March 2011

"No man is an island, entire of itself; every man is a piece of the continent, a part of the main."

John Donne

Abstract

In the information and communication technology (ICT) sector, a revolution is underway in the delivery channel of mobile service (or application) production and provision, and application stores are building up a central position as intermediaries in service delivery. The market is transforming from being one-sided to being two-sided. Thus in this article, we focus on integrating the business model concept with value co-creation with respect to the emergence of two-sided markets and intermediaries. As the transformation from a one-sided to a two-sided market and the birth of intermediaries bring forth value co-creation possibilities, this article aims to find out how value can be co-created in different mobile service production and provision models.

Introduction

Volatility in the competitive environment forces firms to reinvent value instead of just adding it. In addition to reinvention, different economic actors have to work together in order to co-create value. With many innovations, value is co-created through intense collaboration and complex business models. This is highlighted especially in the ICT sector, where several other factors also contribute to the urgent need for the business model to become more comprehensive in terms of value co-creation.

Most of the business model literature has focused on value creation towards the customer; this is one-sided market logic. In one-sided markets, the traditional value chain applies, as shown in Figure 1a. Value moves from left to right, meaning that the left (upstream) represents cost, and the right (downstream) represents revenue. In the two-sided market, as shown in Figure 1b, there are distinct participants on each side, both of which represent cost and revenue. However, this duality of both sides representing cost and revenue is often neglected. Even in the presence of two-sided markets, the one side is often treated as a source of profit while the other side is treated as a loss or as financially neutral.

Figure 1. Value and Revenue Flow in One-sided and Two-sided Markets

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Business Models for Two-Sided Markets

A typical two-sided market in the information era brings together two groups of users, namely suppliers and customers. Examples of these two-sided markets include personal computer operating systems (which bring together software providers and users), web search services (which bring together information providers and seekers), video games (which bring together game developers and players), and online recruitment sites (which bring together employers and job seekers). In the telecommunications industry, the proliferation of application stores has transformed a previously one-sided market into a two-sided market. On one side of the market, there are third-party application developers, who have previously lacked an attractive delivery channel to end-users, such as the Internet has provided for software developers to reach users. On the other side of the market, there are mobile phone users, especially smartphone users, who are hungry for value-adding services that are easy-to-download, easy-to-use, and even free-of-charge. As a two-sided market, application stores give birth to a new delivery channel choice for application developers.

Application stores act as intermediaries between the two sides of the market. They have become the hubs of the telecommunications industry value chain and representing a delivery channel revolution, particularly from the perspective of application developers. Application stores also generate the need to redefine the business model with value co-creation. We argue that the telecommunications industry, to which the Internet world has brought major technological changes and revolutionary commercial changes, is adopting new models of providing the communication and related services or applications. These new models combine the most suitable features from traditional and new approaches so that telecommunications operators can operate in a more agile and co-operative manner.

Based on our empirical data, we have identified four different types of mobile service production and provision models, which will be described in the next section. These models represent different types of delivery channel choices available to application developers.

Choice of Delivery Channel

In general, an application developer has three different delivery channel choices in their pursuit to provide a service (or application) to an end user: the direct channel, the operator channel, and the application store channel. For the application developer, the sales and distribution challenge is to reach an end-user audience that is as broad as possible. For independent or smaller developers, this challenge may be greater because of limited marketing resources; acquiring the attention of their target audiences often requires multiple resources beyond those required to develop the service or application. Similarly, both consumer and business end users, have an interest to gain information and offers from services and applications that potentially provide utility, entertainment, or enhancements. End users cannot approach all relevant developers or even acquire knowledge of their products and offerings. Furthermore, it requires significant technological knowledge to be able to distinguish the suitability of the service or application to the end user’s mobile terminal or access network. Direct distribution of services or applications (i.e., the direct channel), is likely to lead a very fragmented, expensive, and non-user-friendly environment due to the phenomenon called the long tail.

Figure 2 illustrates the four different types of mobile service production and provision models. They represent the different delivery channel choices available to applications developers, the two-sided market phenomenon, and also value-creation possibilities. Production is required with services and applications that have an online element, meaning they utilize server or backend infrastructure. Similarly, we can include certain support and maintenance requirements, even for standalone application. In addition to production, provision includes packaging or bundling, customer management, billing, branding, marketing, sales, and customer acquisition. Thus the delivery channel choice also represents a business model choice and leads to value co-creation possibilities.

Figure 2. Models of Mobile Service Production and Provision

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Traditional operator model: The Internet is changing the way services (or applications) are being provided and used. In the telecommunications sector, application developers have traditionally chosen the telecom operator as their delivery channel when reaching the consumers and enterprise end-users. The applications provided are usually white labeled (branded under the operator’s brand name). The operators have traditionally managed – and created value through – both the technology and service provision. Traditional communication services, like voice and SMS, have been produced and provided by the operators, who have invested in networks and service platforms, as well as operated them for service production. The operators have, at the same time, acquired the customer, managed the customer relationship, and billed the customer, as well as packaged and marketed the service. This is the traditional operator model of providing services.

The traditional model of distributing services and applications to mobile devices is operator centric, where the mobile operator provides the services and application with their communication and access offerings. Where the basic technology may be provided by various sources, the operators develop, operate, package, and bundle the services. They are also handling customer management, marketing communications, and sales activities. The operator-centric model has been dominant in an environment where mobile devices are closed and no real external interfaces are opened for external service provision. The value capture is clearly in the operator’s hands.

Application store model: End users are becoming familiar with the service-provision model from the Internet: services are being made simple to download and easy to use, even free of change. During the past few years, there have emerged an increasing number of terminal-dependent – and thus operator-independent – application stores. For example, Google’s Android Market, Apple’s App Store, and Nokia’s Ovi Store provide applications for corresponding communication terminals, or mobile phones. These stores even provide applications that can be used for communication services – the traditional operator services. This is the application store model of providing services.

