Subba’s Serendipitous moments

May 9, 2008

Business catalysts — New name or a new model?

A very interesting way to look at new business intermediaries which surprisingly shifts value. And some of them end up disintermediating the traditional relationship between the service provider and the user. Prof Richard terms as matchmakers or business catalysts — just another name for those companies. While I have yet to read the complete book, I am curious to find out why the catalysts models work in some cases and why it fails in others. For instance, the entire business model of a neutral E-marketplace has failed in all industry sectors. Dr. Richard seems to have cleverly avoided the question of how to build the catalyst business.

I am definitely looking forward to reading the book.

Richard Schmalensee, the former dean of MIT’s Sloan School of Business, unravels the secrets of a curious breed of companies that acts as matchmakers in the corporate world.

If you were a chemistry buff at school, you’d know what a catalyst means. In layman terms, a catalyst is a substance that sparks off a reaction between two or more agents. There is a breed of companies which does precisely that, says Richard Schmalensee, the former dean of MIT’s Sloan School of Business. “A catalyst,” he says, “is a business that adds value by bringing different groups together. Groups that need each other for some reason but have trouble interacting and facilitating their interactions.” Take this newspaper you are holding in your hands. This is a catalyst too. It brings together advertisers and readers, two distinct groups that would otherwise have had trouble interacting.

The world of business abounds with catalysts, and that prompted Schmalensee to author a book titled Catalyst Code (Harvard Business School Press, 2007) along with David Evans, vice-chairman of LECG Europe. Take credit cards, which bring together consumers and merchants, or operating systems which connect computer end users and applications developers, or even your neighbourhood shopping mall, which brings stores and consumers together. And in real life, there are marriage brokers who bring men and women together. “Once you look at the world through this lens, the list of catalysts just goes on and on and on,” says Schmalensee. The current crop of catalyst companies includes the likes of eBay and Google.

Why catalysts are important today:

One would think that catalysts are a New Economy phenomenon. While that’s not quite true, the fact is that catalysts are much more common today than ever before. Says Schmalensee: “These businesses are becoming more important today because of communications, the rise of the Internet and software platforms.” The Internet is creating meeting places for interactions. eBay, for instance, brings buyers and sellers together on a virtual platform. Cheap communications further make it easy for these people to reach out to others. And software platforms help people to be creative.

Catalysts play an important role in sparking off new industries or disrupting old ones. “See what has happened to traditional businesses because of the Internet. Take Google or Craigslist and see what they are doing to US newspapers,” says Schmalensee. Both Google and Craigslist have changed the rules of the game. While newspapers charge for all classified ads in some areas, Craigslist lets consumers list for free and only charges employers for placing ads. In 2004, they shifted $50 million-$65 million worth of advertising from newspapers in San Francisco. Google, on the other hand, offers targeted advertising. US newspapers are dying not just because people get news online, but also because advertisers are pulling support. “It’s a death spiral: you don’t get subscribers so you don’t get advertisers. Advertisers get better places to go,” says Schmalensee.

The chicken and egg problem:

So how does one go about building a catalyst business? Are there any pointers? “There really is no magic bullet to these businesses,” says Schmalensee. “They are complicated. There is no simple ‘here’s what you have to do’. There is a lot of ‘here’s what you have to do’.” But the biggest issue in building a catalyst business, he says, is that of maintaining balance when you are serving multiple businesses. Take credit cards again. “You need to get customers to carry the cards and you have to get businesses to accept the cards. So you have to balance the system on pricing, in rules and various other things, and make it attractive for both,” says Schmalensee. You can’t serve one group at the cost of the other. “It’s not enough for it to be something that every consumer wants to have. Ultimately, consumers are all going to want to have it if merchants want to take it. So you have to think about what the value proposition for merchants is?” says Schmalensee. “You have to solve the chicken and egg problem simultaneously.”

The lack of balance can upset the catalyst model. Take Diner’s Club which was initially the only payment system in the US. It was a very good deal for consumers because they charged merchants 7% of the bill. “But when American Express came, it just took off,” says Schmalensee. “They changed that model: they offered a lower price to merchants and were a little less generous to consumers.”

Or take video game manufacturer 3DO. “The standard business model in video games is that if you break even, you may even lose money on the console but you make money on the game you write and the games other people write for your system,” says Schmalensee. “Instead 3DO said, ‘Why aren’t video games like PCs? Why don’t we make money on the console and then let the game developers use the system for free?’ It was a spectacular failure.” What happened was simple: game developers said that if nobody’s going to buy those consoles, why should we write games? And consumers said if there aren’t any games, why should we buy those expensive machines?
Role of Early Adopters

Early adopters are very important in catalyst businesses “because you have to solve the chicken and egg problem”. Says Schmalensee, “If you can’t get early adopters, you can’t get late adopters, and then you are dead.” But how one can get early adopters really varies across businesses. Let’s cut back to the credit card example once again. “The inventor Frank McNamara gave 200 of these cards to 200 of his rich friends and then went to Manhattan restaurant and said, ‘Here’s the list of people who have this card, what do you think?’ And the restaurants thought that these are good people. That’s how he kick started credit cards.”

Similarly, when Microsoft wanted to launch Windows 2005, it did a massive publicity first aimed at consumers. The idea was simple: they were trying to tell application writers that here’s what we are going to do to sell this thing to consumers so if you write applications, we can get a lot of consumers to buy them.

“In catalysts almost all the profits are made from one side or the other; you don’t do any 50-50,” says Schmalensee. “The thing to do is to really subsidize the side where you aren’t going to make any money and tell the other side we have these people.” In the credit card case, the profits come mostly from the merchants and not from the consumers. “What McNamara did was give them away initially to consumers and tell merchants, ‘Look the consumers have it’. So you give it away free to the low profits side and then raise the price a little bit and start charging. But use the build-up of one group to attract the other.”

When morphing into a catalyst makes sense:

Since the catalyst model does seem to be gaining ground, does it make sense for traditional businesses to morph into catalysts? “I don’t think it’s for everyone,” says Schmalensee. “The important thing is for traditional businesses to think about an alternative provided by a catalyst. It is for a lot of people on the Internet, but it works for the traditional brick-and-mortar businesses only sometimes.”

Some businesses don’t have a choice really. Stock markets, marriage brokers, singles clubs and shopping malls are by their very nature catalyst businesses. But there are others that did morph into catalysts. When PalmSource first brought out the Palm Pilot, they adopted the traditional we-make-and-sell strategy. They provided all the operating system, the hardware, applications, the works… “Why did they do that? Because there weren’t any obvious partners! Nobody was going to write programs for this device unless there were consumers out there who had them and might buy them,” says Schmalensee. Once they became a little successful, the first thing they did was open the software interface to allow others to write applications programs with it. “So, Palm began to count on other people to write programs. And eventually it even contracted out manufacturing. So Palm, over time, didn’t have to do anything beyond the operating system,” says Schmalensee.

(Richard Schmalensee is the former Dean Emeritus Economics, Finance & Accounting at MIT’s Sloan School of Management. He is the author of the Catalyst Code [with David Evans].)

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2 Comments »

  1. […] post by Serendipitous moments This entry is filed under Credit card. You can follow any responses to this entry through the […]

    Pingback by Credit card » Business catalysts - New name or a new model? — May 9, 2008 @ 2:31 am | Reply

  2. ihype.com is launching in less then a month. Can’t wait. Get paid while you blog!

    Comment by crispus — May 14, 2008 @ 6:06 am | Reply


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