Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
  • How do you encourage speedier adoption of your product or service?
  • How do you increase the value your product or service creates for your customers?
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  • Anonymous said More
    Well written. Well constructed. Tuesday, 13 August 2019
  • Ron Giuntini said More
    As always a good read.
    I have always... Thursday, 25 January 2018

A copy of the full analysis can be downloaded by clicking on the link at the bottom of this blog entry.

 

In Playing the Same-Day Delivery Game Part 1, I discussed the differences between shopping experiences that take place in-stores vs. online, and I noted that same-day delivery services aim to provide shoppers with much of the convenience of online shopping, without the associated delays. I then discussed the Last Mile problem, which has historically been an impediment to the cost-effective provision of same-day delivery services.

In Playing the Same-Day Delivery Game Part 2, I discussed various configurations of delivery networks, including hub-and-spoke systems, aggregator systems, point-to-point aggregator systems, and point-to-point systems.

In Playing the Same-Day Delivery Game Part 3, I discussed the different options for delivery network operations — in-house and outsourced, and others — and the barriers to adoption of same-day delivery services, namely, will enough customers and suppliers sign on?

In Playing the Same-Day Delivery Game Part 4, I discussed why same-day delivery services have reappeared recently, after having been tried and failed in the late 1990s. In particular, I note that over the past decade, there have been tremendous advances in logistics technologies, which have significantly decreased the costs of providing same-day delivery services. I also note that Amazon's and Google's forays into the same-day delivery market are driven by more than just providing delivery services. Specifically, the two companies are seeking to (i) grab a share of the grocery market, (ii) increase their respective shares in the product search market, (iii) generate access to consumer use data, (iv) generate direct access to consumers, and (iv) generate spillover effects to other parts of their technology ecosystems.

In this part of the analysis, Part 5, I discuss how I think different aspects of the same-day delivery game will evolve.

 

Will Enough Consumers Sign Up?

Will enough people participate in same-day delivery services and use them frequently enough to support operations?

As an aside, an interesting paradox regarding same-day delivery services is that such operations will be most cost effective precisely in those areas – dense urban markets – in which it is most convenient for consumers to go out to the stores and pick up supplies on their own.

As I see it, one of the biggest hurdles Amazon and Google face is the long delivery lag. That is, orders must be placed in the morning for delivery in the evening (for people who place orders for Amazon and for people who place orders with Google and aren’t able to get the earlier delivery slots they want). Is this type of delivery with a lag substantially more valuable than next-day service or two-day service, both of which are significantly less expensive to provide? If so, then Amazon and Google do stand a chance.

However, this last question begs the next question: To what extent do people who value same-day delivery services wait until the last minute to place their orders? On its website Instacart says “Most customers choose to have delivery in the next 2 hours.” If, in fact, most people who value same-day delivery services are actually looking for delivery within the next hour or two, then Amazon and Google (and other hub-and-spoke providers) might have a difficult time signing up customers for their delivery services, which require a longer delivery lag. At the same time, if people do want rapid delivery services, then point-to-point systems, both in-house and outsourced (such as Instacart, Deliv, Postmates, etc.), will have an easier time signing up customers than will Amazon or Google.

 

Will Price and Delivery Competition across Suppliers Increase?

The advent of showrooming has ended up forcing bricks-and-mortar stores either (i) to match online prices; (ii) to increase provision of value-added services to justify higher prices in stores; and/or (iii) to discontinue providing the same products that can be  found online for lower prices, or otherwise lose sales to online suppliers (see, for example, Sterling Wong, “Three Ways Retailers Are Fighting Back Against Amazon and the 'Showrooming' Effect”).

Will the availability of same-day delivery services have a similar impact on prices as showrooming did, that is, will it force suppliers to meet prices of low cost suppliers? Also, will the availability of same-day delivery services by some suppliers eventually force all suppliers to offer such services or risk losing business?

The forces driving the practice of showrooming are distinct from those driving the demand for same-day delivery services. The former is induced by a desire for low prices while the latter is induced by a desire for convenience. It follows that there is no reason to believe prices will be forced down as a result of the availability of same-day delivery services. In fact, there is every reason to believe that people using same-day delivery services will end up paying more for the convenience.

