Disruption by Substitution

The most severe disruption that digitalization can cause is the substitution of traditional players by digital platforms. Goods and services that were previously provided by companies, some for centuries, are now being provided by digital platforms. As a result, traditional players are being expelled from the market or reduced to niche players. Such substitution can take different forms.

The most extreme case of substitution takes place when a new digital product substitutes the traditional physical products. It is not only the service provider that is substituted, but the product itself. Such a new product might prove a substitute for traditional offline product and be more efficient in terms of functionalities and pricing. In these circumstances, disruption for the traditional providers of offline services is unavoidable and such providers might just try to delay the transformation and look for new market opportunities.

An example of this kind of substitution is the sale of music records and CDs, which has been largely replaced by digital music distribution. Another example is email, one of the first and more transformative services created in the internet. Email is cheaper, faster, and more reliable than letter mail as distributed by the traditional postal service.

Substitution can also be the result of digital platforms empowering newcomers to compete with traditional players. The product is always the same, but platforms foster new players. This is the case of user-generated content and the sharing economy. As transactions costs are reduced by platforms, non-professional service providers and small companies, under the coordination of a digital platform, are in a position to compete with well-established corporations.

Platforms such as Facebook, but also the HuffPost, are displaying user-generated content, substituting newspapers. This is also the case of the so-called sharing economy and platforms such as Airbnb displacing hotels, Uber displacing taxis, and BlaBlaCar displacing trains and coaches. New service providers, empowered by a platform, can substitute traditional players, at least partially.

Furthermore, substitution can be triggered by platforms transforming a traditional market into a multi-sided market financed with advertisement. A new service provider develops the product in competition with a traditional player, but finances itself not by consumers (at least not totally), but by advertising. Traditional players usually do not have the chance to replicate such a multi-sided market and are forced out of the market.

This is the case with services such as Google Maps. In January 2012, the Commercial Court of Paris ruled in favor of Bottin Cartographes, a map manufacturer, and imposed €500,000 damages on Google France for predatory pricing, as it was providing its mapping services for free. The French Autorité de la Concurrence delivered its opinion12 and helped the Paris Court of Appeals to overturn the judgment in January 2016. No predatory pricing existed; it was just that Google was able to obtain revenue from a different side (advertisers) in a multi-sided market.

Finally, substitution might the result of larger and more efficient multi-sided markets out-competing traditional platforms. Digital platforms can create and curate larger multisided markets with more powerful network effects than traditional offline platforms. This seems to be the case of newspapers in relationship to Google and Facebook. The same situation seems to exist with traditional matchmaker intermediaries such as taxi dispatchers, real estate agents, and dating agencies.

All these cases of substitution by digital platforms are examples of creative destruction, which Schumpeter defined as the “process of industrial mutation [...] that continuously revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”13 Better products empowered by digitalization substitute pre-existing goods and services along with the companies producing them. In all of these cases, a platform replaces the traditional service provider, which becomes redundant and expelled from the markets, or at least reduced to a fringe position in a market niche.

 
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