(October 19, 2004)
An increasing number of high-technology industries in the modern economy are based on computer-like systems: computers, personal digital assistants (PDAs), video game consoles, televisions, smart mobile phones, digital content devices and many other consumer electronics products. And one essential characteristic of virtually all industries based on computer-like systems today is that they revolve around "multi-sided platforms."
Economists define multi-sided platforms as products which serve two or more distinct types of customers who depend on each other in some important way, and whose joint participation makes the platform valuable to each. For example, most segments of the computer industry, from PCs, to workstations, to servers, rely on operating system platforms - Windows, Linux, Apple OS, Novell Netware, Sun Solaris and so forth - which provide services to developers of software applications, hardware manufacturers and end-users. Each group needs the others to participate if the platform is to generate any market value. The same is true for all the other industries mentioned above. A recent paper by Evans, Hagiu and Schmalensee (2004) provides an economic survey of some computer-based industries that reveals parallels in the industrial evolution and prevalent business models adopted by their respective dominant platforms.
Given Japan's international leadership in consumer electronics, one would expect it to be home to many prominent and promising platforms for high-technology computer-based industries. Interestingly enough, however, it is very difficult to find more than two examples of such platforms today, namely, Sony's "PlayStation" and NTT DoCoMo's "i-mode." The main reason for this relative lack of Japanese company involvement is a long-standing weakness in Japan's high-technology sector: the absence of a strong software industry, aside from videogames. In a future column I will attempt to explain why such a mature and technology-intensive economy as Japan's has been unable to produce an internationally competitive software industry, and what industrial policy could remedy this market failure. Here we are concerned with one of the implications.
Despite their apparent lack of interest in software as a product, Japanese electronics manufacturers have been able to maintain their global leadership position by relying on the innovative design, performance, and reliability of highly integrated, stand-alone hardware. However there are signs that the competitiveness of Japanese companies is rapidly eroding in the face of recent developments that are transforming high-technology industries. The first and most obvious one is intensified competition from low-cost manufacturers from Korea, Taiwan and China, which has driven down profit margins tremendously, even for the most established Japanese electronics makers such as Sony, Matsushita, Hitachi and Fujitsu.
The second and far more profound development has been triggered by the rise of networking and connectivity (the Internet and wireless networks), and the advent of digital convergence, i.e., the growing tendency of various electronics products to interoperate and exchange information with each other. The most important consequence of this trend is that product value in high-technology industries is shifting away from integrated and stand-alone performance toward the ability to support a variety of digital content (software applications, music, movies, games, etc.) and share that content with a variety of other electronics products.
Providing access to digital content is the raison d'être of the multi-sided platforms we have enumerated above. The most successful and profitable ones have been created on the premise that it is beyond the ability of any single firm to provide the entire range of products and services that consumers need, but that they can capture value by focusing on the technological support upon which consumers and the providers of these various products interact. PlayStation and i-mode are excellent examples of this approach.
PlayStation was the first truly two-sided platform in the video game industry. When it was introduced in 1995, Nintendo's and Sega's consoles still relied on in-house production for more than 60% of their games, especially their respective "killers," "Mario Brothers" and "Sonic the Hedgehog." Sony, by contrast, had no in-house game-development experience. PlayStation became successful because it was extremely attractive for developers: It was easy to program, was versatile, offered good tools, and was less costly to support because it was based on CD-ROMs and not on cartridges.
Similarly, i-mode's platform business model succeeded brilliantly because it offered an extremely attractive platform for both third-party content providers and mobile phone users: DoCoMo was the first mobile operator to choose the c-HTML language over WAP (wireless application protocol), which greatly reduced costs for providers that already had an Internet website. And it created an advanced and efficient billing system that charged users based on actual network capacity use rather than on network time. At the time i-mode was launched in Japan, the global mobile telecommunications industry was the scene of spectacular third-generation platform failures such as Vizzavi, a joint venture between Vodafone and Vivendi, which made the mistake of attempting to rely exclusively on in-house content provided by Vivendi Universal.
Both of these examples illustrate the fact that providing all products (content, applications, games, etc.) needed by consumers is neither necessary nor sufficient for platform success. Nor is it economically feasible in most cases. Rather, it is sufficient to focus on the highest value-added part of the platform, make it attractive to all market participants, and rely on the market to supply the other products.