The current providers of third-party (outsourced) same-day delivery services provide web interfaces (apps) to users through which orders are placed. When customers order through these interfaces, they are (currently) not able to benefit from club prices, coupons, or in-store specials. In fact, some suppliers charge higher prices on items ordered for same-day delivery than they do for (regularly-priced) items purchased in-store. Finally, customers are constrained by product availability. For example, a customer seeking to purchase a potato may be forced to settle for a 5-pound bag of potatoes if that is all that’s available for delivery. (See, for example, “Grocery Delivery Faceoff – Amazon Fresh, Instacart, WalmartToGo, Safeway”). In support of these claims, Joseph Pisani, in “What's better for grocery delivery: Google, Instacart or Postmates?” has this to offer from his experience using same-day delivery services:

Besides delivery costs, Instacart charges a premium for items from some of the stores it delivers from. That means you will end up paying a lot more than if you walked over to the shop and bought it yourself.

Another downside: getting your groceries delivered means you may be missing out on using coupons or browsing for cheaper alternatives in the store.

For any of these reasons, prices for goods purchased for same-day delivery (by third-party suppliers) should be expected to be no lower (and probably higher) than those purchased in-store.

To the extent that people who value convenience are also looking for low prices, they might not end up using same-day delivery services, due to high prices. Perhaps they will resort to alternative convenience measures, such as curbside delivery services.

The same arguments as to why prices will not decrease due to the availability of same-day delivery services also answer the question as to whether the availability of same-day delivery services by some suppliers will eventually force all suppliers to offer such services or risk losing business. We’ve just established that customers who use same-day delivery services will probably end up paying higher prices for the convenience.  It follows that anyone who values lower prices more than they value the convenience of delivery will opt to do their own (in-store) shopping.  Assuming there are enough customers who value low prices and thus continue to shop in stores in search of bargains, then suppliers who cater to these customers who value lower prices will not be forced to offer same-day delivery services.

 

Will Participating Suppliers Miss Out on Impulse Purchases?

Will suppliers who participate in same-day delivery programs lose out on impulse purchases? And if so, will losses of in-store sales more than be made up for by increases in delivery volumes?

A reader of an article I read commented that customers who order groceries for delivery are still vulnerable to impulse purchases that appear in the suppliers’ on-line listings. I was skeptical; my sense – based on no evidence in particular – was that people who shop in-store are more subject to impulse purchases than people who shop online. Then I found this interesting tidbit from Steven Norton, in “Whole Foods CIO Says Apple Pay, Instacart Paying Off”, which blew away my priors:

Whole Foods’ partnership with grocery delivery app Instacart has resulted in digital shopping carts 2.5 times the size of their brick-and-mortar counterparts. The growth in part has to do with the fact that customers don’t have to spend time walking around a grocery store, Mr. Buechel tells CIO Journal. “When you can shop in a fraction of the time, you’re open to probably having a much larger basket.” Using Instacart, Whole Foods can also recommend products or push promotions directly to customers’ phones.

Mr. Buechel says the partnership, which brings groceries to someone’s door in as little as an hour, has also helped surface new customers who may have shopped at other stores out of convenience, or didn’t see the immediate value of Whole Foods’ products.

 

Will Retailers with Loyalty Programs Use Outsourced Delivery Services?

Grocery stores are particularly active in loyalty programs, as are many of the larger chain stores, such as Costco, Office Depot, and others. Through these loyalty programs, these retailers actively pursue customer loyalty and they collect consumer use data, which they analyze for ways to increase sales. When suppliers outsource their same-day delivery services, it is the third-party suppliers who collect the consumer use data, which the third-party suppliers (currently) do not share with the original suppliers (e.g., grocery stores). Will suppliers who provide loyalty programs to their customers willingly cede this consumer use information to Google/Amazon in exchange for their provision of same-day delivery services?

I seriously doubt it. As early Google experiences suggest (the loss of Office Depot as a customer and the failure of Target to expand into new markets), many of the larger chain stores will probably end up keeping their data and providing their own delivery services. They are large enough so as to be able to generate delivery economies on their own, and their access to consumer use data and direct customer relationships is simply too valuable to cede to third-party service providers, especially those who have the potential to ultimately squeeze out the suppliers and deal directly with customers.

