Adventure of Strategy

Mark Thoma’s posting titled Nooks, Crannies, and Dot-Com “Get Big Fast” Bubbles on Economist's View raises an issue that translates well into professional service firm strategy in the modern era.

He takes a new look at the dot.com crash and questions the conventional view of its cause, namely:

"Too many companies rushed into the market in defiance of all known business fundamentals, and when the crash came, all but a tiny fraction of them just as quickly imploded and went away."

This view, Thoma reports, may be complete nonsense.

He quotes recent research on about 1,100 business plans submitted to an East Coast venture firm during the so-called ‘dot.com era’ (generally accepted to have extended from the launch of Netscape’s IPO in August 1995, until March 2000 when the Nasdaq peaked at above 5100.)

What emerges from the research is that "Get Big Fast" was the defining strategy of the era. Barriers to entry for competitors were perceived to be so low, that it was believed to be critical to be an early entrant into a market and then grow very rapidly so as to keep out challengers. Once this was achieved, then the company could move onto other priorities, like how to actually be profitable.

It’s a misconception that the vast majority of dot.com companies imploded during the crash. Certainly there were some high profile collapses and many ‘wannabe’s’ faded away, but in fact about 50% of the companies in the study were still in business in 2004! The attrition rate, at roughly 20% per annum, was roughly the same as during early boom periods of many other industries. (The automobile industry being a good example.)

One of the fundamental reasons for the crash, it seems, could have been not that there were too many, but too few companies. Or at least companies of the right kind.

"The fact that so many dot-com companies survived suggests that even more could have started. But that didn't happen, says the study. Investors following conventional wisdom of the day were interested only in companies that could dominate an entire industry. In looking for these, they ignored smaller niche opportunities that had the potential to become modest but profitable enterprises."

Most of the survivors were not giants like Amazon or eBay, but small and highly focused niche enterprises selling specialty goods and services. (For instance: wrestlinggear.com, that sells wrestling equipment mostly to high school and college wrestlers.)

It is common cause that Michael Porter’s three sources of competitive advantage (cost leader; differentiation and niche) apply to professional service firms. Take law firms for example. The most profitable firms are:

• The firms that have created a differentiated brand by being “different in ways that are valuable to clients” which in most cases involves being large too;

• The cost leaders, which are usually process firms (like conveyancing factories) that have driven the cost per transaction down to such a degree (through leverage and deployment of IT, for instance) that they can deliver the same quality service as competitors at lower cost, so undercutting them in price sensitive markets

• The niche firms, who focus on dominating highly specialized nooks and crannies in the market where the demand for services in that area exceed supply so they can charge a premium

The first two strategies are well understood. The third less so. Somehow, there is something less attractive about being a small, highly focused firm that aims to be absolutely brilliant at a narrowly defined practice area, than “going for growth.” Even in the dot.com field, "Get Big Fast" is still alive and well. Companies like Interactive, eBay and Google are spending hundred of millions, often billions, on start-ups such as MySpace, Skype and YouTube, which have developed a commanding market presence but without actually making money.

I’d submit that a niche strategy is a vastly underrated area of opportunity. Given the internet and a world where long distance communication is nearly free, one does not have to be in a major centre to become a world authority in a particular area. So a niche strategy may well be a way for a small / medium sized regional firm to achieve greatness and superior profits, if it can align its marketing efforts and service delivery mechanisms to access desirable clients.

It would also of course require that the firm’s lawyers have the passion, appetite and abilities to grow their skills and expertise in that area aggressively, plus maybe a lateral hire or two to accelerate the process and bring in immediate business and market recognition for the area in question.

There seems to be mounting evidence that law firms are beginning to follow a trend perceivable in many other industries, of the “middle falling out of the market.” If this is true, then the strategic response from a “middle” firm needs to be pure Porter:

• Merge (and probably merge again and again,) to achieve the critical mass that clients value in mainstream areas of the market
  

• Focus with brutal intensity on driving up quality (as perceived by clients,) throwing out unprofitable practice areas and dubious clients, or find some other way to better than your competitors in ways that are valued by clients
  

• Focus on the firm’s commoditized services and ruthlessly drive down the cost per transaction to the firm

• Start developing a niche strategy that competes toe-to-toe with the best in the market

Certainly worth thinking about! For a full service firm in the "middle" to craft and execute a strategy to evolve towards become a niche operator is certainly anything but conventional thinking. However, with the right choice of niche, grim determination and, yes, a fair amount of luck (an essential ingredient in any strategy, I'm afraid,) such a strategy may just prove to be a market-beater!

Bruce MacEwen at Adam Smith Esq has also recently blogged about this emerging knowledge about the dot.com bust (and as a former CEO of a dot.com corporation he has a particular interest. See here.