Archive for category business models
Three Mistakes We Make With Models
Posted by Tim in book riffs, business models, innovation on 18 January 2012
Imagine that you live in Australia and you would like to eat a good, genuine bagel. After fairly extensive research, I have discovered that there are two places that you can go. One is called Bagel Nook, and it’s here in Brisbane. Not many people know about it, and one of the reasons is that it’s really hard to find.
Here it is on a map:
Here’s why it’s hard: it’s address is Creek Street, but you can’t actually reach it from Creek Street. To get to Bagel Nook, you have to go down that tiny little laneway that comes off of Adelaide Street. It’s a classic example of the map not being the territory.
The other place in Australia with good bagels is Glicks in Melbourne. It’s also on a tiny hard-to-find street, so to get there you need an equally detailed map.
Now, imagine making an Australian Bagel Road Trip and travel from Bagel Nook to Glicks. If you start with the map with Bagel Nook, and stick with maps of that scale, you’ll need roughly 8,335 pages to cover the trip that you’ll take.
That’s no good. Instead, for most of the trip, this map is what you need:
Maps are models, and we use models all the time to help us understand the world. We use models of roads to help us get around. We use models in science to help us understand physics, the way that economies work, and many other things. John Kay makes a good point about how we use models:
All science uses unrealistic simplifying assumptions. Physicists describe motion on frictionless plains, gravity in a world without air resistance. Not because anyone believes that the world is frictionless and airless, but because it is too difficult to study everything at once. A simplifying model eliminates confounding factors and focuses on a particular issue of interest. To put such models to practical use, you must be willing to bring back the excluded factors. You will probably find that this modification will be important for some problems, and not others – air resistance makes a big difference to a falling feather but not to a falling cannonball.
Our use of mental models is so ubiquitous that we’re often not aware of using them at all. However, we can use the Australian Bagel Road Trip and the quote from Kay to look at three common mistakes that we make with models:
- Using the wrong scale: just as we need a map at the right scale to get from Bagel Nook to Glicks, our business mental models also need to be at the right scale.
In her excellent book The Plugged-In Manager
Terri Griffith talks about the thought process that a manager goes through in making the decision to start using the cloud for some of their computing functions. She talks about how to make this decision, you have to think about how the technology, your people, and the organisation’s processes interact.
But it’s also important to have a good model of how cloud computing works. And this means having a model at the right scale. For most managers, you don’t need a hugely detailed model that includes servers, packet-switching and communication protocols. That’s the wrong scale – too small. But you do probably need to have a model that includes issues like back-ups, security and mobile access.
If you use a model that is the wrong scale, it will be very hard to make good decisions. That’s the first mistake to avoid.
- The map isn’t the territory: even if you have the map for Bagel Nook, it’s hard to find it. You need to be on the ground to figure out to go into that little laneway.
Mistaking the map for the territory is a huge problem in business. Roger Martin addresses this in his book Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL.
Martin talks about the difference between the real market and the expectations market. In the real market, firms make and sell real goods and services, and their performance depends on how effectively they do this. The expectations market is the stock market – and here, a stock is a model of how the firm is expected to do.
Steve Denning talks about the implications of mistaking the expectations market (map) for the real market (territory):
“Maximizing shareholder value” turned out to be the disease of which it purported to be the cure. Between 1960 and 1980, CEO compensation per dollar of net income earned for the 365 biggest publicly traded American companies fell by 33 percent. CEOs earned more for their shareholders for steadily less and less relative compensation. By contrast, in the decade from 1980 to 1990 , CEO compensation per dollar of net earnings produced doubled. From 1990 to 2000 it quadrupled.
Meanwhile real performance was declining. From 1933 to 1976, real compound annual return on the S&P 500 was 7.5 percent. Since 1976, Martin writes, the total real return on the S&P 500 was 6.5 percent (compound annual). The situation is even starker if we look at the rate of return on assets, or the rate of return on invested capital, which according to a comprehensive study by Deloitte’s Center For The Edge are today only one quarter of what they were in 1965.
In other words, mistaking the model for reality has destroyed shareholder value, the opposite of what was intended. We always have to be aware of the models we’re using, and ensure that we’re managing the reality, not the model.
- Using the wrong map: a lot of people contend that a significant cause of many of the recent stock market crashes has been the use of incorrect models. That’s the fundamental issue that Nassim Nicholas Taleb keeps trying to get people to acknowledge. His contention is that the market models in use have vastly underestimated the probability of large price fluctuations. Consequently, when these fluctuations do occur, things blow up.
