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Competitive Strategy

When Data Creates Competitive

Advantage
by Andrei Hagiu and Julian Wright

From the Magazine (January–February 2020)

Keith Negley

Summary. Many executives assume that customer data can give you an
unbeatable edge. The more customers you have, the more data you can gather, and
that data, when analyzed, allows you to offer a better product that attracts more
customers. You can then collect even... more

Many executives and investors assume that it’s possible to use

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customer-data capabilities to gain an unbeatable competitive

edge. The more customers you have, the more data you can
gather, and that data, when analyzed with machine-learning
tools, allows you to offer a better product that attracts more
customers. You can then collect even more data and eventually
marginalize your competitors in the same way that businesses
with sizable network effects do. Or so the thinking goes. More
often than not, this assumption is wrong. In most instances
people grossly overestimate the advantage that data confers.

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The virtuous cycles generated by data-enabled learning may look

similar to those of regular network effects, wherein an offering—
like a social media platform—becomes more valuable as more
people use it and ultimately garners a critical mass of users that
shuts out competitors. But in practice regular network effects last
longer and tend to be more powerful. To establish the strongest
competitive position, you need them and data-enabled learning.
However, few companies are able to develop both. Nevertheless
under the right conditions customer-generated data can help you
build competitive defenses, even if network effects aren’t present.
In this article we’ll walk you through what those conditions are
and explain how to evaluate whether they apply to your business.

What Has Changed?

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Companies built on data have been around for a long time. Take
credit bureaus and the information aggregators LexisNexis,
Thomson Reuters, and Bloomberg, just to name a few. Those
companies are protected by significant barriers to entry because
of the economies of scale involved in acquiring and structuring
huge amounts of data, but their business models don’t involve
gleaning data from customers and mining it to understand how to
improve offerings.

Gathering customer information and using it to make better

products and services is an age-old strategy, but the process used
to be slow, limited in scope, and difficult to scale up. For
automakers, consumer-packaged-goods companies, and many
other traditional manufacturers, it required crunching sales data,
conducting customer surveys, and holding focus groups. But the
sales data often wasn’t linked to individual customers, and since
surveys and focus groups were expensive and time-consuming,
only data from a relatively small number of customers was
collected.

That changed dramatically with the advent of the cloud and new
technologies that allow firms to quickly process and make sense
of vast amounts of data. Internet-connected products and services
can now directly collect information on customers, including
their personal details, search behavior, choices of content,
communications, social media posts, GPS location, and usage
patterns. After machine-learning algorithms analyze this “digital
exhaust,” a company’s offerings can be automatically adjusted to
reflect the findings and even tailored to individuals.

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These developments make data-enabled learning much more

powerful than the customer insights companies produced in the
past. They do not, however, guarantee defensible barriers.

Building Moats with Data-Enabled Learning

To determine to what degree a competitive advantage provided
by data-enabled learning is sustainable, companies should
answer seven questions:

1. How much value is added by customer data relative to the

stand-alone value of the offering?

The higher the value added, the greater the chance that it will
create a lasting edge. Let’s look at a business where the value of
customer data is very high: Mobileye, the leading provider of
advanced driver-assistance systems (ADAS), which include
collision-prevention and lane-departure warnings for vehicles.
Mobileye sells its systems mainly to car manufacturers, which test
them extensively before incorporating them into their products.
It’s crucial for the systems to be fail-safe, and the testing data is
essential to improving their accuracy. By gathering it from dozens
of its customers, Mobileye has been able to raise the accuracy of
its ADAS to 99.99%.

While insights from data are

powerful, they don’t guarantee
defensible barriers.

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Conversely, the value of learning from customers is relatively low

for makers of smart televisions. Some now include software that
can provide personalized recommendations for shows or movies
based on an individual’s viewing habits as well as what’s popular
with other users. So far, consumers don’t care much about this
feature (which is also offered by streaming service providers such
as Amazon and Netflix). They largely consider TV size, picture
quality, ease of use, and durability when making purchasing
decisions. If learning from customers was a bigger factor, perhaps
the smart TV business would be less competitive.

2. How quickly does the marginal value of data-enabled learning

drop off?