When I presented this idea at my Game Theory Meetup, one of the attendees made a keen observation. He noted that it is possible that the larger chain stores could benefit from contracting out their (same-day) delivery services to (non-Amazon/Google) third party suppliers, where the sales process takes place through the chain store, and only the delivery part is outsourced. In this case, the chain stores will still collect all their customer data, while also benefitting from lower delivery costs that outsourced providers could generate.

 

Will Amazon and Google Drive Out More Viable Service Providers?

Amazon and Google are using same-day delivery services to achieve other ends (see previous section What’s Really at Stake in the Same-Day Delivery Game). As such, they can afford to continue to provide same-day delivery services, even if that business unit never becomes profitable on its own. Will the ability of Amazon and Google to run their delivery services at a loss drive out more economically viable delivery services providers?

Other (non-Amazon/Google) delivery services providers fall into three categories, (i) outsourced hub-and-spoke delivery services providers, (ii) in-house delivery services providers, (iii) outsourced point-to-point delivery services providers.

 

Traditional Hub-and-Spoke Delivery Services Providers

Traditional hub-and-spoke delivery services providers include, for example, FedEx, UPS, and USPS. There are two, relevant, distinguishing characteristics of these traditional providers. First, they provide international, national, and regional delivery services, in addition to local delivery services. And second, they provide delivery services for business-to-business (B2B), business-to-consumer (B2C), consumer-to-business (C2B), and consumer-to-consumer (C2) deliveries. In contrast, the same-day delivery services Amazon and Google provide are exclusively for local, B2C deliveries.

Note that Amazon is using USPS for some of its AmazonFresh deliveries, so the USPS may gain more revenues than it loses from Amazon’s foray into same-day delivery segment. Note also that the traditional delivery services providers don’t currently provide delivery services in the (non-ecommerce) grocery segment that Amazon and Google are battling over. As such, the traditional providers cannot be driven from markets that they don’t currently serve.

It is possible that Amazon’s and Google’s same-day delivery services of non-grocery items may cut into local, B2C deliveries of the other traditional delivery services providers. However, the other providers will still have non-local and non-B2C delivery services to fall back onto. So while they may lose market share in certain local market segments, they will certainly not be driven entirely out of business.

 

In-House Delivery Services Providers

In-house delivery services providers include Costco, WalMart, and Office Depot.

As with Amazon and Google, in-house delivery services providers have more at stake than simply profits generated from delivery services, namely customer loyalty and consumer use data. More specifically, in-house delivery services providers can afford to lose money on delivery services, if the provision of such services enables them to offset any losses either (i) by retaining profitable customers, and/or (ii) by retaining consumer use data that they would otherwise have to cede to outsourced (e.g., Amazon or Google) delivery services providers.

If Google or Amazon eventually generate large enough economies of scale in the provision of same-day delivery services, then at some point it may, in fact, become more profitable for in-house providers of delivery services to outsource those operations to Amazon or Google. However, I suspect that exclusive access both to consumer use data as well as to consumers themselves is valuable enough to the large chain stores that they will continue to provide their own delivery services in-house.

 

Point-to-Point Delivery Services Providers

Point-to-point delivery services providers include traditional couriers, together with new startups, such as Deliv, Instacart, and Postmates.

Of the three categories of delivery services providers, the point-to-point delivery services providers are probably the most vulnerable to competition from Amazon and Google. In fact, Instacart is competing head-to-head with both Amazon and Google for the grocery segment, which makes it perhaps the most vulnerable of the delivery services providers to competition from Amazon and Google. However, Instacart seems to be holding its own against the two tech giants, in particular, by being able to pick out good quality produce and by offering faster delivery times.

 

Which Pricing Model for Same-Day Delivery Services Is Optimal?

Behavioral economics suggests a subscription pricing model — specifically a monthly subscription model — would probably work better than either a pay-per-delivery model or an annual subscription model for generating same-day delivery sales volumes.

