Business Model Innovation: a new “buzz word” – Or the foundation of future competition?

Today competition in most industries is rife. Cost pressures exist everywhere. Consumers are more empowered than ever before. Information on products and services are readily available. Technology changes fast. Product and brand life cycles have shrunk. Amidst these changes, the pressure on companies to grow and remain profitable, are even greater than before.

Most industries have a few dominant players today – whom by now have exhausted savings within their cost structures and are not able to cut these any further. We have gone through the era of competitive benchmarking and incurred the savings we could. On the flipside of this coin, most industries also have their clearly defined niche players - or highly differentiated companies - in the second tier, which means that the vast majority of companies are “stuck-in-the-middle”: not large enough to matter and remain dominant because of critical mass, but also not exceptional enough to focus or find a relevant basis for differentiation. On top of this, most companies are followers when it comes to innovation and customer service, thereby eliminating other bases for competitive advantage.

The nett-result of the above is many mediocre companies, with low value proposition differentiation and mediocre returns to shareholders. Companies that are “stuck-in-the-middle” are lost opportunities - where managements were unable to outperform their rivals in any significant way: and these kinds of companies constitute the vast majority of companies in all industries.

Even if you are expanding strongly into emerging markets, cost pressures are still there in most markets, and even in emerging markets, competition is increasing fast and efficiencies are becoming important. Many established companies try and operate in exactly the same way in emerging markets – this means that many of them are not successful in these markets. Companies like Microsoft and Unilever have demonstrated operating differently in these markets is hugely successful. Proctor & Gamble (as reported in Fortune, January 28) has established a research and development centre that specifically focuses on product development for poorer consumers within emerging markets. It taps local talent with the drive and energy to succeed (it is able to attract the very best students) – and it operates far more like a technology “upstart” company than a multinational stalwart. P&G also uses input from the outside extensively in its new product development. Gillette Guard is a product developed specifically for men in emerging markets like India who have no access to running tap water.

Highly successful companies also have to change the way they operate from time-to-time to remain agile, dynamic and adapt to changing markets and operating conditions. Business model innovation therefore equally applies to them, as they need to stay ahead of the curve if they want to remain relevant and retain their leadership. If a business fails to reinvent itself in time, it will find it difficult to recover (Olson & van Bever of Accenture states that their ongoing research reveals that companies that stall in their growth, have a less than 10% chance of recovering – two thirds of such companies are later acquired, go bankrupt or revert to being privately owned). They state that successful companies are the one’s that “fix things before they are broken”.

The famous and controversial strategist Gary Hamel states that 90% of what a company needs to know today, will come from outside of its industry!

In the Harvard Business Review of January/ February 2011 Nunes & Breene claims that the following are important ways to prevent stagnation in a company and to ensure forward thinking is high on the agenda:

Renew the top team earlier than it seems required. Investigate and track the basis of competition in their industries. Balance short-term and long-term thinking within management. Ensure that the workload at the top is effectively distributed. Have more talent available than what seems necessary for the normal

operations of the business. Ensure that new hires fit into the culture of the company. Make staff experience serious challenges to groom them. Make sure employees have room to grow into new opportunities.

So how do you innovate or excel in ways that will re-create value for customers and shareholders – in ways more significant than rivals?

Given the above, there is high interest in new business models: it is seen as an important way in which companies can set themselves apart from their peers, either in redefining the industry they partake in for their markets, or in changing the way they create customer value that makes them far more efficient than rivals in their industry. Whichever way, a new operating model can enable a company to have a serious impact in a market where a traditional approach did not yield the desired results (or is unlikely to change the status quo).

Most companies do not have problems with brainstorms or idea generation. There are countless books that will give us tips and methodologies on how to do that well. It is how to guide them – and operationalise them - that is important.

Often the key issue lies in how a business model is defined – and in what it is.

A business model refers to how a company creates and manages value for its customers and shareholders - it is as simple - and complex - as that. It is therefore constituted of what is delivered, to whom, at what cost, how - and at what margin of profit.

There are four areas that determine company success:

Its markets. Who it targets, whether there are enough of them to make the business viable, how fast they grow and how much money they have available to spend on products and services. Can you sell more to the same people or sell to more people?

Its products and services. What customer needs are being satisfied by company products and services, and how that compares with other companies who offer solutions to the same customer problems or opportunities. Can you sell the same products and services to more people or develop new products and services to sell to the same or more people?

Its operating model. How it “manufactures, markets and distributes” the product and service solutions to current and potential customers. What steps are involved, what is redundant.

Its cost-structure. Can a company do the above cheaper - or better - at the same cost structure (cost of people, capital, raw materials, infrastructure, marketing and sales).

We can only generate alternative business models if we can de-construct the process or value creation and delivery, and once we have done this, review each part of the process and see where we can potentially re-create value in different ways.

Some ground rules that work for me: the components of a business model can entail:

Decide what markets you want to serve. This is dependent upon the resources you have access to.

One of the very first decisions a company makes, is who their customers will be. In this respect, it can decide to serve all within a given geography, or it can decide to serve some segments of the market only.

What decision it makes, depends upon the management, people, capital and other resources the company has access to. If it has wide access and great management and people competence, it may decide it can become a dominant player who will serve all kinds of customers. If it has limitations in some areas, yet distinctive opportunities and abilities, it may decide to only serve certain segments of the market. If it believes it can leverage resources best by only serving some customers, it becomes selective.

If a company owns aircraft – or wants to start an airline, its decision about the segments and geographies it wants to serve, will be dependent upon the resources it has access to. If it has vast access, it may decide to become a large, dominant player that serve high volume destinations. If it has limited access, it may decide to focus on given segments or given destinations only.