In other words, how soon does the company reach a point where
additional customer data no longer enhances the value of an
offering? The more slowly the marginal value decreases, the
stronger the barrier is. Note that when answering this question,
you should judge the value of the learning by customers’
willingness to pay and not by some other application-specific
measure, such as the percentage of chat-bot queries that could be
answered correctly or the fraction of times a movie
recommendation was clicked on.

Let’s say you graphed the accuracy of Mobileye’s ADAS as a

function of customer usage (total miles driven by car
manufacturers testing it) and found that a few manufacturers and
a moderate level of testing would be sufficient to achieve, say,
90% accuracy—but that a lot more testing with a bigger set of car
manufacturers would be needed to get to 99%, let alone 99.99%.
Interpreting that to mean that the customer data’s marginal value
was rapidly decreasing would, of course, be incorrect: The value
of the additional 9-percentage-point (or even a 0.99-point)

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improvement in accuracy remains extremely high, given the life-

or-death implications. It would be difficult for any individual car
manufacturer—even the largest one—to generate the necessary
amount of data on its own or for any potential Mobileye
competitors to replicate the data. That’s why Mobileye was able to
carve out a dominant position in the ADAS market, making it a
highly attractive acquisition for Intel, which bought it for $15
billion in 2017.

When the marginal value of learning from customer data remains

high even after a very large customer base has been acquired,
products and services tend to have significant competitive
advantages. You can see this with systems designed to predict
rare diseases (such as those offered by RDMD) and online search
engines such as Baidu and Google. Although Microsoft has
invested many years and billions of dollars in Bing, it has been
unable to shake Google’s dominance in search. Search engines
and disease-prediction systems all need huge amounts of user
data to provide consistently reliable results.

A counterexample of a business where the marginal value of user

data drops off quickly is smart thermostats. These products need
only a few days to learn users’ temperature preferences
throughout the day. In this context data-enabled learning can’t
provide much competitive advantage. Although it launched the
first smart thermostats that learn from customer behavior in 2011,
Nest (acquired by Google in 2014) now faces significant
competition from players such as Ecobee and Honeywell.

3. How fast does the relevance of the user data depreciate?

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If the data becomes obsolete quickly, then all other things being
equal, it will be easier for a rival to enter the market, because it
doesn’t need to match the incumbent’s years of learning from
data.

All the data Mobileye has accumulated over the years from car
manufacturers remains valuable in the current versions of its
products. So does the data on search-engine users that Google has
collected over decades. Although searches for some terms may
become rare over time while searches for new ones might start
appearing more frequently, having years of historical search data
is of undeniable value in serving today’s users. Their data’s low
depreciation rate helps explain why both Mobileye and Google
Search have proved to be very resilient businesses.

With casual social games for computers and mobile devices,

however, the value of learning from user data tends to decrease
quickly. In 2009 this market took off when Zynga introduced its
highly successful FarmVille game. While the company was
famous for relying heavily on user-data analytics to make design
decisions, it turned out that the insights learned from one game
did not transfer very well to the next: Casual social games are
subject to fads, and user preferences shift quickly over time,
making it difficult to build sustainable data-driven competitive
advantages. After a few more successes, including FarmVille 2
and CityVille, Zynga stopped producing new hits, and in 2013 it
lost nearly half its user base. It was superseded by game makers
like Supercell (Clash of Clans) and Epic Games (Fortnite). After
reaching a peak of $10.4 billion in 2012, Zynga’s market value
languished below $4 billion for most of the next six years.

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4. Is the data proprietary—meaning it can’t be purchased from

other sources, easily copied, or reverse-engineered?

Having unique customer data with few or no substitutes is critical

to creating a defensible barrier. Consider Adaviv, a Boston-area
start-up we’ve invested in, which offers a crop-management
system that allows growers (now primarily of cannabis) to
continuously monitor individual plants. The system relies on AI,
computer-vision software, and a proprietary data-annotation
technique to track plant biometrics not visible to the human eye,
such as early signs of disease or lack of adequate nutrients. It then
translates the data into insights that growers can use to prevent
disease outbreaks and improve yields. The more growers Adaviv
serves, the broader the range of variants, agricultural conditions,
and other factors it can learn about, and the greater the accuracy
of its predictions for new and existing customers. Contrast its
situation with that of spam-filter providers, which can acquire
user data relatively cheaply. That helps explain the existence of
dozens of such providers.

