Playing To Win

The Two Rules that Monopolists Ignore at their Peril

How to Avoid the Monopoly Traps

Source: Jim Sizemore, Cartoon Collections

Businesspeople tend to dream about achieving monopoly status. It is a good thing in many ways, but a dangerous one too. There are two rules by which every monopolist should abide, but few do and hence monopolies tend to end badly. I am writing my 19th Playing to Win/Practitioner Insights (PTW/PI) piece on The Two Rules that Monopolists Ignore at their Peril, because there are strategy lessons for every business in this pattern of failure. (Links for the rest of the PTW/PI series can be found here.)

What is a Monopoly?

A monopoly exists when a buyer believes there is no viable alternative to buying the offering of a single provider — and by offering, I mean the product/service at the price offered. Monopolies are more plentiful than one might think at first blush. Most companies are at least partially monopolists. For some set of their customers, there is no alternative. Their customer will only buy Tide, Guinness, Apple, or BMW. Nothing else will do. These customers would pay considerably more than the prevailing price for the privilege of consuming their sole desire.

However, because only a portion of these company’s customers are monopoly buyers, they don’t charge the full monopoly price because their cost structures would be untenable without the additional of non-monopoly customers, who will only buy at a more modest price. The difference between the higher price that monopoly buyers would be willing to pay and the lower price that marginal customers are willing to pay produces what economists call the ‘consumer surplus.’ The would-be monopolist’s cost structure and the lower willingness to pay are what save the entire customer base from feeling the negative effects of the existence of a monopoly.

But in some cases, the monopolist can acquire a volume of customers who feel that there is no alternative that is sufficient to make the economics of their business work at that scale. They are pure-play monopolies. Historically, that was Hudson’s Bay Company in beaver pelts, DeBeers in diamonds, Pan Am in US overseas flights, AT&T in long distance, IBM in mainframe computers and Microsoft in PC operating systems. Did they all have 100% market share? No. But it was close enough that they could operate largely as monopolies — and extremely profitable ones.

In the proverbial good old days, it was straightforward to create a monopoly by piecing it together through acquisitions — the John D. Rockefeller way. But antitrust legislation (Sherman/Clayton) rendered that difficult. Today’s monopolies are mainly grown from the creation of a category — Amazon in online retailing, Google in search/search-based advertising, and Facebook in social media/social media-based advertising. [Of course, there is always the exception that proves the rule. With antitrust authorities utterly asleep at the switch, Luxottica has been able to acquire its way to a virtual monopoly in eyewear.]

None of Amazon, Google, or Facebook was actually first in its field. But they did what future monopolists need to do: invest like crazy and provide a fantastic product/service experience for customers. In their early days, they were all too small to be profitable. But they invested ahead of profitability — with the gold at the end of the rainbow as a monopoly to enough customers to have very attractive profitability. That is the story of Amazon, Google and Facebook, as well as many of their predecessors.

That having been said, most monopolists seem bound and determined to disobey the two rules for monopolists.

Rule #1: Be Wary of Dynamic Segmentation

Dynamic segmentation is a concept I have always attributed to Boston Consulting Group founder and father of business strategy, the great Bruce Henderson. But I have checked with my BCG friends and apparently, he didn’t talk about it — so maybe it is something I thought up. Who knows?

In any event, monopolies are hugely attractive. They have routinely (as in the cases of AT&T, IBM, Microsoft, Google, and Amazon) made the monopolist in question the most valuable company in the world. As a consequence, there is a huge incentive to attack the luxurious market of an existing monopolist — and innumerable companies do so. The monopolist must understand that these insurgents can’t help themselves: the opportunity is too attractive.

But taking on the monopolist at the heart of its business is rarely their approach. The dominant approach is to chip away at the edges of the monopoly. Think of the monopolist’s business as a circular disk. At the center is the perfect customer who thinks the monopolist’s offer is perfect. As you move away from the center, the offering is ever less perfect to those customers. And that is where insurgents attack: not at the center but at the fringes. And they win fringe customers.

When MCI and Sprint attacked AT&T’s monopoly, they didn’t attack the core of middle-American residential customers. They went after large businesses, who were being vastly overcharged relative to cost to serve, in order for AT&T to subsidize undercharged rural customers. Facebook’s insurgents aren’t attacking the core of its business. They are picking off customers who are hyper-sensitive to privacy issues (MT Social) or hyper-sensitive to ads (MeWe) or want to get credit for their participation (Minds) or they are searching for ideas/inspiration (Pinterest). If successful, that insurgent becomes the new monopolist for that niche — some of which are too small to be profitable, others not.

