Mike DiBenedetto dot com

One of the most interesting classes I took this year at Columbia Business School was “Developing Strategies for High Tech Firms.”  The class was taught, phenomenally well I might say, by Raul Katz.  I thought it might be interesting for prospective MBAs with an interest in technology and internet businesses.  It’s not a fantastic paper but gives you an idea of how one might combine the study of a successful web startup with a few theoretical strategy models.  The paper deals with eHarmony and how it should respond to the competitive threat presented by Chemistry.com.  Enjoy.

Online personals may be a strong platform business for the dominant players like eHarmony but the market is certainly not winner take all.  For one, it is not a natural monopoly.  The fixed costs of running a dating site are low and do not prevent newcomers from entering the market.  As evidence, roughly 850 new dating sites launch per year.   For us to consider online personals a winner take all market, it would have to have strong and positive network effects, high multi-homing costs, and low demand for differentiated features.  The network effects, which will be discussed in more depth below, are indeed strong and positive.  However, there is little evidence that users perceive the multi-homing costs to be high since paying members of dating sites belong to at least three other personals sites.  Additionally, there are a number of free sites that provide nearly all of the features of the pay sites.  While one might assume that all users are simply looking to meet other singles and that the simplest set of dating site features would suffice for all sites, it is not so.  Daters looking for hookups those looking for future spouses would obviously require vastly different privacy, matching and profile elements.  Proof lies in the difference between Craigslist.org’s sparse photo-less random encounters ads and eHarmony’s roughly 250 question personality profiles.  Thus, we can safely determine that there is room for a number of players in the online personals market.

Since men and women can be thought of as separate sets of users looking to connect exclusively with members of the other group, we can view the online personals market as a two-sided market with strong and positive cross-sided network effects.  There are obvious exceptions for homosexual users of dating sites but we will limit our discussion to the heterosexual market that eHarmony addresses.  In its market, there are both indirect and direct network effects:

Negative Direct: The more men there are, the more competition each man faces for women’s attention

Positive Direct: The more men there are, the more attractive the site is for women and the more potential dates each man can find

Negative Indirect/Cross-sided: None

Positive Indirect/Cross-sided: As suggested above, the more women join the site, the better the chances for each man to meet someone special

(The effects are identical but reversed for women.)

Looked at through the lens of Porter’s Five Forces, the online industry can be seen as very attractive from a structural perspective.  As an attractive industry without a winner take all structure, there is a high level of competitive intensity.  New entrants pose a large threat, so much so that 850 new dating sites launch per year, as mentioned above.  However, most of these fail quickly because of the strong network effects wielded by the dominant sites in the market.  While there are a number of services to choose from, buyers are extremely fragmented (in fact, their fragmentation is exactly why they are joining a dating site!) and are therefore in a weak bargaining position. Additionally, buyers place a large value on finding dates and/or potential mates.  Relative to the cost of dates themselves and other monthly expenses that singles have, the costs of dating sites are quite low.  Further proof lays in the fact that professional matchmakers charge up to $10,000 for their services.  The threat of substitutes looms large in the online dating industry.  Companies in this market must compete with bars, friend introductions, church functions and work place meetings.  Indeed, exhibit 7 in the case shows that only 4% of internet users in committed relationships met their partners online.  Thankfully, online dating service providers do not have to deal with powerful suppliers.  In fact, there are no suppliers that sell anything other than commoditized products and services such as servers, web hosting, marketing, etc.  While there are a number of niches that allow companies in the web dating market to stake out different segments, the final force in Porter’s framework, rivalry among existing competitors, is the largest hindrance to each firm’s success.  eHarmony faces competition from both more casual dating sites like Match and OkCupid.com, which were typically free or charged lower monthly fees to members, and newer long term relationship focused sites like Chemistry.  These mass market services wield a lot of power and contain large networks of their own.  Additionally, there are niche sites like JDate.com seeking to carve out a portion of the market that only wanted to date within a small semi-exclusive community.  While this competition limited each player’s profitability, its effect is mitigated by the fact that price competition has not played an adverse role in the market.  Conversely, excluding the free sites, prices of eHarmony’s competitors have been on an upward swing in recent years while its have remained constant.