Consider the analogous example to delivery services provided by John Gourville and Dilip Soman in “Pricing and the Psychology of Consumption”:

Consider this example. Two friends, Mary and Bill, join the local health club and commit to one-year memberships. Bill decides on an annual payment plan — $600 at the time he signs up. Mary decides on a monthly payment plan — $50 a month. Who is more likely to work out on a regular basis? And who is more likely to renew the membership the following year?

Almost any theory of rational choice would say they are equally likely. After all, they’re paying the same amount for the same benefits. But our research shows that Mary is much more likely to exercise at the club than her friend. Bill will feel the need to get his money’s worth early in his membership, but that drive will lessen as the pain of his $600 payment fades into the past. Mary, on the other hand, will be steadily reminded of the cost of her membership because she makes regular payments every month. She will feel the need to get her money’s worth throughout the year and will work out more regularly. Those regular workouts will lead to an extremely important result from the health club’s point of view: Mary will be far more likely to renew her membership when the year is over.

As the gym membership example illustrates, same-day delivery services providers benefit more in several ways when their subscribers use their delivery services more frequently. First, the delivery services providers benefit from the added economies of scale. That is, each added delivery serves to decrease the average cost of providing all other deliveries. Second, to the extent that delivery services providers generate fees from suppliers based on the volume of delivery services provided to consumers, delivery services providers benefit more when they provide more delivery services. And finally, consumers who use their subscription services more intensely generate more value from their subscriptions and are thus more likely to renew their subscriptions then less intensive users. And since monthly subscriptions should generate more deliveries than annual subscriptions, monthly subscriptions should be more valuable than annual subscriptions to customers, suppliers, and delivery services providers alike.

One of my Game Theory Meetup attendees challenged my conclusion. He claimed that people who use subscription services in which regular (i.e., monthly) payments are automatically charged to their accounts wouldn’t necessarily feel any more “pain” from monthly payments as they do from annual payments. I absolutely agree. Studies in behavioral economics show that people feel less “pain” when they use credit cards than when they use cash, and they also become inured to regularly scheduled payments. It follows that a monthly pricing scheme in which customers make regular credit card payments for their same-day delivery services might not, in fact, end up generating (much) more usage of same-day delivery services than annual payments.

 

Which Same-Day Delivery Service Providers Will Eventually Prevail?

There are large economies of scale in the provision of same day delivery services. Unless a market (e.g., city) is large enough to exhaust these economies of scale, one would expect there to be few eventual survivors (if any) in the market. So will multiple or overlapping same-day delivery services providers end up surviving, or will the providers end up partitioning themselves into distinct market segments?

To the extent that customers in different market segments have different needs, delivery service providers might do best by specializing in those specific needs. Figure 4 provides a list of consumer product market segments, together with special needs that effective delivery services providers should fill. For example, Instacart seems to be gaining momentum as a delivery services provider that specializes in same-day deliveries of groceries by providing well-chosen perishables and speedy deliveries.

Figure 4

However, the problem with specialty delivery services, such as Instacart, is that consumers who want the option of purchasing items for delivery across different market segments will have to subscribe to multiple delivery services. Is the value to these customers of any special needs worth the extra costs of multiple subscriptions? If not, then specialty delivery services might not end up with enough customers to be profitable.

To the extent, then, either that (i) the value of specialty services is not worth the cost of subscriptions to multiple delivery services, or (ii) customers tend to purchase items across different market segments for a single delivery, then delivery service providers might do better by providing a variety of offerings. Presumably, this is the whole point of Amazon’s and Google’s delivery services.

I suspect that given what’s at stake (see “What’s Really at Stake in the Same-Day Delivery Game”), neither Amazon nor Google will leave the market too soon even if their delivery services end up bleeding money.

As I mentioned in above (in the section Will Retailers with Loyalty Programs Use Outsourced Delivery Services?), I suspect that large chain stores (WalMart, Costco, Target, Office Depot) will end up providing their own in-house delivery services (or outsourcing just the delivery part of their sales) so as to maintain access to and control over consumer use data and consumer relationships.

Finally, as for the companies for which providing delivery services is their main focus, I suspect that most of these companies will not be able to generate enough daily sales volumes to cover their costs of operations. If they are to survive, they will probably have to supplement their delivery operations with some other value-added services.

 

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