Innovative Bird Keeps All the Worms

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As the old saying goes, “The early bird gets the worm,” but in the business world this principle doesn't always apply. In many cases, the early bird ends up opening a can of worms while the innovative, patient bird is left with all the spoils.  This concept has come to light with the recent announcement that social networking site MySpace is being sold for a pittance by News Corp. (NWS) to Specific Media Inc., an advertising network company. Although Myspace may have beat Facebook to the punch in establishing a social network footprint, Facebook steamrolled Myspace into irrelevance with a broader more novel approach.  Rather than hitting a home run and converting a sleepy media company into something hip, Rupert Murdoch, CEO of News Corp. struck out and received crumbs for the Myspace sale (News Corp. sold it for $35 million after purchasing for  $540 million in 2005, a -94% loss).

Other examples of “winner takes all” economics include:

Kindle vs. Book Stores: Why are Borders and Waldenbooks (BGPIQ.PK) bankrupt, and why is Barnes and Noble Inc. (BKS) hemorrhaging in losses? One explanation may be people are reading fewer books and reading more blogs (like Investing Caffeine), but the more credible explanation is that Amazon.com Inc. (AMZN) built an affordable, superior digital mousetrap than traditional books. I'll go out on a limb and say it is no accident that Amazon is the largest bookseller in the world. Within three years of Kindle's introduction, Amazon is incredibly selling more digital books than they are selling physical hard copies of books.

iPod vs. Walkman/MP3 Players:  The digital revolution has shaped our lives in so many ways, and no more so than in the music world. It's hard to forget how unbelievably difficult it was to fast-forward or rewind to a particular song on a Sony Walkman 30 years ago (or the hassle of switching cassette sides), but within a matter of a handful of years, mass adoption of Apple Inc.'s (AAPL) iPod overwhelmed the dinosaur Walkman player. Microsoft Corp.'s (MSFT) foray into the MP3 market with Zune, along with countless other failures, have still not been able to crack Apple's overpowering music market positioning.

Google vs. Yahoo/Microsoft Search: Google Inc. (GOOG) is another company that wasn't the early bird when it came to dominating a new growth industry, like search engines. As a matter of fact, Yahoo! Inc (YHOO) was an earlier search engine entrant that had the chance to purchase Google before its meteoric rise to $175 billion in value. Too bad the Yahoo management team chose to walk away…oooph. Some competitive headway has been made by the likes of Microsoft's Bing, but Google still enjoys an enviable two-thirds share of the global search market.

Dominance Not Guaranteed

Dominant market share may result in hefty short-term profits (see Apple's cash mountain), but early success does not guarantee long-term supremacy. Or in other words, obsolescence is a tangible risk in many technology and consumer related industries. Switching costs can make market shares sticky, but a little innovation mixed with a healthy dose of differentiation can always create new market leaders.

Consider the number one position American Online (AOL) held in internet access/web portal business during the late nineties before its walled gardens came tumbling down to competition from Yahoo, Google, and an explosion of other free, advertisement sponsored content. EBay Inc. (EBAY) is another competition casualty to the fixed price business model of Amazon and other online retailers, which has resulted in six and a half years of underperformance and a -44% decline in its stock price since the 2004 peak. Despite questionable execution, and an overpriced acquisition of Skype, eBay hasn't been left for complete death, thanks to a defensible growth business in PayPal.  More recently, Research in Motion Ltd. (RIMM) and its former gargantuan army of “CrackBerry” disciples have felt the squeeze from new smart phone clashes with Apple's iPhone and Google's Android operating system.

With the help of technology, globalization, and the internet, never in the history of the world have multi-billion industries been created at warp speed.  Being first is not a prerequisite to become an industry winner, but evolutionary innovation, and persistently differentiated products and services are what lead to expanding market shares. So while the early bird might get the worm, don't forget the patient and innovative second mouse gets all the cheese.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Performance data from Morningstar.com. Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, AAPL, AMZN, and GOOG, but at the time of publishing SCM had no direct position in BGPIQ.PK, NWS, YHOO, MSFT, SNE, AOL, EBAY, RIMM, Facebook, Skype, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.