Ad-Sponsored Entrants Increase Competition

Powerful web-based technologies and increased acceptance of online businesses have lowered the barriers to entry for companies which base their strategy on ad-revenue based business models. These intruders compete in industries including newspapers, software applications, television programs, and online search. How should an existing market participant with a subscription-based business model react to the new entrant(s)?

Business school professors Ramon Casadesus-Masanell (Harvard Business School) and Feng Zhu (University of Southern California) explain an analytic framework to analyze that question in an article, “Strategies to Fight Ad-sponsored Rivals,” in the Oct 26, 2009 HBS Working Knowledge (http://hbswk.hbs.edu/item/6298.html).

First, they defined four business models found in these markets:

1. Subscription only: 100% of revenue comes from subscriptions or user fees
2. Ad-sponsored only: content is free and all revenue is generated by ads
3. Mixed single-product: the majority of revenue is received via subscriptions and/or fees for access to a single product/service and a limited number of ads are seen by subscribers
4. Mixed product line extension: a new product line is supported by advertising while the original product line is maintained as subscription only

What should an incumbent with a subscription only business model do if a new firm enters the market with an ad-sponsored business model? Incumbents prefer to maintain their subscription only model. Think Apple iTunes vs. free sites. This is especially true if advertising rates are low since the intruder will have less opportunity to generate revenue and the incumbent less incentive to switch to or add an ad-based revenue model to the organization. The incumbent and the new entrant may co-exist in the marketplace.

However, when advertising rates are high, the incumbent may want to establish its own ad-based offering to compete directly with the intruder. This option is most likely to kill the competing ad-based entrant, but with lower profits in the meantime as some of its customers switch from the subscription service to the lower-quality ad-based offering.

The potential path for the incumbent is less clear when: 1. Users’ reaction to advertising is highly negative 2. Advertising rates are low 3. The cost of a product line extension is high

In these cases, the dynamics of the industry and the participants must be carefully analyzed to determine the optimal action. The authors point out that extending the product line is often not optimal because of the increasing likelihood of conflicting marketing messages and the inefficiencies of maintaining multiple product lines.

How does their theoretical model work in the real world? The authors cited two examples from the newspaper industry to illustrate what happens when incumbents operating under a paid subscription model adopted a mixed product-line extension to drive competitors out of their markets:

“By taking a significant stake in Metro Boston in 2006, The Boston Globe effectively switched from a mixed-single-product model to a mixed-product-line-extension model. This strategy helped The Globe push BostonNow, a free ad-sponsored entrant launched in 2007, out of the market in less than a year.”

“We observed a similar pattern in Spain. While Metro in Spain was successfully launched in 2001 and by 2004 had achieved profitability, the competition with Que!, an ad-sponsored paper launched in 2005 by Recoletos (a large media group), forced it to shut down its operations in 2009 (http://spanishnews.es/20090201-free-metro-newspaper-ceases-to-exist-in-spain/id=195/, accessed April 2009).”

How do this theoretical framework and examples apply to your industry, especially real world competitive landscapes are much more complex than this framework?

If you are an incumbent, you must examine how negatively your users would view advertising in your subscription product, how expensive would a product line extension be, and what is the sweet spot for profits, not revenue. You may choose to lose some customers to ad-supported competitors because the maximum profit potential lies in adhering to a pure model.

If you are an ad-sponsored entrant, analyze the incumbents’ likely responses to your presence and determine the trade-offs between maximizing advertising revenue and customers, and profitability.

There may be room in the marketplace for both a pure subscription model and a pure ad-sponsored model, because, as the authors note, organizations do best when they focus their strategies and do not try to be all things to all people.