ONLINE INFORMATION SERVICES THE CHANGING MARKET Keynote Address, INTERNATIONAL ONLINE Meeting London, England December 1983 by R. K. Summit
A.
INTRODUCTION
Before addressing the "Changing Market in Online", the keynote topic, I would like to say how pleased I am to be able to participate once again in this International Online Meeting. Also I would like to report to you some of the internal events at DIALOG which have taken place during the past two years since our spinoff in 1981 which have kept me from this meeting. In early 1981, spinoff planning was undertaken in earnest. My management and I had long felt it desirable that DIALOG operate outside of the government contracting environment of Lockheed Missiles & Space Company. With the spinoff which occurred in June of 1981, we incorporated previously "borrowed" functions of finance, contracting, administration, human resources, and legal. We were established as a separate and fully accountable profit center. In August 1981 Lockheed decided to evaluate divestiture of DIALOG for various reasons: We have been approached over the years with expressions of interest. Lockheed decided to get out of the commercial airline business which would entail enormous write-offs, some of which the sale of DIALOG could offset if it could be effected in 1981. It wasn't entirely clear at that time that information services was a line of business that made sense within the corporation. In early 1982 it became obvious that divestiture would not be accomplished in 1981. The questions then became: Continue divestiture initiatives? Remove DIALOG from marketplace? Later in 1982 the decision was made not only to remove DIALOG from the marketplace and continue DIALOG within Lockheed, but in addition to establish an Information Systems Group which would include DIALOG and two other recently spunoff Lockheed companies CADAM which specializes in the development and license of computeraided design software, and DATAPLAN which offers computer-based
flight planning services. The Information Systems Group was formally established early this year as part of a general corporate reorganization. The companies remain intact as separate organizations, but report to a group president. Establishment of the Lockheed Information Systems Group is important for several reasons; it represents: Formal acknowledgement by Lockheed management that information systems and services are an important part of its future business. Assurance of continuity of service for customers of DIALOG. Provision of formal machinery and resources for the growth and development of DIALOG. I can report to you with confidence that: DIALOG is no longer on the market. We receive full top-down support from Roy Anderson and Larry Kitchen, Chairman and President of Lockheed, respectively, through Dick Taylor, Group President, to me as President of DIALOG. For the first time in DIALOG'S history we have all of the machinery in place to operate with full effectiveness within a commercial marketplace. B.
A MODEL OF THE ONLINE INFORMATION SERVICES MARKETPLACE - A DISTRIBUTOR'S PERSPECTIVE
Now let us take a look into the economic environment in which we operate. It has become fashionable to utilize models to analyze complex relationships. I would like to develop with you a relatively simple, conceptual model of the online services industry from the distributors perspective in order to examine some of the relationships among and between customers and distributor organizations, as well as to forecast some likely results of alternative marketplace actions. Too often we think only of the relationships within our own companies - perhaps because they are easier for us to control. It is nonetheless useful to think occasionally of the broader community in which each of us is merely one contributing part. Such -2-
a view gives us a broader framework into which we can fit current or prospective events to better assess their likely effects. The Model. The overall market model is one of demand and supply. It says that over any period of time, total revenue generated by demand or the use of online services equals the total cost of supplying these services to the customer community. To break this equation down a bit, we have:
DEMAND SIDE
SUPPLY SIDE Total Operating Costs + Total Royalties + Total Surplus
Total Industry Revenue
FIG. 1
Online Services Industry - Simplified Model
Total industry revenue, on the left-hand side, is the total amount paid by online service customers to distributors in the course of conducting searches. Total operating costs are what it costs the distributors to operate all of the online service facilities in the industry - that is, the cost of computers, storage, operations personnel, programmers, customer services, marketing, etc. Total royalties are the amounts paid by distributors to database suppliers. Surplus is the item that makes the equation balance. Surplus can be positive or negative and is sometimes known as profit when positive, and as subsidy or investment when negative. Surplus is thus the total amount earned or lost after deducting operating costs and royalties from revenue. Disequalibrium tends to exist in the industry if surplus is either very positive or very negative. If very positive, new entrants will be attracted to the industry; if very negative, distributors will tend to leave the industry. Before we examine the model in more detail, you might wish to consider what you feel to be the state of the industry at present with regard to the SURPLUS account. Do you feel it is negative, very negative, positive or very positive? If you are like most -3-
observers, you probably feel it to be negative or very negative. If this is indeed the case, and unless the negative surplus can be improved, we might expect to see some distributors leave the marketplace, a situation which we will explore further on. A restatement of Figure 1 provides a more useful structure for analyzing industry relationships. In this case (Fig. 2 ) , the notation we use depicts the industry as consisting of several customers and several distributors, and has as factors measurable and controllable cost elements.
