In case you forgot….

If the only way for a company to increase it’s earnings is to fire people and cut costs they have a much bigger problem than they think, you simply cannot shrink your way to greatness.

In case you needed some more clarity on the Deflationary impacts of technology here it is, written by Mark Suster from Upfront Ventures. He explains it clearly and concisely.

Amazon – Amazon is the ultimate deflationary business. Everybody knows the story well. They launched as an online book seller. They had huge scale advantages because they could offer a much wider book selection since they didn’t need to be limited to the physical floor space of a physical retailer. They had huge cost advantages because they didn’t need to pay for retail space or all of the retail workers. They even had a government break because they didn’t need to charge taxes and thus consumers got an even better price.

But Amazon didn’t try to build a hugely profitable business. Does that sound dumb? I always see naïve journalists comment negatively on businesses that are “not profitable.” Sometimes it’s good to not focus on profitability and sometimes it’s bad.

There is a tension between profitability and growth. The more you want the latter the more investments you make in people and infrastructure now to pay for faster growth that expense of short-term profitability. It doesn’t work for every business. But if you are growing uber fast, building for scale and have access to capital to fund your growth then it’s always the smart play.

So instead of maximising price they kept cutting costs. Innovator’s Dilemma. How do physical retailers compete with that? Especially when Amazon will offer free shipping for its best customers. And Amazon wasn’t content with just being books, they wanted to be THE Internet retailer. Walmart in the cloud. This generation’s Sears Catalog. So they kept cutting costs of everything they offered.

And then they decided they wanted to be the Internet retailer of computing services so they created Amazon Web Services (AWS). And they made it so cheap that everybody gravitated towards them. They had a scale advantage and were driving deflationary economics (in other words, massively driving down the costs of goods & services).

I was at Salesforce.com when Amazon was super aggressive on that storage pricing. I met with our network experts to figure out whether we could launch a competing service. The assessment of our best experts was that we couldn’t.

Their view was that Amazon was taking a loss on providing Internet storage.

I have not inside data on that but I’ll be they were right. I’ll bet that Amazon’s view was to start with a loss leader because they knew that storage costs could come down and that they could add more service on top of their storage product and ultimately provide a profitable bundle of IT services to their customers.

In other words, storage might have been a “loss leader.” In any event, they had such scale advantages in providing this Internet infrastructure that to this day nobody in the industry has come close to matching them.

In my estimation this is one of the biggest strategic mistakes Google has made in not competing more aggressively with AWS. The Cloud is the future at Amazon has an enormous lead. As far as I know, the revenue in AWS is not publicly broken out but the last rumor I heard was that it had crossed $1 billion per year.

Google – They have led the deflationary pressure on advertising, bringing whole industries into chaos. This has particularly hurt the print media businesses that can no longer charge enough to pay for editorial, printing and distribution.

They are bringing deflationary economics to word processing, spreadsheets and office automation. They are bringing deflationary economics to local advertising. I guess I would describe Google as the ultimate scale & deflationary business.

Skype – As with many deflationary businesses, Skype started by giving away its product for free. Free phone calls anywhere in the world is as deflationary as it gets.
Telecommunication companies are still charging people for phone calls when the costs to them of providing the calls is infinitesimally small. Data transfer is what costs telecom companies money these days.

Ultimately when Skype had 10’s of millions of users it rolled out products that made money. They started with “Skype Out” which was placing a call from a Skype line to somebody on a normal telephone. They charge for this call, but they charge at rates that are an order of magnitude cheaper than a telco.

Expect this industry to be whiplashed by deflationary economics in the next 5-10 years. It’s no wonder they’re pushing so hard to be become our Internet supplier and our TV suppliers. Unfortunately for them neither of these businesses will escape the deflationary maelstrom either.

Deflationary economics tend to eat at the core of traditional offline businesses.

Of course I could go on and on including businesses like AirBnB, DropBox, Box.net, Yammer and so on.

All deflationary. But by now you have got the point.

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