The economy is a network. I’m Reading Smart World by Richard Ogle and he talks about a couple of the important implications of this. The networked nature of the economy tells us a lot about how innovations diffuse – particularly some the difficulties new ideas face in getting adopted. It sheds light on some questions like: how did Xerox go from having a 75% market share in photocopiers to a 37% share in less than five years in the 1980s? How did Google enter a crowded search market and come to dominate it so quickly?

It turns out that long periods of stability punctuated by sudden unexpected change a very typical of networks, and Ogle explains why in the book (which is very good). The stability is driven by the tendency of the rich to get richer in networks. What we see in networks based on personal interactions is that people, ideas, websites and products that are well-connected to start with tend to be more likely to attract new connections than those that are less connected. Researchers call this “preferential attachment” – and that is what drives both winner-take-all markets like search, and oligopolies (a handful of major firms dominating a market). The rich get richer effect keeps the major players in a market in power, making it very difficult for new entrants to get in. That’s what gives us the long periods of stability.

However, when the structures of these markets change, the usually do so incredibly quickly. How? The Google and Xerox examples show two different ways this can happen.

The Google example is simplest. The Google search algorithm was enormously better than anything else around at the time. When Google started, there were a bunch of different search engines. Yahoo, Lycos and Alta Vista all covered generic search – and for a long time all of them had actual people linking websites to search terms. Ask Jeeves was slightly different, as it attempted to answer natural language questions. If you were using the internet through the 90s, you’ll remember how horrible the search results tended to be. It was often even difficult to find a particular site by searching for its name! It’s part of what gave the web it’s serendipitous nature. That was cool (and a bit whimsical), but it limited the overall usefulness of the web.

The innovation of the Google algorithm then was able to take over the market very quickly simply by being better. It provided usable results, which were usually much more accurate and complete than those from other search engines. They also automated scanning the web for new sites – so you no longer had to submit your website to the search engine so that it would know that you were there.

So one way to effect a rapid change in a networked market structure is to introduce an innovation that is substantially better than what is out there. This is particularly effective if the market is still relatively new, and people are still trying to figure out what works best.

However, once you have a dominant player in place, simply being better doesn’t work as well. I’ve done some testing, as have a few other people, and it looks like the results from both Yahoo and Bing might be a bit better now than those from Google. And yet, people aren’t switching. Once a dominant player is there, you not only have to introduce an innovation that is substantially better than what they offer, you have to get people to break connections with that competitor. This is often incredibly difficult (or impossible) to do. Think of the Dvorak keyboard versus QWERTY, and Beta versus VHS for just a couple of examples.

If better doesn’t work, what can you do? This is where business model innovation comes in – as illustrated in the case of Xerox. In the early 1980s Xerox dominated the photocopier market. They sold high-volume machines to big corporate users. If you were small, you either used technology that was 40 years old, like mimeograph machines, or you went to a copy centre where there was enough volume for them to justify buying a big xerox copier. Then firms like Canon and Ricoh decided to enter the copier market. Did they make better copiers? No. They actually made copiers that were much worse on nearly all dimensions. They were slower, they were less reliable, they were of lower quality. So why did people buy them? Because they were affordable, even if you were a small office.

Canon and Ricoh innovated the other parts of their business model as well to support cheap copiers for everyone. They dumped expensive in-house professional sales and service – selling their copiers through office supply stores and letting independent contractors service the machines. So their innovation was not in the technology – it was pure business model innovation – they figured out a way to connect up with a huge number of people that had previously thought that a copier in their office was far too expensive to ever consider. They expanded the network.

Xerox’s market share didn’t drop because they were losing sales so much as it dropped because the number of copiers being sold overall went through the roof. It wasn’t until about 10 years later that Xerox was in trouble – that’s how long it took the new companies to develop the capabilities they needed to compete directly against Xerox in the high-volume part of the market. This is a classic disruptive innovation strategy, and a great example of business model innovation.

When these kinds of changes happen, they are incredibly rapid. Both the stability and the rapid changes are due to the fact that the economy is a network. Understanding this can help us develop more effective strategies for getting our innovative ideas to spread.

(Dvorak keyboard picture from flickr/lezoni de stile under a Creative Commons License)