"Reaching out, not building walls" might be one way to characterize the process of social networking. It is also an apt description of the core competitive strategy of firms in the social networking services industry, as new research by Virginia Tech Pamplin College of Business professors shows.
In what they believe is the first systematic empirical study of its kind, faculty members Devi Gnyawali and Patrick Fan investigated how social networking companies compete and how their competitive moves affect overall firm performance.
"Unlike traditional industries where firms try to build walls and protect advantages, firms in emerging digital industries, in general, and social networking companies, in particular, reach out to third-party developers and other partners," Gnyawali and Fan say. The firms undertake a variety of actions with these outside parties to "co-create value" in order to attract, retain, and satisfy their own users or customers and improve their companies' performance.
Social networking firms have changed the way people communicate and socialize with each other, the professors note. Departing from previous computer-based communication systems for e-mail and online forums, companies such as Facebook, MySpace, LinkedIn, and Twitter use Web-based software to connect users with friends, family members, business partners, or other individuals through such formats as text chat, messaging, video, voice, file sharing, and blogging, in addition to mail and discussion groups.
The professors, along with doctoral student James Penner, have written an article about their work for a special, "digital systems and competition" issue of Information Systems Research, a leading journal in the information systems field.
Their findings, Gnyawali and Fan hope, will help managers develop appropriate strategies. "A better understanding of the nature of competition and implications of competitive actions will allow managers to think in nuanced ways about how to successfully compete in this rapidly changing industry," the researchers wrote.
Gnyawali, an associate professor of management who specializes in studying how firms compete, collaborate, and create competitive advantage, and Fan, an associate professor of accounting and information systems and a specialist in data mining, business intelligence, and social computing, decided to focus on the social networking industry because of its unusual characteristics; the widespread popularity of its services; and its "explosive growth" over the past three years, which has made it "one of the most dynamic segments of the Web 2.0 industry."
Gnyawali notes that a 2008 Morgan Stanley report showed that 6 of the top 10 Internet sites are social — none of which were on the list in 2005 — and that Facebook and YouTube had more page views than Google or Yahoo. Facebook has more than 250 million active users, while MySpace has nearly 130 million active users, according to the companies' Web sites.
The need for more scholarship on firms in the digital industry, which use the Internet and information technology to provide goods and services, was another reason for Virginia Tech's work. Information systems scholars, Fan says, have examined the strategic roles information systems and information technology play in a firm, but "few scholars have systematically and holistically examined the digital industry's competition dynamics."
Management scholars, Gnyawali says, have extensively studied competition dynamics, but their research has focused on publicly traded companies in such traditional industries as airline, pharmaceutical, steel, and computer. "Thus, while newer forms of industries are emerging, and digital technologies are becoming very critical in these industries, we don't know the ways in which firms in such emerging digital industries compete," he says. "Our research addresses this critical issue."
Building on research in both information systems and strategic management, Gnyawali and Fan developed a conceptual model to examine competition in the social networking industry from two strategic perspectives: "value co-creation," meaning how firms "create perceived and real benefits for their users by engaging other parties as partners and contributors"; and "repertoire of competitive actions," which refers to the volume as well as complexity or diversity of competitive moves.
The researchers analyzed their model with archival data they collected on the competitive actions of the 52 largest firms (in terms of membership). They identified 15,000 news reports on these firms over three years: 2005, 2006, and 2007. A computerized text analysis software program they developed flagged key action words in the news reports, Fan says, and "allowed us to eliminate reports that did not contain purposeful competitive intent, such as an announcement of an annual report filing." The software program also recorded the date, source, and number of words in the article.
Competitive actions tend to be industry-specific, Gnyawali says. "So we took extensive steps to ensure that our list of actions is highly relevant to the social networking industry." These included examining business press and industry-specific research and seeking feedback from industry experts. The researchers ended up identifying 47 different categories of actions, which they defined for coding and analysis purposes. "We made sure that our list is both comprehensive and relevant, so that it can be used by other researchers for further studies on the industry," he says.
Lacking access to firm revenues, income, and other financial data, the professors used page views as a measure of firm performance. A market-based performance metric such as user traffic, they note, is the best alternative, especially in an industry with strong network effects and where ad-based revenue generation increases with page views. Other researchers, they point out, also view Web traffic as an important non-financial indicator of Internet firms' performance.
Their results, Gnyawali and Fan say, show that "firms that undertake value co-creation actions enhance their performance." Furthermore, firms that undertake a complex action repertoire — strategic actions on diverse fronts, rather than "a large volume" of actions or a concentration of efforts in a few areas — achieve better performance.
Explaining the first finding, Gnyawali says "social networking firms create value by leveraging the knowledge and expertise of third-party developers to develop applications that will help entice, engage, and delight users, and by collaborating with other companies to extend the usefulness of the social networking firms' sites through product development, new market penetration, and pursuit of new uses of existing products and services."
Regarding their finding on action repertoire, Gnyawali says firms that undertake complex actions make it more difficult for their competitors to understand the intent and consequences of the various actions, the researchers argue. "Moreover, because each type of action requires commitment of different types of resources," Gnyawali says, "rivals find it very difficult to match a firm's complex actions — which provides a window of advantage to the firm." Lastly, a firm that undertakes many types of actions is likely to have developed capability in multiple areas and can leverage these capabilities to offer better products and services and attract more users.
The surge in recent years of Facebook relative to then market dominant player MySpace, the researchers note, highlights the impact of the complexity of actions on firm market performance. MySpace had "first-mover" advantage in music downloading and grew tremendously — more than 300 percent (in page views) from November 2005 to November 2006 — as it expanded its music, photo, and video capabilities. However, its growth has since slowed, while Facebook undertook competitive moves on multiple fronts: being more inclusive in membership, being the first to open the platform to allow co-development with third-party vendors, actively pursuing alliances, and continuously creating and improving services.
Working with complex technologies and rapidly changing business environments, social networking firms must constantly look out for sources of advantage, Gnyawali says. "The rules of the game could be changed by one firm's major competitive actions, and firms need to keep innovating their products and services in order to engage and lock in customers."
Their study, Fan says, suggests many possibilities for future research. "We examined all alliance actions and did not distinguish among competitor, supplier, and cross-industry alliances. As the industry evolves and alliances become more pronounced, it would be interesting to examine the extent to which alliances are made with direct competitors and what implications they have for firm strategy and performance."
Future research, he says, "could delve deeper into the role of users and advertisers in value co-creation, and the role of information systems and information technology in collaborative and competitive actions."
The researchers note several limitations of their study. The private nature of the social networking industry was a major obstacle, preventing them from collecting a variety of information, including "meaningful financial measures of firm performance," or using common, firm-level control variables such as assets, market capitalization, or number of employees.
They were unable to obtain information on advertisers and the amount they paid to social networking firms and were unable to gather data on users — a significant shortcoming, the researchers felt, given the important role that "experienced and passionate users" play in improving the quality of social networking services. "Having data on how users are engaged in the value co-creation process would have produced even more interesting findings," the researchers note.
Nevertheless, their study has produced interesting insights about the pattern of firm competitive actions in an emerging and rapidly growing industry, Gnyawali and Fan say, and has important implications for future research and management practice.
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