To gain a strong position in the market, competitors must first gain a large enough user footprint to provide users with numerous potential partners.  Potential strategies to gain users would include: giving away free memberships, providing high quality matches or focusing on a niche.  Next, since there is a limited shelf life to dating site customers [a happy customer will no longer need a dating site by definition], companies must primarily compete on reputation and brand once a sizeable audience is built.  To further any advantage competitors gain through branding they will need to extend themselves as platform businesses.  At least one of two strategies will lead to a sustainable platform advantage: raise multi-homing costs so users are confined to their network; or increase the switching costs from one network to the other.  It is unclear how difficult these two can be accomplished since increased multi homing costs will likely only come from inflated prices which bring with them inherent disadvantages.  Furthermore, switching costs entail filling out new profiles and surveys which are usually not high barriers.

With prices that have historically loomed above its competitors, eHarmony enjoys a differentiation advantage.  Contributing factors to this strong competitive advantage are superior matching technology, strong network effects enabled by a large userbase of marriage-minded singles, and a strong reputation and brand earned through the algorithm’s success.  These all originate in the company’s initial focus on the underserved marriage market and the skills of its founders in creating an accurate way of identifying potential matches and allowing customers to easily and safely work their way towards meeting suitable mates.  On top of these strong resources that differentiate it from most of its competitors, it avoids the negative network effects that many of its competitors suffer from by maintaining some exclusivity to its membership and directing users to matches rather than letting them sift through millions of undifferentiated profiles.

The company creates value, in short, by delivering the exact value that is sought out by a large previously underserved market, singles who need help finding a spouse.  In the past 40 years, American singles have come to see spouses an “experience good” that make them feel good.  Therefore, they demand compatibility and shared values.  In the offline world, a single adult may spend thousands of dollars and months if not years to discover whether a potential mate is compatible.  On top of all that, this process often results in a broken heart!  eHarmony uses proprietary algorithms and a unique user interface to help users avoid that long and costly process.  Even if the service didn’t have a large success rate (which is does), the resulting financial, time and emotional savings represent a significant value proposition to its users.  It then extracts some of that value with its monthly subscription revenues.

The type of customers that derives the most value from eHarmony are slightly different than the typical dating website visitor.  Web users who visit dating sites skew slightly young, male, and urban.  In contrast, 60% of eHarmony users are female and less populous areas are overrepresented among its userbase.  eHarmony’s target customers and those that reap the highest rewards are those that are actively seeking future spouses.  Additionally, they are most likely avoiding men who use dating sites to arrange affairs and random hookups.  Therefore, they are willing to pay extra for an environment where that use is limited and discouraged.

To calculate eHarmony’s competitive advantage, we can subtract cost from WTP for it and its most similar competitor, Chemistry.  We will use the monthly fee as the WTP.  To calculate cost, we will use monthly ad spend per paying subscriber because as eHarmony CEO Greg Waldorf said, “For the generalists, it is basically a customer acquisition story.”

* Number derived from facts in case: eHarmony had roughly half of Match’s 1.3M paying subscribers.  Therefore, 1.3M/2 = 650K paying members.

**Chemistry had 2M registered users and I’m assuming a industry standard 5% conversion rate from registered users to paying subscribers.  Therefore, .05x2M = 100K paying members.

As we can see eHarmony’s competitive advantage is 49.69 – 41.62 = $8.07 per user per month.

Now we must assess whether this advantage is sustainable by turning to Grant’s resource based theory of competitive advantage.  Grant says that an advantage’s sustainability depends on the durability, transparency, transferability and replicability of the resource/capability behind it.  eHarmony’s advantage is clearly based on a small set of resources and capabilities including its algorithm, reputation and network.  These are clearly durable because as some of its customers leave the site, having found happiness with a mate, new singles will decide to get serious about finding a spouse.  Their customer base is ever renewing.  The resources and capabilities are transparent, which is not a good thing.  eHarmony’s competitors clearly understand what is at work in its success.  However, these resources and capabilities are not easily transferable.  It will be very difficult for competitors to establish a base of users looking for marriage.  Additionally, eHarmony’s reputation for setting up future marriages is unparalleled – it is, so to speak, firm-specific.  And their algorithm is proprietary, though many industry insiders doubt how effective its patent will be in court.  There is also a large amount of private information and knowledge that eHarmony’s management team possesses, including the components of the algorithm, the travails of designing such an algorithm, and the determinants of successful relationships, that other firms do not have access to.  The replicability of eHarmony’s key resources and capabilities are less clear.  If a firm had an existing network of daters, an internally developed algorithm for matches and a strong brand in the dating world, it could potentially replicate eHarmony’s success.  However, the marriage-specific reputation that eHarmony has developed over the past years will continue to give it an advantage of any firms replicating its strategy in the near future.  Lastly, to increase the sustainability of its advantage, eHarmony could pursue a strategy that George Day added to Grant’s framework.  That is, it could signal retaliation against any company that directly competes in the online marriage matching market.  It could offer temporary price deals to undercut competition, or it could compete against the core product of a larger competitor that introduced an eHarmony rival.  Or it could preempt any marketing and advertising plans by its competitors.  This might instill fear into any potential entrants.

