Cracking The Catalyst Code

In a new book, Richard Schmalensee and David Evans examine "catalyst" companies that profit by linking two distinct groups

What do Vogue magazine, Visa credit cards, and eBay (EBAY) have in common? Each of these disparate companies has profited by connecting distinct groups of customers who need the other via a specific platform. Vogue, for instance, is an advertiser-friendly print magazine that links luxury-goods companies and fashion designers with wealthy readers. Visa began as a plastic card that links retailers with shoppers via easy, cashless, payment transactions. And eBay is an auction Web site that links buyers and sellers via the Internet.

In their forthcoming book The Catalyst Code (to be published by Harvard Business School Press in early May), Richard Schmalensee, dean of Massachusetts Institute of Technology's Sloan School of Management, and co-author David Evans, vice-chairman of consulting group LECG Global Competition Policy, present a wide spectrum of such companies, which they label "catalysts." In the book Schmalensee and Evans aggregate their shared research, experience, and analysis of a surprising variety of enduring businesses, and provide a six-step process aimed at those looking to launch, expand, and sustain so-called catalyst—or two-sided—businesses.

Of course, many of the examples are the usual suspects: Google (GOOG) and Amazon (AMZN), for instance. But Schmalensee and Evans are careful to go beyond the obvious and include historical and non-Web-, non-tech-based examples such as the credit card. Plastic was a classic example of creating a platform for payment transactions long before online transactions were possible. Their practical guidelines range from clarifying and identifying the specific communities that need to be connected via a catalyst platform, to analyzing and applying the design strategies of earlier, successful catalysts to keep communities engaged and returning to the platform, be it virtual or physical.

The book is also full of cautionary advice, including examples of unprofitable failures. Remember the ill-fated, which crashed because its online pet supplies cost more than if bought in brick-and-mortar stores? And Schmalensee and Evans also offer perhaps the most shocking recommendation of all: that the catalyst code isn't a one-size-fits-all panacea that any company can apply to reap profits à la Google. Instead, they discuss how companies can assess if the framework is right for their own business models.

On a recent visit to New York en route to Massachusetts between conferences, Schmalensee and Evans sat down with's Reena Jana to discuss what kinds of companies and business models can best benefit from cracking the catalyst code.

There's currently so much attention being paid toward tech and Web 2.0 companies, in business schools, the media, and boardrooms alike. Why did you decide to include old school references, such as paper magazines and nightclubs?

Evans: The book is really designed to get people to think outside the box. So a reader will ask, what does a Manhattan nightclub such as Bungalow 8 have in common with Microsoft (MSFT) Windows? And what does Vanity Fair magazine have in common with Visa credit cards? And you start to think of principles. You start to see a lot of very important common elements. In the book, we talk about how they share characteristics, such as promoting interactions between the two specific groups being brought together.

Schmalensee: Frankly, we and a lot of other economists started thinking about how very diverse, very disparate yet successful businesses are actually organized in much the same way, and face essentially the same business problems.

There are insights that you learn from looking at how BusinessWeek is designed that you can apply when considering how to design the next Google or the next Windows interface…for instance, in terms of user-friendliness or how information is presented and organized.

Speaking of the power of design on a business's success, what's a good example of a prominent catalyst business borrowing a design from a totally unrelated business?

Schmalensee: eBay. If you go on the eBay page, it's really designed to get people to mix it up. This idea of mixing it up is the essential characteristic of a shopping mall or department store. Malls and department stores offer shoppers the notion of serendipity. When I go on the eBay page—or, for that matter, when I go to Neiman-Marcus—I often don't necessarily know exactly what I'm looking for. I stumble upon "great finds." It's part of the fun of the shopping experience. The whole idea of serendipity is a real characteristic of how the eBay pages—and the Mall of America—are specifically designed to surprise people, to show them things that they may not have necessarily thought about. It's a physical design characteristic that's also true for virtual spaces.

You make it clear that the catalyst code and the framework you offer for driving a successful catalyst business is not a cure-all strategy, and cite "single-sided" companies which have been perfectly successful, such as restaurants and auto manufacturers. So when is it appropriate to use the catalyst model?

Evans: The first key question [for businesses considering applying the catalyst code to ask] is, "who are we bringing together with whom, and for what purpose?" You have to understand that and get that right. And then it turns out to be hard in theory and hard in practice to get the pricing right for the use of that platform. Because with most catalyst situations you tend to have one side that pays the freight and one side that rides free. In other words, how do you find the right balance? In the book we talk about whether a catalyst should charge customers to use the platform, or not. Google's free for Internet searches, but advertisers pay to use the platform.

Throughout the book, it seems that you imply that business models can be as much of an innovation as new technologies that can enable entirely new platforms.

Schmalensee: That's certainly one of the things that the catalyst code framework really highlights. It's not just applicable to technology. The deep insight is that this is a way I can connect people and create value. And here's the business model that allows me to do that in a profitable way. That is, fundamentally, innovation.

Can you give an example?

Schmalensee: Microsoft Windows. Yes, a big part of the Windows story was about designing the interface. And people always give Bill Gates and Microsoft a hard time about ripping off Apple (AAPL). But the brilliant insight, the brilliant innovation for Windows was the business model, how Microsoft recognized that if they gave tons of stuff away to developers, and priced it low to users, that would ignite a catalytic reaction between the two of them. Just recognizing and developing that business model was a tremendous innovation. And that's what generated the value.

What's the biggest difference between earlier dot-com business successes and those of today? And what's the most valuable advice you can give to those companies striving to be the next Amazon, and not the next

Evans: The Web 1.0 companies were all about scaling up quickly. We hope the lesson from The Catalyst Code is that businesses need to achieve balance. The best way to do so is to start small, get the balance right, and then explode that thing out.

Schmalensee: In other words, start at the scale where you can afford to make mistakes. Get it right, then grow it. We're pretty big on pushing growth when you've got it right. But you don't want to crash and burn.

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