Overshoot and Recreate:
Increasing Returns and Stages of an Enterprise

James B. Smethurst

03/17/1998

[Author's Note: This model was developed in collaboration with Bryan Coffman in July and August, 1997.
Please also refer to the traditional Stages of an Enterprise model.]

In the new, hyperchange economy, more and more organizations are discovering that traditional business models are no longer effective. Today's economy is demanding, unforgiving, and full of more opportunities than ever. Increasing returns is driving companies to approach growth in radically new ways, changing with it MG Taylor's Stages of an Enterprise model.

"Increasing returns" is a phenomenon that challenges the classical economic assumption that the more widgets that you have, the less each widget is worth--decreasing returns. If you have one TV, getting a second one is not terribly important, and a third becomes trivial. Increasing returns postulates that the more widgets are out there, the MORE valuable each one becomes. Kevin Kelly ("New Rules for the Network Economy") uses the example of the fax machine. The first fax machine ever produced was worth nothing--there was no one to send a fax to. The second fax machine made the first one valuable. Now each additional fax machine sold adds value to every fax machine sold before it because it ADDS TO THE NETWORK of fax machines. There are now more people who can send and receive faxes. Thus the value of fax machines comes not from their scarcity, but rather from their plenitude!

The story of increasing returns is one of market share. Take another example of increasing returns: the VHS vs. Betamax wars. It is generally agreed that the Beta was the better machine, and yet the VHS is now not only dominant, but exclusive in the marketplace. How did this happen? Wouldn't "rational" consumers choose the better product? The surprising answer is that, while rational, the success of VHS depended on chance as much as anything else. When VHS and Beta first hit the market, no one knew which was the better product. For some reason (or no reason), a few more people bought VHS than Beta. Now an interesting thing begins to happen. People who are considering buying VCR's ask their friends what they should get, since it is convenient to be able to share video tapes or to have a friend record a program for you. Thus more people began buying VHS than Beta since a majority of their friends had VHS. Now video rental stores began popping up, and it made very little sense for them to stock BOTH VHS and Betamax tapes. After doing a little market research, more rental store owners chose to invest in VHS tapes than Beta tapes. This, in turn, encouraged more buyers of VCRs to purchase VHS machines, since those were the tapes that were more readily available. Thus increasing returns turned a very small initial difference in market share into VHS's market domination and Beta's extinction. By becoming the market standard, VHS made its competition irrelevant. VHS defined the market.

There have been a few companies, mostly in the high-tech industry, that have learned the lesson of increasing returns: you must gain market share fast and cheap in order to become the standard in a new market. This requires very rapid growth from the beginning in order to jump-start the increasing returns cycle that will allow you dominate a market and generate revenue down the road. This rapid growth should eliminate the competition, but it also generates a momentum of growth that is very likely to be unstable. This is the "Overshoot and Collapse" path that the traditional Stages of an Enterprise model warned us against BECAUSE it was unstable. In an economy where instability is the rule, invoking Overshoot and Collapse in order to gain market share (or create a new market) becomes the preferred path.

America OnLine is a terrific example of this approach, although it is arguable if it was their intention to do so. AOL's initial growth was astronomical. With heavy marketing and incentives for joining, AOL attracted, literally, more members than it could handle. At the moment when the Internet was becoming popular, AOL offered people an easy way to get on board, and it offered special incentives for members who enticed their friends to sign up. As a way of keeping members, AOL allowed members access to exclusive chat rooms, the ability to view who among the other AOL users they knew were currently signed onto AOL, and the happy ability to retract e-mails sent to other AOL users before they were viewed. When they maxed out their capacity and users frustrated with busy signals began switching to local ISPs, AOL quickly ramped up their capacity by orders of magnitude--not to handle the members they had at the time, but to handle the membership they hoped to reach in the future.

The lesson here is that of re-creation. The initial rapid growth of a company should win it market share, but it will not be a stable entity. The question comes quite rapidly--as soon as the company hits its peak and begins to turn down the "Collapse" curve--"What do you want to do with this market?" At this point, you have customers and a huge share of the market. Now what? What do you want to create now? It is at this moment that you must push the Entrepreneurial Button and recreate your company. Create a vision for what you want to do with your new-found market and build to that vision. Fixing the glitches in the current system will be too slow, too inefficient, and generally futile. Like AOL, you must build your capacity for the future of the market you just created. Now that you have their attention, drive them to a new place. Only by recreating the organization to achieve something newer, bigger, better and different can you hope to pull the organization out of its collapse path and onto a successful curve--a curve, incidentally, that would be impossible WITHOUT having first gone through the Overshoot and Collapse path.

The on-going browser wars are another manifestation of this phenomenon. Microsoft can give away its Explorer because it makes its money off of other products and services that the Explorer makes available to its users. Kevin Kelly calls this "Follow the Free", but the curve is the same for products as well as organizations--give away a lot of it cheap in order to win market share, and come in later to USE the market to generate profit.

It is also an interesting exercise to look at the battle between the Macintosh and the PC from the same vantage point. Because it was licensed to just about anybody to manufacture, the PC became the standard in markets across the world, which allowed software and hardware developers both to focus on one operating system and innovate their products by having so many more people working on the same problems. Apple held very tightly to the Macintosh and therefore lost the ability to have licensees innovate and enter new markets for them.

This approach to growing a business or generating products is laden with risk, but ironically enough, it is becoming the safest way to proceed in an economy driven by change. By keeping the Entrepreneurial Button in mind, by being willing to let go of the ladders that got them to where they are, organizations can grow rapidly enough to dominate markets yet stay nimble enough to survive through and to thrive on re-creation.

See also: Looping and Leaping: Quantum Mechanics and Stages of an Enterprise

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