The Gist: In order to stay competitive and protect profit, companies must continually innovate and do so strategically. Strategic innovation means identifying what differentiates a company from its competitors (what Moore calls a company's "Core") and focus company efforts and resources accordingly. Too often, however, companies focus too heavily on the basic points of competition (what Moore calls "Context"), committing resources to activities that are expected and necessary but have a low return on investment. Continued focus on Context at the expense of Core leads to commoditization of services and the erosion of profit.

Ebook Implications: As new competition enters the publishing market attempting to change the industry's business model, incumbents must identify what truly differentiates its services and make smart, strong investments.

About a month ago, Daisy Whitney over at the New Media Minute sent me a copy of “Personal Effects: Dark Art.” It was the first print book I have read in a long time (since I got my Kindle, in fact). And, picking it up and turning the pages felt kind of strange. However, it made me appreciate the vast differences between print and electronic books.

The book, for those who have not read it, is about an art therapist named Zach Taylor who is trying to solve a bizarre mystery involving murders supposedly committed by a blind man with air tight alibis. Zach interacts with his patients (who are all suspected or convicted criminals) primarily through art. He asks them to draw, sculpt, and compose pieces of art which he believes reveal information about the individuals and the crimes that landed them there. The book, both directly and indirectly, suggests that images and sound contain a great deal of information that cannot simply be communicated by speaking. This message is reinforced by the multimedia elements throughout the book. Physical clues are included that readers can sort through -- pictures, business cards, and a drivers license. Individuals can also call phone numbers and listen to characters’ voicemails and visit websites that offer additional information and images. Even the look and feel of the pages in the book communicate something and help set the tone for the story.

The book’s use of visual and auditory elements to enhance the communication between the author and the reader brings to mind Jerry Zaltman and his consumer behavior research. The premise of Zaltman’s work is rooted in cognitive psychology which reveals that individuals generally do not think in terms of words or numbers, but rather in terms of images and metaphors. This poses a challenge to any company (or psychologist, in the case of “Personal Effects”) that wishes to understand what someone truly thinks.

Historically, companies have attempted to understand and predict consumer behavior by asking questions and measuring responses or by observing behavior (for example in focus groups) and trying to extract generalities. Zaltman, however, believes that these methods yield a poor understanding of consumer behavior and result in suboptimal business decisions. These traditional methods are insufficient because there is a disconnect between how people think and how companies have traditionally attempted to measure those thoughts. To remedy this, Zaltman developed the ZMET test which asks consumers to spend some time thinking about a product and gather or produce a series of images that represent their thoughts and feelings. Individuals then have a conversation about these images with trained interviewers who attempt to discover underlying thoughts (what Zaltman terms deep metaphors) and their relationship to one another.

After finishing up "Personal Effects: Dark Art", I went back to reading on my Kindle. And, while I love the device, it lacks a traditional book’s ability to set the tone and to otherwise communicate a message through cover art, font selection, and even paper choice. Because individuals think in terms of images and metaphors, it is not surprising that some individuals have been hesitant in adopting the ebook platform. According to Imran Khan, 72% of individuals cite the look and feel of paper books as a reason not to purchase an e-reader. While this number seems large, the statistic (and the overall study) are subject to the same shortcomings that Zaltman discusses in his research. For example, this figure does not reveal the intensity of the feeling or its underlying emotional motivation. These hidden factors, if properly understood, could help ebook companies to increase consumer adoption.

Changes to new technologies always bring about costs and benefits that consumers must weigh. Other forms of media have experienced similar consumer reservations in their transition to digital. While these reservations are important, their significance cannot be understood solely through traditional forms of market research.

A couple of weeks ago, I, along with the rest of the ebook community, was trying to digest all of the news related to Amazon’s deletion of George Orwell books from a number of Kindle devices. There was (and still is) a flood of articles related to the decision and the subsequent actions by Amazon executives and Kindle consumers. One of these articles, published by the New York Times, interviews Jonathan Zittrain who lays out briefly why Amazon’s actions are troubling. Intrigued, I decided to buy his book “The Future of the Internet: And How to Stop It” and have since had a hard time putting it down.

