And that’s exactly what happened. Instead of each company growing at 5 per cent a month, the new, merged firm (which retained the name Betfair) grew at 15 per cent a month for eighteen straight months. The betting-exchange market took off. It changed the face of gambling, first in Britain, then in all other countries that allowed such exchanges to operate. By April 2006, just six years after its launch, Betfair was worth over £1.5 billion. The firm recently announced its two-millionth customer. We reckon it has 95 per cent of the betting-exchange market worldwide.
As we shall see, Betfair typifies the best kind of business anyone could hope to start or work in–one where the network itself enlarges the market, and also awards one firm an overwhelming share of that market. We think this is a new trend in business and a new way of thinking about it, although it is comparable to another conceptual breakthrough, made in the 1970s.
One of the ‘Aha!’ moments of my life came when I was twenty-five. I was finishing my MBA at the Wharton School of Business in Philadelphia and was looking around for a job. At that time, the hot field was strategy consulting–helping big firms decide where and how to beat competitors and build valuable businesses. Strategy consulting had been invented a few years earlier, in the mid-to-late 1960s, by the Boston Consulting Group. BCG seemed a great place to start a career–it paid well and provided fascinating work with top corporations willing to part with huge fees even for wet-behind-the-ears consultants.
At my interview with BCG, I rather naively asked the recruiting vice-president why big firms with plenty of bright people on their own staffs paid young consultants so much. ‘Basically, we’ve got a model,’ he said.
We categorise business units into one of four types. By far the best businesses are what we call ‘stars’. These are businesses that are number one [in market share] in a high-growth market. Nearly all the value in the stock market and the economy comes from stars. But stars are rare. A large company is doing well if it has a few star lines of business, or even one. Many have none. And they often don’t realise how valuable these businesses are. We get our clients to focus on these stars and make them as big and dominant as possible. And we get clients to create other star businesses when they can. It’s simple but powerful. It’s why our clients thrive and why we can pay you ridiculous money. Your job is to analyse the companies’ businesses in accordance with our model and see which category each business falls into, and therefore what to do with it. That requires no industrial experience, just raw intelligence.
This was my introduction to BCG’s famous growth–share matrix, with its cash cows, question-marks and dogs, as well as stars. The cash cows are where a company is the leader, but market growth is low–such as Heinz in baked beans or soup. Cash cows are very solid, good businesses. They should be profitable, but don’t normally require a lot of cash to be reinvested–they generate cash, but not much growth. Dogs are not good news–they have weak market shares in low-growth markets, and are typically not very profitable (their margins are thinner than those of cash cows in the same market, because they don’t enjoy the same economies of scale). Dogs don’t generate much cash. Question-mark businesses are not leaders in their markets either, but those markets are high growth. For example, in the 1990s firms flocked to become Internet service providers, but only one company in each country could become the leader. Question-marks will become valuable only if they seize leadership from the star business in their market. This usually demands an awful lot of cash, and it might not work even then. If question-marks don’t become stars, and the market stops growing, they end up as dogs–having sucked in a lot of cash, they’ll never pay it back. That’s why they’re called question-marks: either the firm should invest like hell to replace the leader, if that will work; or it should sell the question-mark, since buyers will often pay for potential growth even when there are no profits.
Well, I became a true believer in star businesses, a kind of business fundamentalist, simplifying everything down to one great truth: stars are much more valuable than people realise. Before long, BCG was moving on to newer, more sophisticated models. But I stuck with the star formula, eventually starting my own star ventures and encouraging everyone else to do the same.
So why are stars so great? BCG’s explanation started with costs–with economies of scale and the benefits of greater experience. The biggest firm in any particular product or service would have greater volume over which to spread its fixed costs, so its unit costs would be lower than those of smaller rivals. Then the ‘experience curve’ kicked in–a business with greater experience than its rivals would find smarter and cheaper ways to operate.
The cost advantage came from being the market leader and it applies to ‘cash cows’, too–leaders in low-growth markets. (For example, Heinz can make baked beans more cheaply than any other firm; it is bigger than any other producer and has been baking beans since 1869.) So what was special about being the leader and being in a high-growth market? BCG said that a high-growth market enables a leader to add revenue faster than all its rivals, to gobble up experience at a faster rate, and thereby to drive down unit costs at a faster rate. Increasing revenue and falling unit costs would make profits soar in a way that a firm in another, less vibrant market could only dream about. Ultimately, a star business would have much lower costs and much higher profits than any competing firm. The gap between the capabilities and costs of the leader and followers would keep widening, increasing the value and security of the star business. For example, when mobile phones were growing very fast in the 1980s, the Nokia Corporation of Finland abandoned all its other businesses to focus exclusively on becoming the leader in that product. By investing heavily, growing faster than any other mobile-phone maker, and achieving much lower unit costs, Nokia eventually made 80 per cent of the world’s mobiles. The company is now valued at eighty billion dollars.
Yet, in the early 1980s, it was far from clear that Nokia would win. When markets are immature and growing very fast, market share can be volatile–there is a lot to play for. Whoever gains clear leadership and successfully defends it ends up with a great star business. But an early leader might lose its star position–and most of its value–if a rival overtakes it in the early days of very high market growth. For instance, in the early, high-growth days of mainframe computers in the 1950s, the market leader was Remington Rand. But it ultimately lost out to IBM. Similarly, in 1959, Xerox invented the plain paper copier and by the mid-1960s it had a great star business. But by the early 1980s, Canon had replaced Xerox as the global leader in copiers. And the early leader in search engines was AltaVista, launched in 1995 and an instant star. But it was comprehensively thrashed by Google, founded three years later, and now perhaps the most valuable star business in the world.
Stars are exciting and expanding places to work and learn, and they can afford to pay you well. What’s more, stock options held by employees, or shares held by investors, can become life-changingly valuable. Yet, although everything BCG said about stars is true, that’s not the whole story. Not all stars are equal. There’s a constellation of stars that shine brighter than the rest, a distinctive type in their own right. In a critical extension of BCG’s thinking, I’ve come to realise that the ideal business is a network star– a star venture that has strong network characteristics.