Match’s 2006 launch of its serious relationship spinoff Chemistry.com presented the first serious threat to eHarmony’s core business.   Feature-wise, Chemistry closely matched the user experience of eHarmony.  It also targeted the serious relationship segment and charged premium prices over Match’s flagship offering.  It sought to differentiate itself from eHarmony by matching users on different types of personality traits, claiming to deliver matches based on whether the users will experience “chemistry” upon meeting.

This new competitor was backed by the considerable resources of Match and IAC, ensuring that it could advertise heavily to attract new users.  Depending on how Match marketed Chemistry, the new site also might be able to grow quickly by drawing upon the enormous network of Match’s daters.  In this scenario, Match could use Chemistry to envelop eHarmony’s market by targeting Match members who have become frustrated with casual dating and are ready to seek a spouse.  Match would then up-sell these users to memberships on Chemistry.  These two methods of quickly acquiring new members, paired with its slightly differentiated positioning, put Chemistry in place to seriously threaten the powerful network effects that eHarmony relies on to grow its userbase and drive its bottom line.  If Chemistry was able to claim users that would have otherwise gone to eHarmony, the inflow of new users that keeps eHarmony alive would slow down and its current users would slowly leave the site.  This would cause the site to begin a contraction that would have serious negative impacts on its indirect network effects.  Since typical dating sites, and presumably Match, already have a male skew, Chemistry could focus on up-selling Match’s marriage-ready male users.  There might be some firm-specific knowledge within Match that would allow the company to predict when men were ready for such a solicitation by taking into account their messaging activity with other female members.  A reduction in new male eHarmony members would further increase the female skew on eHarmony, thus reducing the indirect network effects for females, which might in turn cause a migration to Chemistry.

In evaluating eHarmony’s strategic options to deal with the threat from its competitors, especially Chemistry, I would prioritize paths that do nothing to diminish the value of its key resources and capabilities and that extend or improve these assets, rather than creating entirely new capabilities.  Using these two bedrocks, I will analyze the options from the least to the most attractive;

