Can Rosetta Stone Reach the Fourth Level of Advantage?

I'm heading down to Orlando next week for Verne Harnish's Growth Conference where about 500 mid-market CEOs will hear from a roster of innovative business leaders including Tom Adams, CEO of Rosetta Stone. I've covered Rosetta Stone here before and think it is making a plethora of intriguing counter-intuitive moves--like an outthinker. I recently had a chance to sit down with Tom and we discussed how Rosetta Stone is seeking to advance its lead in language learning. Here are some key takeaways.

Only 20 minutes into a 13-hour flight on China Air toward Bangkok, I got something oddly precious being strapped to a seat, surrounded in white noise, with a silent phone: insights.

I spent last week talking with the CEO of Rosetta Stone (RST), and while on this flight, I had an insight: Rosetta Stone is on a proven path, the same one that most of the highly disruptive companies of the past twenty years--Dell, RIM, Google--have trodden.

This does not guarantee RST's success. Others have tried to climb the same footholds and slipped, but RST seems to know where to go. Here is the path to the four levels of advantage:

• Level 1: follow the pack. Simply copy what others are doing, adopting proven best practices, with the goal of being number 4 or 5 in your market. Like the number three bird in a flock, you won't get there first, but you enjoy an easy ride. Most companies--probably 60 percent--compete at level 1.
• Level 2: inspire the pack. You may find one or two things you can do differently and exploit them as long as possible, knowing that others will eventually copy. The innovators who launch cutting edge products find their creativity copied by the behemoths that compete at this level. TiVo creates the DVR, Cablevision takes it. Philips invents the CD-Rom and loses the market to lower-cost competitors. Tesla Motors (TSLA) inspired all major car companies to launch electric cars in the next two years. My unscientific estimate is that 30 percent of companies compete at level 2.
• Level 3: bewilder the pack. A better idea, if you can find it, is to do something the competition will resist copying for a while because it costs too much to imitate, relies on capabilities and experiences they lack, or hurts their core businesses. Dell "going direct" and Southwest's re-adopting the point-to-point model are examples of this. I believe only 5 to 7 percent of companies compete at this level.
• Level 4: leave the pack. Occasionally a company will actually leave the pack by doing so many things differently and--this is a critical point--making these points of differentiation interdependent, that they become something new. Disney, for example, evolved from an animated film company into the first truly diverse media company, going from cartoons (which gave them characters) to parks (which gave them closer customer relationships) to experiences (hotels, cruise ships, etc.). You can copy pieces of the Disney model but trying to excel at all of them, particularly the culture, is nearly impossible. GE put in play a similar dynamic. My guess is fewer than 3-5 percent of companies have the guts to compete at level 4.

I am not saying that Rosetta Stone will be the next Disney. Leaving the pack involves immense execution risk because you must learn entirely new skills and build capabilities foreign to your core market. But I can see RST taking the nascent steps to get there.

RST started off in the pack, building a $30 language-learning software to compete with $30 language-learning DVDs and books (level 1). It inspired the pack by adopting interactive technologies with engaging imagery and games (level 2). It started bewildering the pack by orienting itself as "natural learning," or helping people learn a language not by conjugating verbs or by memorizing vocabulary, but rather by replicating the immersive experience (level 3).

Now RST is attempting to build capabilities completely foreign to the language learning market. They are actively building positions in cloud computing, social media, and virtual services. They just released the second version of their "Totale" product, which blends their traditional computer-based program with a suite of online tools. You can take a course on your computer and, after you complete a few exercises, attend a live, online coaching session. If you are learning Chinese, say, you would find yourself face-to-face with a Chinese tutor who interacts with you and a few other students.

Totale will also match you up with others learning Chinese (or even native Chinese speakers learning English) and allow you to play a number of online games that help you build your skills.

Tom spent an hour walking me through the offering. While I found it intriguing as a user, what interested me more was what a competitor would see. To replicate this offering a competitor would have to be able to build a service culture among a network of language coaches across the world and integrate it into their current offerings.

Starbucks has proven how hard building a service culture can be. Starbucks employees must look you in the eye for two seconds when they hand you a coffee. Try to get a Dunkin' Donuts coffee employee to do that consistently. Competitors of RST would have to build a new culture, social networking and critical mass of coordinated information in order to challenge RST.

Reaching level four isn't easy, but then again RST does not have to become the next Starbucks, Facebook, and Google rolled into one. But it does need to be competitive across all three industries. If it can do this well enough I think we will see it follow the paths of others who have dared to leave the pack and create something truly special.