It’s important to keep in mind that technological progress can

undermine a position based on unique or proprietary data. A case
in point is speech-recognition software. Historically, users needed
to train the software to understand their individual voices and
speech patterns, and the more a person used it, the more accurate
it became. This market was dominated by Nuance’s Dragon
solutions for many years. However, the past decade has seen
rapid improvements in speaker-independent speech-recognition
systems, which can be trained on publicly available sets of speech
data and take minimal or no time to learn to understand a new
speaker’s voice. These advances have allowed many companies to
provide new speech-recognition applications (automated

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customer service over the phone, automated meeting transcript

services, virtual assistants), and they’re putting increasing
pressure on Nuance in its core markets.

5. How hard is it to imitate product improvements that are based

on customer data?

Even when the data is unique or proprietary and produces

valuable insights, it’s difficult to build a durable competitive
advantage if the resulting enhancements can be copied by
competitors without similar data.

A couple of factors affect companies’ ability to overcome this

challenge. One is whether the improvements are hidden or deeply
embedded in a complex production process, making them hard to
replicate. Pandora, the music-streaming service, benefits from
this barrier. Its offering leveraged the firm’s proprietary Music
Genome Project, which categorized millions of songs on the basis
of some 450 attributes, allowing Pandora to customize radio
stations to individual users’ preferences. The more a user listens
to his or her stations and rates songs up or down, the better
Pandora can tailor musical selections to that user. Such
customization cannot be easily imitated by any rival because it is
deeply tied to the Music Genome Project. In contrast, the design
improvements based on learning from the customer use of many
office-productivity software products—such as Calendly for
coordinating calendars and Doodle for polling people about
meeting times—can be easily observed and copied. That’s why
dozens of companies offer similar software.

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The second factor is how quickly the insights from customer data
change. The more rapidly they do so, the harder they are for
others to imitate. For example, many design features of the
Google Maps interface can be easily copied (and they have been,
by Apple Maps, among others). But a key part of Google Maps’
value is its ability to predict traffic and recommend optimal
routes, which is much harder to copy because it leverages real-
time user data that becomes obsolete within minutes. Only

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companies with similarly large user bases (such as Apple in the

United States) can hope to replicate that feature. Apple Maps is
closing the gap with Google Maps in the United States, but not in
countries where Apple has a relatively small user base.

6. Does the data from one user help improve the product for the
same user or for others?

Ideally, it will do both, but the difference between the two is

important. When data from one user improves the product for
that person, the firm can individually customize it, creating
switching costs. When data from one user improves the product
for other users, this can—but may not—create network effects.
Both kinds of enhancements help provide a barrier to entry, but
the former makes existing customers very sticky, whereas the
latter provides a key advantage in competing for new customers.

For example, Pandora was the first big player in digital music
streaming but then fell behind Spotify and Apple Music, which
are still growing. As we noted, Pandora’s main selling point is that
it can tailor stations to each user’s tastes. But learning across
users is very limited: An individual user’s up-or-down votes allow
Pandora to identify music attributes that the user likes and then
serve that person songs sharing those attributes. In contrast,
Spotify focused a lot more on providing users with sharing and
discovery features, such as the ability to search and listen to other
people’s stations, thereby creating direct network effects and
luring additional customers. Pandora’s service remains available
only in the United States (where it has a base of loyal users), while
Spotify and Apple Music have become global players. And though
Pandora was acquired by Sirius XM for $3.5 billion in February
2019, Spotify became a public company in April 2018 and as of
early November 2019 was worth $26 billion. Clearly,

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customization based on learning from an individual user’s data

helps keep existing customers locked in, but it doesn’t lead to the
type of exponential growth that network effects produce.

7. How fast can the insights from user data be incorporated into
products?

Rapid learning cycles make it hard for competitors to catch up,

especially if multiple product-improvement cycles occur during
the average customer’s contract. But when it takes years or
successive product generations to make enhancements based on
the data, competitors have more of a chance to innovate in the
interim and start collecting their own user data. So the
competitive advantage from customer data is stronger when the
learning from today’s customers translates into more-frequent
improvements of the product for those same customers rather
than just for future customers of the product or service. Several of
the product examples we’ve discussed already—maps, search
engines, and AI-based crop-management systems—can be
quickly updated to incorporate the learning from current
customers.