In his book, Zittrain discusses the history of modern technology, focusing on the oppositional forces caused by generative technologies (e.g. the PC and the Internet) and appliancized technologies (e.g. the iPhone and the Kindle). Generative devices, which invite contributions and changes from anyone, offer numerous advantages, most notable of which is increased innovation. Application specific devices (which are closed and centrally managed), on the other hand, give up these benefits in order to be simple and stable.

To achieve this simplicity and stability, however, appliancized technologies must be tightly controlled, often through explicit regulation. Perhaps the most visible example of this today is the iPhone. To develop commercially for the device, developers must submit an application to Apple for approval. Many applications do not make Apple’s cut, often for unknown reasons. While this regulation has many obvious problems, it does result in an enjoyable user experience.

Today, this same issue confronts ebooks and e-readers. To put books on a Kindle (or any other e-reader), publishers and authors must distribute their content in approved formats. To sell in the Kindle store (or many of the other stores tied to a device), publishers and authors have even fewer options -- the proprietary file format and the accompanying DRM are required.

This control, as many Kindle owners discovered, does not end at the point of purchase. Tethered devices and their stored content can be controlled throughout the product’s life. This control is not all bad. Amazon, for example, has used its control to design a better customer experience. (I, for example, love how both my iPhone and Kindle know what page I’m on and update my place in a book automatically). Even Zittrain recognizes that these tethered devices can offer a superior customer experience -- provided that the manufacturer understands what the customer wants both now and in the future. And, this is the real issue. Perfect customer knowledge is unlikely at any point in the product stage -- but the negative ramifications of an appliancized device are greatest in the early stages of a product’s life.

Amazon’s decision to create a closed Kindle ecosystem is grounded in sound business principles. However, this decision comes at a price. By maintaining strict control, the company may be forfeiting opportunities to spur innovation around its device -- innovations that could help grow the ebook market and perhaps even lead to additional demand for its Kindle ebook store.

In his book Free, Chris Anderson lays out the arguments for a Free pricing strategy and gives some good examples of how it can succeed. (A list of 50 of these examples can be found at the back of the book, organized by business model). Relying primarily on these examples, Anderson strives to prove that products, and especially digital products, can be (and many should be) free because the marginal cost of providing them is low and getting lower all the time. While this sounds nice (especially to consumers), Anderson eventually points out that Free works in only limited situations. Free has a place in the economy -- alongside paid products and services.

Despite the stories of success and the evidence that Free can be profitable, Anderson fails to give the reader any real framework with which to understand these models and evaluate any further applicability. The most egregious example of this is his discussion of two-sided networks. In his introduction, Anderson boldly declares that economics has nothing to say of Free. In the following sentence, he backtracks (but only slightly) and says:

In fairness some [theories] do exist, as later research would reveal. But they were mostly obscure academic discussions of “two-sided markets” and, as we’ll see in the economics chapter, nearly forgotten theories from the nineteenth century.

Anderson’s later discussion of two-sided networks barely runs over a page. Instead, Anderson focuses on Bertrand marginal cost pricing, concluding that in competitive markets characterized by abundance, price tends to fall to marginal cost. Based on this, companies selling information products should seriously consider Free. Best yet, these companies should be the first to do so.

Anderson takes examples that run counter to this theory (e.g. Microsoft) and explains them away by stating that they fall outside the restrictions set by the definition (Microsoft does not operate in a competitive industry). While that may be true, it does not explain why Windows beat out the Mac OS in the early history of computers without charging consumers the marginal cost. (The theory actually states that there need only be 2 companies). More fundamentally, if Anderson is willing to discount this example because it falls outside the theory’s assumptions, he would need to discount any application of the theory as no market meets the strict restrictions set forth by Bertrand.

Microsoft’s success was due to a number of different factors, many of which can be understood in the context of two-sided networks. Bertrand economics, while undoubtedly useful, is too simple an explanation to be used in isolation and to the extent that Anderson recommends. Anderson’s heavy reliance upon Bertrand economics focuses too much on price and too little on network value.

Free worked in many of Anderson’s examples because it increased the size of a platform and that size has real value.