Open operating systems in mobile devices have enabled the development of native applications on the particular environment. Mobile device manufacturers and providers of open operating systems have established market places, or application stores, to promote their environments and advertise an increasing number of services and applications based on their environments. Whereas the operator channel is limited to the geographical area where the mobile operator is operating, the application stores are practically limited to the certain mobile operating systems or devices from a certain manufacturers, thus limited the target market. Generally, the application stores act only as the distribution and billing channels. Everything from development and production to packaging and bundling are managed by the developer. Application stores form market places where the end users are able to find and purchase a great number of services and applications, but the fulfilling is the responsibility of the provider. Applications stores charge developers for the distribution and billing, but most of the value creation is gathered by the developer.

Managed service model or brand co-operation model: Between the two extremes shown in Figure 2, there are a number of potential ways of combining these models. In some communication services, operators outsource the technology and even creation of the service concepts to smaller, more agile players that are even able to produce the services in the Internet or the “cloud.” This results in faster service-creation times and more cost-efficient structures. Operators are able to brand the services and include them in their product portfolio, increasing the value brought to their customer. These are the managed service model and brand co-operation model.

Operators have many advantages in their markets: they have an existing customer base, a brand, a billing mechanism, an established distribution network, and, in many cases, a marketing budget among the biggest in the market area. However, operators are limited to their market area and a global or wide geographical presence requires co-operation with a number of operators. Furthermore, different operators have different interfaces to which the developers have to adapt. And in many cases, the operator channel may not be the most cost efficient for the developer. The operators know that they are the most prominent distribution channel for their customer and often price their services correspondingly.

Value capture in the operator channel model varies depending whether there is a contractor relationship or a revenue-sharing relationship, or whether the operator acts only as the billing mechanism. But in the cases where services are provided by the operator channels or with the operator banding, the developer has fewer possibilities to capture most of the value.

Impact on Value Co-Creation

In one-sided markets and in traditional value chains, value creation is sequential, with the value moving from left to right. With the sequences from left to right, value is ‘added’. However, with technological advancements, value is no longer created in a linear and transitive process; value creation is becoming less sequential, more synchronic, and more interactive.

Three types of value co-creation and related interdependence between the supplier and customer can be distinguished (Forsström, 2005). The first type is sequential, which implies that one party gives something to the other, thus making the output of one’s activity the input of another. This type of value co-creation and interdependence represents the linear value chain, one-sided market logic, and in our study, the traditional operator model.

The second type is pooled value co-creation and interdependence, which refers to supplier and customer or any two or more collaborating or coopetiting parties providing a joint pool of resources from which they both draw. In our study, this is the managed service model or brand co-operation model, where both application developers and operators need and benefit from the resources of the other.

The third type is reciprocal value co-creation and interdependence, where parties mutually exchange inputs and output and there is a need to learn from each other. This type of value co-creation involves the customer as a co-producer of value. Reciprocal value co-creation is present with our application store model.

Research Implications

The different models described in this article highlight several noteworthy issues. First of all, the traditional operator model represents linear and transitive-value-creation logic, thus making the model and the application developer’s delivery channel choice a manifestation of a one-sided market, where value in the chain moves from left to right and it is added in different stages. Thus, with respect to this type of delivery channel, value co-creation possibilities are narrow due to the inherent characteristics of the delivery channel.

Second, with the managed service model or brand co-operation model, value co-creation possibilities are relatively greater compared with the traditional operator model. However, the value creation process in these models is still more linear and transitive than synchronic and interactive. Thus, in terms of the number of market sides, the managed service model and brand co-operation model are still seen as representations of one-sided markets.

Third, the application store model is a true occurrence of a two-sided market, where the application store acts as an intermediary. Whereas the long tail of mobile applications makes it difficult for application developers to bring their applications to the awareness of a wide end-user audience, the application store model (or the “open garden approach”) can enable and stimulate the emergence of mobile applications along the long tail in a positive way. As a central hub, the application store offers visibility for application developers. Since the application demand is distributed over an increasing number of applications and the mobile application market is more fragmented than earlier, there is more variety both in supply and demand where niche products can achieve high usage among the few who adopt them. The increasing number of applications and greater variety of supply and demand accentuate the intermediary role of an application store in order to generate positive network effects. With the application store model, value creation is synchronic and interactive; hereby value is co-created.

While no model studied here is preeminent compared to the others, the developer has to make the choice between the channels and, as described in the study, the business model related to it. This choice is based on the application, the target market’s brand awareness, and above all, the developer’s strategy. Naturally one can choose multiple channels or accommodate channel decisions for the different target segments or markets. In this case, however, the developer has to maintain consistency between channels in order to avoid conflicting business models or pricing plans for individual end-customer segments.

Channels, operators, and application stores typically see application sales as a complementary tool for enhancing the attractiveness of their core product, such as a communication or access service for mobile service operators, or an end user device or platform for application store operators. In this sense, application sales have been seen only as an individual tool for creating competitive advantages in marketing. However, in recent years, the financial importance of application sales has increased along with the growth of the ecosystems and, subsequently, the number of applications and developers in the network.

Conclusion

This study illustrates that the inherent characteristics of the delivery channel have implications on the business model, both in terms of the delivery channel choice from the perspective of the application developer and in the function of the delivery channel from the perspective of the operator or application store. These delivery channel characteristics, such as value co-creation possibilities whether operating in a one-sided or two-sided market, have been discussed here in the context of mobile service or application production and provision but they also have relevance in other settings.

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