Moreover, as the study by Evans, Hagiu and Schmalensee suggests, most of the value of computer-based platforms seems to reside in the software platform. Think of Microsoft and Apple. By controlling the operating system and encouraging competition among PC hardware manufacturers, Microsoft managed to establish itself at the center of the PC industry. Apple, on the other hand, although it had preceded both Microsoft and IBM in the PC industry, made a key strategic mistake by insisting on keeping the software and hardware platform integrated, which prevented it from achieving the necessary scale to compete with IBM-compatible PCs. More recently, in the market for hand-held digital assistants, Palm started off in 1998 integrated like Apple, but by 2001 it realized that its most valuable product was the Palm operating system, which it began licensing to competing hand-held manufacturers such as Sony and Handspring, before eventually spinning it off in 2003 and creating Palm Source.
Digital convergence reinforces this value shift from hardware to software. This process brings together formerly distinct products - TVs, PDAs, computers, smart mobile phones, DVD players; and other digital content devices such as video game consoles - and creates significant economic value for consumers by allowing them to access and transfer digital content seamlessly through a variety of devices. It is a very high-stakes development for all the industries involved, and many devices are mentioned in the current debate over whether the TV, the PC, or something else will matter most. One thing is certain, however: In a converged world, content and the software systems and protocols (operating systems, digital rights, and intellectual property management technologies) that control content flows will command an increasingly large share of economic value relative to the underlying hardware.
Strikingly, none of Japan's big names in electronics seems to be in a good position to provide a dominant platform for the converged digital economy. Business Week recently dedicated an entire issue to digital convergence and named five companies it thinks will play a major role because they own critical components: Microsoft, Intel, Comcast, Samsung, and IBM - none of them is Japanese. The same issue contains a ranking of what it views as the top 100 information technology companies: The highest-ranked Japanese firm comes in at number 39 and, not surprisingly, it is NTT DoCoMo - behind no less than 15 Korean, Taiwanese, and Chinese companies.
Perhaps the clearest example of Japanese high-technology firms' inability to build valuable platforms around their hardware strength is Sony. It is quite clear that Sony is aware of the challenges we have just described: It is in the process of developing the technology to link together its many electronics products, from computers to mobile phones and TVs. Still, its efforts have been insufficient at best. Consider the market for downloadable digital music. Sony invented the "Walkman" and countless other music-playing devices, and possesses an unmatched amount of digital content (Columbia, CBS Records and, as of September 14, MGM). Yet it is three years behind "iPod" and "iTunes." This market was pioneered instead by Apple, a company which has neither content nor much experience with consumer electronics apart from PCs. However Apple does have experience in one important area: the creation of successful software platforms. Indeed, the core of the iPod/iTunes system is Apple's "QuickTime" software, which allows consumers to purchase music through the iTunes website, encrypt it in MP3 format on their computers, and transfer it to their iPod digital music player, all the while managing digital rights.
This is not very different from the PlayStation platform strategy and it is somewhat paradoxical that Sony was not able to learn from its success: provide an attractive platform and rely on the market for content (be it games or music), rather than attempting to acquire and self-provide as much content as possible. In fact, Sony's digital technology development has been hindered rather than helped by its content acquisitions because of internal conflicts between Sony Music and its electronics division over digital rights management and piracy issues.
It is only natural then that since its creation, PlayStation has been by far the most profitable group among Sony's business, often accounting for more than 40% of operating profits (促24.8 billion out of 促50.5 billion in 2002, for example). Currently the company's revitalization hopes largely hinge on PlayStation, although it is unclear how its new "PSX" model, despite its ability to play DVDs, can expect to become a true platform for the digital home and compete with a combination of countless other home electronics devices running, for example, Microsoft's "Windows."
The awkward position of Japanese electronics manufacturers when it comes to establishing platforms is caused by their lack of experience with software platforms. In other words, there is a lack of "platform thinking" - not of technical capacity -, which prevents them from becoming competitive software players. The implication is a risk of seeing "their" industries become dominated by foreign firms that provide scalable and cross-device software platforms.
Still, computer-based industries will not necessarily be dominated by software firms, as illustrated by the exploding market for smart mobile phones. The dominant platform in this industry is the "Symbian" operating system1, which currently supports more than 2,500 applications specifically designed for smart phones. Symbian was created in 1998 and is currently a joint venture of the major handset manufacturers (including Fujitsu and Matsushita), led by Nokia and Ericsson. As technological progress made mobile phones look and function more and more like small computers, these companies realized the potential value of an industrywide software platform and established Symbian to prevent other proprietary operating systems such as "Windows CE" from taking control of the industry.
There are obvious similarities with the current situation of Japanese electronics manufacturers, but there are also many reasons why a Symbian-like software joint venture among such software makers is hard to envision. Nonetheless, it is an interesting possibility to consider.