• New Business: This option does fulfill the requirement of exploiting one of eHarmony’s core resources – deep knowledge about human relationships – however, it suffers from other flaws.  There are a huge number of entrenched information and community sites catering to those interested in wedding, life change, parenting, etc. advice.  Making a dent in these markets will require a lot of marketing and may provoke competitive responses.  Launching an advice site also would be entering into entirely new territory for eHarmony, which presumably knows little about advertising and less about content.  Additionally, this content strategy would not even fuel growth to eHarmony’s dating site because people interested in these areas are presumably already married! 
• Increasing Userbase: While this goal sounds promising, the means to get there may involve several costly tradeoffs.  Increasing advertising may yield decreasing marginal returns and may push the company away from its successful track record with direct response marketing.  Furthermore, Match has recently shown that it is willing to spend heavily on advertising as well.  A move by eHarmony might be matched by Chemistry leading to an ad spending frenzy with low returns for both parties.   Additionally, pursuing the goal of drastically increasing membership might lead to price reductions and even a price war.    This could damage the reputation and profit generating ability of eHarmony forever.  Other plans floated by management, which include reducing membership barriers, will lead to changing key assets that have made eHarmony a hit.  While it may pay off, the risk is simply too big.  Undesirable members could seriously diminish member WTP and/or tarnish the match-making ability of eHarmony. 
• Expanding to Medium Term Relationships: This strategy is the platform envelopment strategy – eHarmony could move to Match’s market and bundle its serious relationship service with its more casual offering.   This option is also a defensive strategy in that it attacks Match’s core offering in return for Match invading its own.  Turning that sentiment around, this strategy could provoke defensive reactions from other competitors in the medium term/casual dating market including PlentyofFish.com, Yahoo Personals, etc.  On the positive side, research has shown that many online daters are dissatisfied with the experience of web-initiated dates which indicates that there is an unmet market need that could be addressed by eHarmony’s secret sauce, its matching algorithm.  However, we must consider the reputational effect this might have in the perception of eHarmony’s core marriage-minded users.  This strategy also brings to mind many questions regarding its execution.  Would a medium term dating service and eHarmony share users?  Would users get matched with people who wanted different types of relationships?  Would the medium term service be priced at eHarmony’s price point?  Is the WTP of the non-marriage-minded that high?  If the price is lower, will that lower the WTP of eHarmony’s core users?  Will offering the algorithm or a spinoff at a lower price cannibalize eHarmony’s userbase and revenues?
• Going Global: Expanding to English-speaking countries and then to the EU also entails expanding on one of eHarmony’s greatest assets – its matchmaking algorithm.  Furthermore, it would not require intense capital investments upfront.  Match’s ability to generate 30% of its revenues, roughly $100M, abroad speaks wonders about the potential of overseas markets.  It is reasonable to posit that the same unaddressed market segment exists there as it did in the US prior to eHarmony’s launch (more on this below).  Additionally, Match’s presence abroad indicates that Chemistry might go international soon.  If eHarmony does not internationalize, Chemistry might claim these markets and establish strong network effects.  Before tackling any global strategy, eHarmony must first evaluate whether its capabilities can be internationalized.  Do they pass the RAT test, as outlined by Donald Lessard?  Is eHarmony’s match-making relevant abroad?  People get married everywhere.  Additionally, in more traditional cultures, there is a move towards singles picking their own spouse on the basis of compatibility which plays into eHarmony’s advantage.  Is match-making appropriable?  Yes.  Is it transferable?  The answer to this question is unclear.  However, eHarmony’s matchmaking would almost certainly provide better matches than any other service out there, even if overseas users desire different things than American users.  Furthermore, eHarmony’s ability to understand relationships would allow it to quickly develop a knowledge base and an updated algorithm that catered to each local market.  One caveat is that demand forecasting in international expansion is always difficult.  To that point, Canada and European countries have fewer marriages per 1000 people and residents there have more critical views of marriage in general.  However, despite these differences, there are still large numbers of adults who view marriage favorably and who are single who would likely be eHarmony members.

Before launching an international expansion, eHarmony must assess the requirements of a global expansion. In addition to funds and resources to build localized sites, which the company likely has or could acquire quickly and cheaply, the company must commit to a strong marketing push to educate consumers about eHarmony’s differentiated features.  The marketing that worked in the US will need to be tailored and the company will need to go out of house to local advertising agencies to develop appropriate plans.  While Match has pursued a successful partnership strategy both domestically and abroad by partnering with sites such as AOL and MSN, eHarmony has yet to enter into such arrangements.  With its strong differentiation advantage established in the US, it will likely not have to enter into such partnerships unless local conditions demand it.  While eHarmony’s relationship experts have American marriage science down pat, they may need to bring in local experts who can work with the in house R&D teams to develop locally suitable algorithms.  This may not be cheap to develop but it may not need to be ready for the initial launch.

While the global option won’t stop the threat from Chemistry, it will insulate eHarmony from many of its most negative effects.  It will bring in additional revenue streams, promote fast user growth in entirely new markets, and diversify away the risk inherent in selling only one product to only one market.  With its focus on lifelong matches, it is possible that global connections can be offered to members thus increasing eHarmony’s powerful cross sided network effects.  Domestically, if eHarmony can retain focus on improving the algorithm and marketing its continued advantages, it can put its reputation to work to steal new customers in the long term relationship segment that Chemistry up-sold from Match.  Additionally, it will threaten Match’s efforts abroad and force them to invest more overseas.  It is likely that Match will follow eHarmony’s lead and debut global versions of Chemistry.  This is an unavoidable evil but eHarmony cannot be late to the global game and forego the network effects that have made it so powerful in the US.