Space.
All inquiries regarding this article should be directed to

1"Biochips Go Big Time", Alexandra Stikeman, Technology Review, March 2001.
3"Big Blue goes ape on Sand Hill Road", Steve Silverman, Red Herring, February 20, 2001.
5Sun Microsystems acquired Infrasearch on March 7.
Gnumarkets is one of the first movers in this space and purports to have established the first peer-to-peer marketplace with transactions devoid of any middlemen.
7Some companies to watch in the P2P space:
Knownow, Kalepa Networks, OpenCola, Xdegrees, gonesilent.com, Lightshare.
8"P2P gets mobile, taps Bluetooths Wireless Tech", Ben Chamy, CNET.com
9"Customers as Innovators", Michael Schrage, Technology Review, January/February 2001.


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