The substantial long-term value creation potential of virtual communities notwithstanding, organisers of virtual communities are likely to face significant near-term economic challenges on both the revenue side and the cost side. They will be driven by two forces: competitive dynamics and technology evolution. But those who enter the virtual community business expecting a quick return on investment are likely to be severely disappointed.
Revenue pressures
In a nutshell, the dilemma for the virtual community organiser is that the most accessible revenue sources in the near term will be the least attractive from the viewpoint of driving growth. On the other hand, the revenue sources that are most attractive are likely to be beyond the reach of the community organiser in the early years of community formation. The result will be limited revenue generation from the virtual community in the near term.
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One revenue source immediately available to the community organiser is member fees (especially subscription or usage fees), which can be charged from the first day. However, charging member fees is likely to slow growth of membership substantially. That in turn could delay readiness to tap into other attractive revenue streams: advertising and transaction commissions. It could also expose the community organiser to competitive threats from more aggressive competitors pursuing pre-emptive member acquisition strategies and therefore offering free access to their community.
In contrast, while the virtual community organiser would love to be able to tap into advertising and transaction commission revenue streams from the outset, these will both take time to materialise. The problem is that it is very hard to sell advertising for a community with few, if any, members about which little is known. Advertising spending on the Internet has tended to be concentrated in the high-traffic Web sites. In 1995, for instance, the top ten Web sites captured 35 percent of all advertising spending and the top fifty sites captured 70 percent.
Transaction commissions depend both on the number of members as well as the number of vendors actively participating in the community. With few potential customers (most of whom are poorly understood by the community organiser) combined with the concern over a new intermediary coming between the vendor and its customers, many vendors are likely to wait on the sidelines, until a critical mass of members and usage profiles can be aggregated.
Adding to these challenges are some near-term technical realities. The Internet (as of 1996) is not yet a commerce friendly environment. Key technologies in such areas as usage information capture, payment systems, and authentication are not yet broadly deployed. Therefore, much of the advertising and transaction commission potential remains beyond the reach of the virtual community.
The net result: revenue generation by virtual com- munities in the near term is likely to be quite limited.
Cost pressures
Limited revenue generation might not be so bad on its own, but it is coupled with substantial near-term cost pressures. The result could be a near-term margin squeeze that is very painful, if not fatal.
Virtual community organisers will need to pursue highly leveraged strategies by aggressively mobilising other people's resources to serve their ends. Even with such leveraged strategies, however, the community organiser will be under enormous pressure to spend aggressively on member acquisition, especially in the first several years. This pressure will be both economic -- driven by the desire to accumulate a critical mass of members and to unleash the dynamic loops -- and competitive, driven by concern over the need to primp competitors and, if possible, discourage them from entering at all.
Early entrants will gain the field
Those who aspire to play the role of community organiser or owner will need to move quickly and aggressively to increase the likelihood of becoming the first to aggregate a critical mass of members in a target area. Increasing returns suggest that late entry will certainly be the most expensive option and may become so expensive that it is either prohibitive or at least unattractive, given the enormous up-front investment required and the difficulty of earning an adequate return on that investment.
Investment requirements escalate
Here's the catch: A low barrier now is almost certain to build insurmountable barriers to entry over the next five years. These barriers to entry take a variety of forms: unique assets accumulated by early entrants, switching barriers for members, factor cost increases, and scale and scope economies.
Unique assets accumulate. Virtual communities today start out on a relatively level playing field. The technology is broadly available to all. No one has yet accumulated unique assets that differentiate one community from another in a compelling way and that must be replicated for a new entrant to be successful.
Fast-forward several years. By this time, virtual communities are in full swing in all the obvious categories. Aggressive member acquisition strategies have yielded their expected result: a critical mass of members participates in the leading communities, populated and active bulletin boards and chat areas are accumulating usage profiles, and as a result the communities are learning more and more about who their members are.
Established players have by now accumulated some unique assets. They have members, a key asset relative to later entrants. Our economic model on the consumer travel community suggests that an aggressive organiser could acquire almost 400,000 members by the end of the third year of operation. Moreover, established communities have specific members with distinct identities who are unlikely to be active across multiple other communities within the same category.
Second, their memberships will have a higher proportion of builders and buyers than a newcomer. It takes time to convert the browser.