But the result is that the original monopolist’s territory becomes ever smaller as it is dynamically segmented around the edges. Ironically, the same thing happens in due course to the new entrants’ monopolies. So, dynamically over time, markets keep segmenting and segmenting into shrinking monopolies. It is inexorable.

Facebook provides a good example. It continues to grow due to international expansion. But it is important to always remember per William Gibson, the future is already here, it is just not very evenly distributed. The future is America’s teenagers who use Facebook at a share about 20 points lower than adults. And for only 10% of them, Facebook is their preferred social media platform (compared to over 30% for Snapchat and YouTube). Nothing is going to stop that train, which has already left the station, from continuing down its track.

The rule is that you have to recognize the inevitability of dynamic segmentation in your cost structure. As a monopolist, your fixed cost structure is sized to support your big disk. As the big disk gets chipped away, the business model collapses unless you manage your cost structure with the understanding that dynamic segmentation is going to happen. For IBM, going from a virtual monopoly in mainframes to competition chipping away at the edges caused its economics to collapse. The same happened to AT&T in long distance, resulting in it selling to Southwest Bell Corporation (SBC) for a song.

But it is very hard to internalize this inevitability. Monopolies are so exquisitely profitable that monopolists want to spend like drunken sailors — just visit their obscenely lavish corporate headquarters — and that is because they ignore Rule #1.

Rule 2: Remember your job is to respect your customers

How does a little monopolist grow its monopoly from a tiny one to a big enough one to be economically survivable, then attractive, then a money machine? It is by delighting its customers. And it isn’t altruistic. It needs more customers to get the economic model to work. And each customer benefits from the attempt to get the next one in order to make the economics work. It is a win-win!

But then the monopolist gets to the point of making the economics work, and beyond there, the monopoly becomes a magnificent profit machine. At that point, another customer would be perfectly nice, but who really cares? The monopolist is rich beyond its wildest dreams.

At that point, unless the monopolist remembers Rule #2, customers go to the back of the line. They just cease to matter. In fact, they become an irritation that gets in the way of self-actualization, which is the thing that really matters to the monopolist. And then the monopolist comes up with clever ways to make more money by abusing them. Sell their data to nasty people. Force them to sign restrictive contracts. Bias search results that they used to count on for their objectivity. It goes on and on. (The analog for businesses with only a small core of monopoly customers is to take those customers completely for granted while making luxurious offers to attract new customers.)

And then the monopolist starts the slow downward spiral. It is a very slow death. Again, the future is already here; it is just not evenly distributed. Customers will appeal to the government for help (ask AT&T, IBM and Microsoft). Or they will use a different device because it doesn’t use the monopoly operating system. Or they will abandon the monopolist’s service just to prove a point. In due course, the economics crater.

The Two Rules Together

To give an example of the two rules together, the future is already here for Facebook and the future is represented by US teens, who are demonstrating dynamic segmentation in real time and abandoning and/or deprioritizing the Facebook platform. It is because US teens are more sensitive to the kind of abuse Facebook visits on its customers than are their elders. Facebook’s economics are being supported by its international penetration. But once that curve flattens and the dynamic segmentation penetrates the whole of its business, its economics will be threatened with the kind of collapse experienced by AT&T and IBM in previous eras. And Google and Amazon better watch out too. Arguably they are on the same path, just not as far along.

Practitioner Insights

The advice is not just for pure monopolist because every business is a monopolist to some of its customers. Regardless of whether that proportion is 100% (full monopoly) or a modest fraction, it is in an unstable state that will be driven by dynamic segmentation. But your actions can either accelerate or slow its detrimental impact on the economics of your business model. Detrimental dynamic segmentation is accelerated by the natural tendency to slip into abusing your customers — because you know that they don’t believe they have an alternative. However, that abusive behavior will act as a powerful magnet for insurgents who will chip away at the edges of your monopoly and, thanks to you, will find a receptive audience. It is slowed if you take extraordinary measures to respect your customers and treat them as if they have lots of alternatives, even if they don’t. If you do respect them, you will protect your very best customers from the effects of dynamic segmentation and will be rewarded with a longer-lived and more productive monopoly.

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Roger Martin

Roger Martin

Professor Roger Martin is a writer, strategy advisor and in 2017 was named the #1 management thinker in world. He is also former Dean of the Rotman School.