A counterexample is offered by direct online lenders, such as

LendUp and LendingPoint, which learn how to make better loan
decisions by examining users’ repayment history and how it
correlates with various aspects of users’ profiles and behavior.
Here, the only learning that is relevant to current borrowers is
that from previous borrowers, which is already reflected in the
contracts and rates that current borrowers are offered. There’s no
reason for borrowers to care about any future learning that the
lender may benefit from, since their existing contracts won’t be
affected. For that reason, customers don’t worry about how many
other borrowers will sign up when deciding whether to take a loan

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from a particular lender. Existing borrowers might prefer to stick

with their current lenders, which know them better than other
lenders do, but the market for new borrowers remains very
competitive.

Does Data Confer Network Effects?

The answers to questions 6 and 7 will tell you whether data-
enabled learning will create true network effects. When learning
from one customer translates into a better experience for other
customers and when that learning can be incorporated into a
product fast enough to benefit its current users, customers will
care about how many other people are adopting the product. The
mechanism at work here is very similar to the one underlying
network effects with online platforms. The difference is that
platform users prefer to join bigger networks because they want
more people to interact with, not because more users generate
more insights that improve products.

Let’s look at Google Maps again. Drivers use it in part because

they expect many others to employ it too, and the more traffic
data the software gathers from them, the better its predictions on
road conditions and travel times. Google Search and Adaviv’s AI-
based crop-management system also enjoy data-enabled network
effects.

Often companies can level the playing

field by buying data from alternative
sources.

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Like regular network effects, data-enabled ones can create

barriers to entry. Both types of effects present a huge cold-start, or
chicken-or-egg, challenge: Businesses aiming to build regular
network effects need to attract some minimum number of users
to get the effects started, and those aiming to achieve data-
enabled network effects need some initial amount of data to start
the virtuous cycle of learning.

Despite these similarities, regular network effects and data-

enabled network effects have key differences, and they tend to
make advantages based on the regular ones stronger. First, the
cold-start problem is usually less severe with data-enabled
network effects, because buying data is easier than buying
customers. Often, alternative sources of data, even if not perfect,
can significantly level the playing field by removing the need for a
big customer base.

Second, to produce lasting data-enabled network effects, the firm

has to work constantly to learn from customer data. In contrast, as
Intuit cofounder Scott Cook has often said, “products that benefit
from [regular] network effects get better while I sleep.” With
regular network effects, interactions between customers (and
possibly with third-party providers of complementary offerings)
create value even if the platform stops innovating. Even if a new
social network offered users objectively better features than
Facebook does (for instance, better privacy protection), it would
still have to contend with Facebook’s powerful network effects—
users want to be on the same social platform as most other users.

Third, in many cases nearly all the benefits of learning from

customer data can be achieved with relatively low numbers of
customers. And in some applications (like speech recognition),

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dramatic improvements in AI will reduce the need for customer

data to the point where the value of data-enabled learning might
disappear completely. Regular network effects, on the other hand,
extend further and are more resilient: An additional customer still
typically enhances value for existing customers (who can interact
or transact with him or her), even when the number of existing
customers is already very large.

CONCLUSION

As even mundane consumer products become smart and

connected—new kinds of clothing, for instance, can now react to
weather conditions and track mileage and vital signs—data-
enabled learning will be used to enhance and personalize more
and more offerings. However, their providers won’t build strong
competitive positions unless the value added by customer data is
high and lasting, the data is proprietary and leads to product
improvements that are hard to copy, or the data-enabled learning
creates network effects.

In the decades ahead, improving offerings with customer data

will be a prerequisite for staying in the game, and it may give
incumbents an edge over new entrants. But in most cases it will
not generate winner-take-all dynamics. Instead, the most
valuable and powerful businesses for the foreseeable future will
be those that are both built on regular network effects and
enhanced by data-enabled learning, like Alibaba’s and Amazon’s
marketplaces, Apple’s App Store, and Facebook’s social networks.

A version of this article appeared in the January–February 2020 issue of Harvard

Business Review.

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Andrei Hagiu is an associate professor of

information systems at Boston University’s
Questrom School of Business.

 @theplatformguy

Julian Wright is a professor of economics at

National University of Singapore.

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