SUPPLY SIDE
DEMAND SIDE Total Industry Revenue
=
Total Operating Costs + Total Royalties + Total Surplus
whi<zh becomes E. (No. Searches, x Ave 1 Price/Search.) x i=l-m
=
j = j distributor n = total number of distributors
i = i customer m = total number of customers
FIG
2
E. (Op. Costs. + Royalties. + -* Surplus .) -1 ^ 3 j=l-n
Online Services Industry - More Detailed Model
In order to understand the equation, think of the demand side of the equation as representing the number of searches performed by each customer times the average price per search for that customer summed (Z) over all customers (of which these are m ) . Perhaps m, the total market, equals 80-100 thousand customers in the case of bibliographic services. Any particular value of i represents a particular customer. On the supply side of the equation we sum up the three cost elements (operating cost, royalties and surplus) for each distributor for all n distributors. There are perhaps 15-20 significant distributors in the case of bibliographic services. Any particular value of j represents a particular distributor. Another way of thinking of this model is as two large tables. The -4-
demand table would have m rows, one for each customer, and two columns, one headed "Number of Searches" and the other headed "Average Price per Search." Similarly the supply table would have n rows, one for each distributor, and three columns headed "Operating Cost", "Royalties" and "Surplus" respectively. If you were to fill in the supply table with the actual values of particular services, you would find that some services have a positive surplus whereas others have a negative surplus, corresponding to their individual profitability and non-profitability. In the demand table you would likewise find considerable variation. Some customers would be shown to conduct a large number of searches at a high average price whereas others might conduct a small number of searches. Obviously this model could be factored into more detailed cost elements and a variety of classes of service, but it can be quite useful even at this level of generality. The Effects of Changes. Let us examine a few inferences we can draw from the model. Each of the subsequent analyses will be "in the short run." That is, we will consider only the direct, short-term effect of a change, understanding of course, that in the long run, other factors than those considered here can come into play. For purposes of this examination we will assume total industry surplus to be negative, and will assume changes that make the surplus account more negative to be destabilizing, and changes that make the surplus account less negative to be stabilizing. The events to be examined are distributor withdrawal, entry of a new distributor to the marketplace and increases in the customer base, number of searches per customer and price per search. If total industry surplus is negative and as a result, companies tend to withdraw, which companies are likely to Withdraw? Perhaps those with the highest individual negative surpluses. If one such company withdraws from the industry, we can see that there is likely to be more demand available to the other distributors. This additional revenue will tend to reduce negative or increase positive individual surpluses of remaining distributors. In the short run, however, such withdrawal will not increase or decrease -5-
total industry royalties. Thus, withdrawal of a particular distributor under conditions of a negative industry surplus will tend to have a stabilizing effect on the industry. A recent example of withdrawal has been that of the New York Times Information Service which was acquired by MEAD. In this case, although much of the residual demand revenue went to MEAD, other distributors also benefited by attracting some amount of the demand formerly held by the NYTIS. Conversely, what happens if a new distributor enters the marketplace under conditions of negative industry surplus? If total demand remains the same, the new distributor increases total industry operating costs and thus must increase total negative surplus, thus destabilizing the industry. To the extent that the new entrant attracts demand away from existing distributors, their individual surplus accounts are decreased in that their operating costs in the short run remain relatively constant. Where such distributors are operating with a negative surplus, they may be more quickly forced to withdraw. For a new entrant not to have a destabilizing effect on the industry, it would have to increase total demand by an amount equal to its own operating costs and royalties. An example of a new entrant is the recently announced service of Chemical Abstracts Service. Unless it is able to attract new demand to the industry equivalent to the cost of operating its service, it could have a destabilizing effect on the industry. On a more positive note, let us see what happens if we increase the number of customers (m), the number of searches per customer and/or the average price per search. Considering these changes in reverse order, the overall results of an increase of the average price per search are unclear and depend on whether the increase results from an increase in royalties or an increase in distributor prices or both. Price increases, however, have an important secondary effect on both the volume of searching done by existing customers, and on the rate that new customers are attracted to the industry. Thus, whereas price increases by distributors can appear to increase surplus in the short run, such increases -6-
in a competitive marketplace can result in shifts in demand distributors. Increases in royalties can have a short term of decreasing the number of searches and a long term effect decreasing the rate at which new customers are attracted to industry.
among effect of the
Let us consider the other'two factors on the demand side. If the number of searches per customer can be increased and/or the number of customers using online services can be increased, all elements of the supply side of the model benefit through increased overall revenue. Such increased revenue can decrease any negative surplus that exists thus increasing the stability of the industry. Training programs by database suppliers and distributors alike tend to increase the number of searches per customer; similarly marketing programs tend to increase the number of customers (m). These activities tend to benefit not only the individual distributor (or database supplier), but tend also to have a stabilizing effect on other distributors and the industry as a whole by decreasing the negative surplus (that is, unless the total costs of these functions exceed revenues less royalties). Perhaps an even more exciting prospect lies in the potential for additional demand represented by the explosive growth of the personal computer marketplace. In order to realize this potential, however, two challenges must be met. Personal computer users in the aggregate must represent new demand, not simply a transfer of demand from existing customers. Also, the total revenue generated by this potential new segment of demand must exceed the additional operating costs and royalties required to support them if they are to contribute to the surplus account. Nonetheless these are exciting challenges and we face what is probably a greater opportunity than at any time in the history of online. Our ability to benefit from this opportunity will depend to a large extent on our understanding of the relationships inherent in the model, and our commitment to conduct our affairs in ways that benefit the industry as well as our individual organizations. With these thoughts, I welcome you to an exciting International Online meeting. -7-