Why it’s Hard to Set a Standard and Maximize Short-Term Profit

After my post yesterday on Kevin Lynch’s move to Apple (link), Infinity Softworks CEO Elia Freedman sent me a followup question:

“This line is interesting: ‘You can’t set a standard in tech and maximize short-term profit at the same time.’ Talk more about this?”

He’s right, I did assert that without explaining it. So here goes:

There are a couple of different tech industry things that we call standards. The first type of standard is a product that almost everyone uses because it has critical mass: Microsoft Word, Internet Explorer, etc. The second type of standard is a technology or tech specification that almost everyone builds on or incorporates into relevant products: HTML, JPEG, etc.

Once in a while you can establish a standard without limiting your short-term revenue (Adobe Photoshop is probably an example; it's carried a premium price ever since it was introduced in 1990). But in most cases, to establish a tech standard you have to limit your near-term profitability. Sometimes that means lowering your margins for quarters or years until the standard is established. In other cases it means permanently giving up some revenue streams in order to create a position of power.

A few examples:

—Adobe gradually gave away PDF in order to solidify it as a standard for document interchange. At first Adobe made the PDF reader free of charge, and eventually it gave away the PDF standard itself, enabling other companies to create PDF readers and creators that competed with Adobe. This move enabled PDF to become one of the most resilient standards in computing. Think about it – despite the hostility of much of the Internet community, and full-bore attacks from Microsoft and others, PDF continues to be a standard today.

When Adobe gave up control over PDF, it reduced the near-term revenue it could have earned through selling PDF readers and creator apps. This undoubtedly lowered Adobe’s quarterly revenue for a while, but it enabled PDF to survive as a standard when many other Adobe standards have withered away. Plus Adobe managed to keep a nice business selling PDF management software to large companies.

—Amazon has been selling e-reader devices at cost for several years in order to jumpstart the market for ebooks. I doubt Amazon will ever make much money from its hardware, but it’s willing to make that sacrifice in order to control the ebook transition and establish itself as the standard electronic bookstore.

—Google doesn’t charge license fees to use Android in a smartphone. This played a huge role in the early adoption of Android by phone makers; I think there’s a good chance the OS would never have taken off if Google had tried to charge for it. Google obviously hopes to make the money back through bundled services, but it’s not clear how successful that will be, and in the meantime Android is a huge cost sink for Google.

—Many open source companies operate by giving away their software and then charging for services or other ancillary products related to them. This approach defers revenue until the software becomes established as a widely-adopted standard.

As I explain in Map the Future, strategies like this are very problematic for an analytical company that focuses on logical cost-benefit planning. The benefits of establishing a standard are usually nebulous and risky, while the costs are immediate and painful. Faced with that kind of choice, most analytical companies will focus on tangible near-term opportunities. Thus Adobe made the prudent and logical decision to make money from Flash Lite when it had the chance, rather than sacrificing revenue to possibly make it a standard in the future.

You made your choice, now you have to live with it.

In the tech industry, the road to hell is often paved with prudent business decisions.