When innovation isn’t enough: How collective action problems can block market formation

Better Place: A good idea before its time. Wikimedia

As we approach 2020, it may seem as though we are on the cusp of a transition toward a more sustainable, electricity-based transportation system. However, with electric vehicles (EVs) currently comprising less than 0.5% of cars on the road worldwide, and many producers and consumers still hesitant, a reality check is needed.

In 2007, 12 long years ago, everything seemed to be moving in the right direction. The company Better Place, led by the charismatic and experienced Shai Agassi, embarked on a mission to rid personal transportation of oil by 2020. Better Place proposed a revolutionary business model built around EVs. With a professional team, a sophisticated charging infrastructure that swapped an empty EV battery in just two minutes, a vehicle developed by Renault-Nissan, media excitement, and 900 million dollars of venture capital, the company seemed destined for success. Yet after first roll-outs in 2012 in Denmark and Israel, quarterly demand never exceeded 100 vehicles.

Having burned through all its cash, Better Place filed for bankruptcy in November 2013. This dramatic failure not only doomed Better Place, but was a major setback for the transition toward a future of sustainable transportation.

The collective roots of failure

What went wrong? We believe that Better Place suffered from what we call a collective action problem. When Better Place launched, many elements necessary for a working market were missing – consumers weren’t willing to consider electric driving; there was no producer value chain that permitted efficiency, scaling, and variation in production, no complementary charging options with agreed-upon formats were in place, and there was no effective and favourable regulation.

Companies in such situations of high market-formation uncertainty face four critical questions:

  • What actions are needed to build a working market?

  • What are the risks of engaging in these efforts, given that the market may fail?

  • Who should undertake what action and when?

  • Under what conditions should players collaborate rather than act independently to achieve a working market?

In our research paper we identified how and when different collective action problems may hinder market formation, and what kind of solutions companies may employ to address these problems. Our findings can be crystalized into a map involving four “market formation regimes”, each associated with particular factors that highlight the nature and risk of these different collective action problems.

Demand and supply challenges during market formation, highlighting regimes with increasing market formation uncertainty (temperature spectrum) and likely collective action problems. Author provided, CC BY

 

Key questions to ask

In our research, we developed a sequence of questions that can help companies identify the specific market formation challenges they face and how to address them. The first relates to the state of development of the market.

Does the critical market infrastructure exist?

A market infrastructure is the social and material “plumbing” necessary for a working market. It involves both demand factors, such as consumer familiarity with the product categories and recognition of the products’ value, and supply factors, such as technology standards, supply networks, and agreed-upon ways of producing. Because company and market success depend on the presence of this market infrastructure, it can be seen as a “collective good”–something that benefits all but is owned by no one.

Thus, a first critical question to ask is to what extent are there significant supply and demand related market infrastructure challenges. In some cases, this critical market infrastructure exists. A good example of this is Groupon, which created a new market of online discounted vouchers by connecting buyers and sellers in a novel way. While the product category was new, it was based on longstanding norms and practices, and knowledge of coupon exchange. This is an example of Regime I (Figure 1), where there is already an established market infrastructure. Here, market formation occurs when companies simply pursue their own individual interests and there are no collective action problems.

Do one company’s efforts make a difference?

In contrast to the Groupon example, in many new and emerging markets, companies must overcome multiple supply and demand challenges to develop this necessary market infrastructure. Companies’ willingness to contribute to market infrastructure development depends on whether their efforts give them a clear advantage. If so, companies may benefit from first mover advantage.

A good example of this is VHS. In the battle for dominance in the market for video players, VHS exploited the first-mover advantage by enlisting movie producers to use the new format. In so doing it not only excluded its main competitor, the Betamax coalition, but also built the market.

By contrast, in the market for search engines, Google rose to dominance as a second mover by adopting novel market infrastructure innovations centred around Internet advertising and search, and leveraged this with their strong internal knowledge and capabilities.

Both cases highlight a situation of market uncertainty due to a limited pre-existing market infrastructure (Figure 1, Regime II). Yet, while situations with second mover advantage may allow later entrants to “free ride” on first movers who have begun to develop the market infrastructure, such problems rarely halt market formation. Thus, in Regime II, because companies can see their efforts give them a significant advantage, thorny collective action problems are unlikely.

Does market formation require distinct contributions from different companies?

In contrast to the previous examples, if companies receive limited benefits from early actions to overcome supply and/or demand challenges, market formation faces a considerable barrier. For example, Segway failed to transform transportation because it was unable to define a specific market segment and lacked a dedicated road infrastructure or favourable regulation. How this “start-up” problem is overcome depends on the degree to which different companies can provide critical resources to develop the market infrastructure.

In some cases, forming the market requires many but similar contributions. For example, consider the disruption of the classic gastronomy in France by what became known as nouvelle cuisine. Adopting nouvelle cuisine required restaurateurs to cast aside established rules, principles and practices. Early adopters faced the risk of being rejected by customers, colleagues, and powerful food critics within a highly professionalized, conservative and status-conscious market.

The challenge of achieving recognition for a new product category is an example of Regime III start-up problems, which tends to be associated with high demand uncertainty (Figure 1). In Regime III, challenges can be reduced through cumulative efforts from different actors. For nouvelle cuisine, doing this helped build its legitimacy.

Diverse contributions from a range of players

Sometimes a particular combination and sequence of contributions is necessary to form a market. Specific contributions may be required from numerous companies, i.e. distinct producers and retailers, state agencies, educational organizations, producers of complementary goods. These all possess unique capabilities or resources that other companies do not.

This was the situation Better Place found itself in. To be a viable electric vehicle provider, a company needs to build upon pre-existing efforts from automotive and battery producers, charging infrastructure providers, as well as ICT developers. Without this, few consumers will consider EVs, and those who do experience a low product value. Under such demand and supply uncertainty, most companies in the market face unclear opportunities and high risks, resulting in reluctance to commit resources critical to successful market formation.

In such cases, market formation requires specific efforts. Companies in these types of situations must not only look to promote their individual products, but align collectively with other companies to promote the market as a whole, and ensure it is sustainable. A serious challenge for companies is the lack of guidance or clarity on what to do – should we allocate resources to educate consumers? Seeking favourable regulation? Forming market standards? The challenge is multiplied when considering how and when to take one or more of these actions and by trying to influence others with resources that we don’t possess. Such challenges currently plague developments for markets ranging from commercial space travel to edible insects.

In Regime IV, market formation tends to require trust to develop among potential collaborating actors, usually coming from different sectors. Success is much more likely when there are pre-existing industry bodies and associations, or when powerful and well-resourced actors already exist and can provide market leadership in building the market. Market formation success may require well-coordinated favourable government regulation.

Electric vehicles: Looking forward

So, what about the future of EVs? As environmental consciousness and pressures mount, lessons from past failures increase, and local, regional, and federal support grow, opportunities for EVs grow. But market formation uncertainty remains high and a thriving EV market requires producers (new and established) and other actors to not only build on these opportunities by increasing commitments but also by coordinating their efforts.