In industries like banking, there are viable large and niche companies.

If a company enters a saturated market, it may decide to only serve selected customers, which will mean it requires lesser resources in focused areas.

Markets therefore determine competence, but competence may also determine what markets you can viably serve.

A decision about markets can only be made once the customers and competitors are known and understood: only then can the parameters for successful competition be determined and a business model be constructed accordingly.

Do not define an industry by your definition: define it as customers satisfy their needs, regardless of technical industry definitions. This will often straddle related industries.

Whatever choice is made about the customers you want to serve, it is important to understand their wants and needs, and how these are currently served by the competitors within the industry and related one’s.

It is no longer sensible to view an industry from a company perspective: convergence and overlap now means we need to view how customers are using different competitors to perform different functions for them – and where the gaps and opportunities lie within these, regardless of the technical definition of these industries.

Consumers are often blind to finite industry definitions: they apply their own (or at least the trend-setters will do so). Yet, most companies still define their competitors narrowly.

As an analogy, it is fair to say that an over-emphasis on transaction accounts, loans and savings by banks over the years, have left opportunities for new financial services companies (i.e. investment companies, asset management companies, brokerages) that today satisfy a whole host of “un-met” needs. If banks defined their businesses differently years ago, you would arguably not have had the proliferation of the industry we have today. One has to be careful not to translate current competence into future stagnation. If the future requires different definitions, it is entirely in the hands of a company to change its ways.

In the same way, it can be said that an over-reliance upon airtime and data by telecommunications companies, are leaving opportunities for new companies to offer new solutions. Convergence means in such industries a whole host of competitors are now viable players.

The iPod/ iPad products straddle several traditional industries, yet the underlying customer need-base upon which it is built, has always had these needs, even though it used several different traditional competitors to solve them. All that these new products did, was to be blind to traditional definitions and offer products that conveniently and simply combine it in one device.

Carefully de-construct how value is created and delivered to customers, and question everything that does not directly contribute to that.

This is often seen as complex, but it is actually simple. Most companies have the following different functions they perform that will enable them to create and deliver value to the consumer.

What value proposition (translated into products and services) they offer to customers.

What is required to deliver this, for example:o A given recipe.o A given patent.o A given production/ manufacturing process.o Given inputs that enable the creation and delivery of the value

proposition: The types of people, skilled and trained in a given way. Systems, processes and ways of working that will enable

consistent delivery of the value proposition and ensure a consistent adherence to a given quality.

Certain standards of quality. The raw materials required to do this, delivered timeously.

The costs of the above. The selling price of the above relative to competitors. Logistics (in “just-in-time” manufacturing processes savings are incurred

because companies do not have to have warehouses with idle goods waiting to be used as components in manufacturing). Similarly, the faster it can get goods from manufacturing to end-customer, the better.

The management system of the company. Is the company managed effectively to deliver customer value at a fair price - resulting in an above average profit margin?

The way these end products and services are marketed - and delivered - to customers.

The after-sales service of such products and services. How and where the products and services are sold (i.e. what channels are

used). How the customers are invoiced and how they pay, as well as how payment

is traced and managed. The communication and feedback between the company and its customers. What alliances, partnerships and other external resources are needed. The way the company is financed. The way the company pays tax and relates to its external environment.

In reviewing new business models, we may often use one or more of the above to generate alternative ways that will make a company standout from its peers.

In the last fifteen years, many new companies leveraged new technologies like the Internet to devise new and more profitable business models – also straddling traditional geographical boundaries of doing business. Low-cost airlines rely heavily upon internet booking systems; a company like Amazon have a very low cost-structure relative to Barnes & Noble; eBay has none of the costs associated with traditional auctions and comparative websites like Hippo in SA are eliminating the need for brokers. Despite the fact that many of these companies offer an expanded range to customers (because Amazon does not carry huge stocks in multiple places, it can offer every conceivable book on its site without incurring the carrying costs associated with it), they have a much lower cost-structure than traditional rivals.

To use another analogy, low-cost airlines are able to offer lower prices to customers because they have re-defined some of the aspects mentioned above, like: not offering free food, hence giving customers a choice to pay less - and buy food should they want to - instead of raising prices for everyone to cater for all customers; using aircraft that is more fuel efficient; only flying to destinations that have a high demand; using home airports that are cheaper than traditional airports; using the internet or other ways to sell tickets as against travel agents or expensive airline offices.

Although Starbucks makes money out of selling coffee, it changed the format thereof - this enables it a far larger profit margin than those selling coffee in the traditional manner (i.e. Maxwell House with tinned instant coffee or ground coffee beans). The process whereby it creates incremental value to coffee enables it a much higher profit margin. But to do that, it created an entire “superstructure” that encapsulates its value proposition.

Because Skype uses a different delivery mechanism, it can offer cheaper calls than traditional companies.

In conclusion

Amidst a volatile and fast changing environment, companies need to adapt to changes faster than before, and in ways different from simply benchmarking traditional industry leaders. It can be argued that benchmarking will simply prolong the suffering of a weakly positioned company.

It is important that a company puts the mechanisms in place to pre-empt market changes - to create the new competitive space itself, rather than to be forced into a second fiddle position by a rival company. To retain leadership, means that management must renew itself regularly and put the mechanisms in place to attract

and enable the right talent - and a corporate culture that is able to manage short and long-term thinking. It has to “fix” things that are not yet “broken”.

The area of such innovation can be varied, but four main areas are important: the customers the company aims to attract; the products and services it makes and delivers; the way that value is created and delivered to customers and shareholders and lastly, the cost-structure of the company (can they do the above cheaper than rivals). Once we understand the basis of competition, we can generate alternatives that will create and sustain company value.