How do business models get killed?

It’s an interesting question. I was talking about business models with Jason Potts last week and he said “maybe the definition of a mature industry is one where the business model has stopped evolving.” This suggests that it’s not technological innovation that changes industries, but rather business model innovation. So maybe old business models are murdered by new ones.

Adrian Wooldridge makes an interesting point about this in an article on innovation in universities in The Economist:

Lawrence Lowell, the president of Harvard, argued that “institutions are rarely murdered; they meet their end by suicide…They die because they have outlived their usefulness, or fail to do the work that the world wants done.” America’s universities quickly began “the work that the world wants done” and started a century of American dominance of higher education. They need to repeat the trick if that century is not to end in failure.

So a business model can die by suicide by failing to do the work that the world wants done. Or it can be killed if someone comes up with a better business model (something that universities should be thinking about right now). Often, these two forces work together to kill a business model.

But sometimes, maybe a business model can only be temporary. In response to my post The Property Ladder Theory of Bubbles, my student Mathieu Halley made a great point in the comments. He said:

The question that this raises for me is something of a counterpoint: I wonder what the worth of establishing a fixed term business is?

Is it potentially worthwhile to establish a firm and specifically plan from the beginning for it exist only for the duration of a particular bubble/growth period, instead of implicitly expecting it to exist forever?

I ran across a perfect example of this the other day: websites selling off overstock from luxury brands. There’s a terrific post on by Matthew Carroll on The Business of Fashion called The Rise, Stumble and Future of Gilt Groupe’s Business Model. The whole post is worth reading. Gilt Groupe was formed in 2007, and it was one of the first websites designed to hold flash sales of luxury remainders. According to Carroll, the timing was pretty close to perfect:

The timing of Gilt’s launch couldn’t have been better. In the months that followed, fashion and apparel brands began to feel the impact of a global recession that would ultimately give rise to one of the most challenging macroeconomic environments in the history of modern retailing. Seemingly overnight, wholesale inventories became unmovable as retailers drastically reduced product assortments and orders.

As a consequence, many fashion brands were forced to liquidate excess inventory positions, causing a sudden and significant supply glut for “cut out” goods. Prior to the Great Recession, brands would have sold this excess inventory through off-price channels like Loehmann’s, T.J. Maxx and Century 21. But as the economy sank, these retailers were asking for discounts as high as 90 percent, while merchandising clothes in a haphazard fashion which did nothing to protect the high-end image brands had spent years cultivating.

Gilt has done pretty well for itself. Revenue in 2010 was $425 million, they’ve built a strong customer list, and all of their metrics are going up. Sounds great, right?

However, there are problems. To support that level of revenue, Gilt needs increasing amounts of name-brand goods to sell at a discount. However, in light of their success, there are now many flash sale clothing sites around, and all of them need designer clothes to sell cheap. And there aren’t that many cheap designer goods around.

Here is how Carroll frames the problem:

An anecdotal comparison of the brands and products available on Gilt today versus those available in the company’s first couple of years shows that, over time, quality level has gone down. Back in 2009, it was possible to find prestige brands like Ralph Lauren Purple Label and Porsche Design on Gilt, in stark contrast to the many unknown brands that populate the site today. This meant that each time a subscriber opened an email and the product did not communicate the excitement-to-value ratio that had originally made Gilt so successful, their inclination to open subsequent emails from Gilt, and the brand’s position as a curator of style, suffered.

He has some excellent suggestions about how to improve things for Gilt (and for the flash sale sites in general), and they could well work.

But what if this business model only really had a lifespan of 5 years? The early success was built on unusual market circumstances – you could call it a cheap luxury goods bubble. Sometimes we get exciting new business models out of bubbles that have long-term success. But sometimes the best thing you can do in a bubble is sell off at the right time.

I don’t know what the answer is in this particular case. But I do think it’s worth starting to think about the lifecycle of business models, regardless of your industry.

That’s three ways then that a business model might be killed: murder, suicide, or natural causes. Which is yours most susceptible to?

(The picture of the Gilt Groupe warehouse if from Fantabulously Frugal)