Third, established organisers have accumulated significant amounts of member-generated content from their bulletin boards and chat areas that are unique to their communities. If I want access to that content, I must participate in that community. Also, because established players have accumulated large numbers of members, it is likely that this member-generated content has become quite deep and specific.
Fourth, established organisers will have accumulated detailed usage and perhaps transaction profiles of their members. They will know how much time they spend in the community, with whom they interact, what their interests are, and, in many cases, what kinds of products or services they have purchased. Once again, this information will be unique to the community that captured it. If an advertiser or vendor wants to target members with certain profiles, it will need to do business with the community organiser to leverage the value of that information. How would a new entrant with few members and even less information about them compete for advertiser spending or vendor time and attention?
Three years from now virtual communities will no longer be undifferentiated start-ups. The leaders will be well-developed commercial enterprises with a range of unique assets that give them powerful differentiation, from the perspective of potential new members as well as that of potential advertisers and vendors.
Perhaps the most significant, and yet most subtle, barriers to switching communities are the relationships that members develop within them. Those who become active in the communication forums of a community begin to get to know and trust the input of other members. Either we all switch or none of us switch.
One of the reasons there is such a high churn rate today within on-line offerings is that few on-line initiatives have focused on developing the moderated communication forums in which these personal relationships can develop. Those few who have developed have generally done so recently, and there has not been enough time for these relationships to form.
Even more subtly, members are likely to establish significant, trusting relationships with virtual community organisers.
Other factors are also likely to play a role in the building of switching barriers. At one level, simply becoming familiar with the distinctive "look and feel" of a specific community is likely to make some members loath to change. As communities develop the ability to tailor their offerings to individual members, this will also generate a switching barrier. A new community that lacks a visitor's usage profile will be unable to tailor its offering (for example, displaying a certain sequence of screens based on observing how the person has navigated through the community in the past) even though the technology may be available to all organisers. Agent technology introduces another potential switching barrier: agents typically must learn member preference over time; once members invest significant time and effort, they will think twice about moving to a new community and confronting a new set of agents with no insight into their preferences. There is no substitute for experience.
Factor costs increase
Some of the key talent required to build virtual communities today may become much more expensive as time passes. The most notable examples are the hosts of bulletin boards and chat areas who help to make these vibrant and focused forums for communication. Today it is not a highly developed skill, and, where available, it tends to be supplied by individuals who are passionate about on-line communication and are willing to contribute their time for free or for nominal amounts (such as free on-line access). Over time, we anticipate that this skill will become much more highly valued and that talent will command a substantial premium, much as it does in the music or movie industry.
Marketing and data analysis skills will also be essential to the success of communities, and, once again, people having these skills and demonstrating a proven track record in an on-line environment are likely to command a substantial premium.
The result of these emerging markets for scarce skills will be to bid up the price of these factor costs, which represent a substantial portion of operating costs in the early years.
Concentration limits opportunities for entry. Increasing returns businesses tend toward concentration over time. This tendency is not surprising given the reinforcing effect of dynamic loops in operation. These loops operate over time both to accelerate revenue growth (the big get bigger) and to drive down unit costs (the big get richer). Smaller players have little choice but to redouble their efforts to get bigger or risk getting swallowed by one of the larger players or being shoved into bankruptcy court.
The implication is that those who wait a few years to enter this business are likely to find themselves up against large players in any specific community category. The fragmented atmosphere that now characterises the on-line world is likely to prevail only in the near term as players jockey for position. The large players to come will enjoy significant scale and scope advantages.
Economies of scope will also play a role. As is explained in more detail later, community organisers will be able to share specific functions across an entire community covering very broad and diverse areas. In the travel community cited above, for instance, the member support function can be shared across the entire travel community, creating a substantial advantage relative to an emerging community seeking to target a narrower segment of the travel market, like the Hawaii travel community.
The net result is that new entrants will confront a concentrated business driven by large community organisers who enjoy substantial operating cost advantages, clear differentiation through unique assets, and high switching barriers for their existing members. n
Net Gain
Expanding markets through
virtual communities
By: John Hagel III and Arthur G. Armstrong
Published by Harvard Business School Press
Distributed by IBH (Delhi)
Pages:220, Price $24.95