The post by John Kay addresses the problems with this, as does this one by Mark Buchanan, and they’re both worth reading. The key point though is simple: if you use a model that isn’t accurate, you can’t make good decisions.
Models are an important part of how we make sense of the world. However, we often make mistakes in our use of models. To avoid these mistakes, try to make sure that the model you use is at the right scale for the decision you’re making, try to manage the real market, not the model built on top of reality, and try to make your models as accurate as possible.
And if you know of any other good bagel places here in Australia, please let me know!
Three Things You Can Do With a Business Model
Posted by Tim in business models, experiments, innovation strategy on 17 January 2012
Yesterday I looked at Eight Models of Business Models and Why They’re Important. However, in writing about how different people conceive of business models, I didn’t have enough space to address the really critical issue with them:
What can you actually do with a business model?
Once you’ve defined your business model, here are three ways that you can do with it:
- Test Your Organizational Design for Consistency: one of the key issues in looking at business models is that they must be internally consistent. If your value proposition is that you’re the cheapest, this has a direct impact on the choices you need to make about who to hire, how to train them, the relationships you’ll have with customers, who your customers need to be, etc.
In response to yesterday’s post, Graham Hill said on twitter:
None of the business model work passes muster. There are dozens, maybe hundreds of dependent variables. Not repeatable.
This is a valid point, if your objective is to try to replicate someone else’s business model. Bob Sutton makes a similar point in a great review of Inside Apple: How America’s Most Admired–and Secretive–Company Really Works
by Adam Lishinsky. It is one of those reviews that is just a nice piece of writing – worth reading whether or not you’re actually interested in the book.
Sutton raises an important point:
Apple is nearly the exact opposite of the kind of organization hyped by people like Gary Hamel and even Peter Drucker. It is centralized, secretive, fear-ridden, punitive, and not much fun for most people who work there. But it works because the pieces of the “organizational design” fit together, or at least did fit together when Jobs was there, in an elegant way. The secrecy is so severe that, when products are launched, even senior people are surprised by the final product because people are on a strictly “need to know” basis. But this is offset with a system of roles and responsibilities — and crucial to all of it– is what Apple calls the DRI, the directly responsible individual, a centerpiece of the organization. There is clear responsibility placed on individuals, not so much on groups and committees. Although groups and some committees do exist, the DRI can always be found and is where attention is focused. Which means that that it is clear where to go to provide guidance, to integrate their work with others, and who will be fired, blamed, and replaced — and celebrated too.
…
My point here, and this follows an old conceptual perspective called “contingency theory,” is that other organizations that want to be like Apple –and that seems like so many now — need to be especially careful about copying individual pieces, because the reason it works is that the multiple elements fit together.The point here is to be wary of picking up one part of someone else’s business model and dropping it into yours. If the whole business model isn’t consistent, you’ve got problems. So unless you have Apple’s intuitive sense of what customers need, it’s very dangerous to say “Apple doesn’t do focus groups, so we won’t do focus groups.”
- Innovate the Business Model: Henry Chesbrough and Richard Rosenbloom tell two stories of business model innovation in the copier industry in their paper The Role of the Business Model in Capturing Value from Innovation. When Haloid Corporation tried to launch the first Xerox machine, they used the same business model as the mimeograph machines that they were competing against.
The initial launch of Xerox machines failed, because they cost six times the machines they were competing against. It took an innovation in the business model to succeed. Instead of trying to replace a mimeograph, Haloid decided to try to replace a secretary. This meant a new value proposition, a new market segment (only large firms), a new revenue model (leasing instead of purchasing), and so on. With the new business model, and with no change to the underlying technology, the Xerox machine took off.
Haloid Corporation changed their name to Xerox, and they dominated the market for nearly 30 years. Until another business model innovation started to seriously erode their market share.
Business model innovation is a powerful form of innovation. So once you’ve described your business model (or that of your industry), start thinking about how you can change it.
- Use it to Test Your Market and Your Assumptions: Steve Blank likes to say that a business model is just a set of hypotheses about the market. So you can use the business model to test your assumptions about what will work as you introduce new ideas.
Experimenting is a crucial part of innovation. You can use business model analysis to identify the assumptions that underlay your innovation – this tells what experiments you need to try.
Blank documents the process in his fantastic Lean Launchpad series, where he talks about nine teams in his entrepreneurship class at Stanford used the business model concepts to launch start-ups. Here is a description of one of the experiments:
The first team to present was D.C. Veritas, the team building a low cost, residential wind turbine. During the week they interviewed 7 more companies and consultants, developed case studies for 20 different cities in 5 states, and finalized the bill of materials for the wind turbine. But the big project for the week was testing and analyzing Customer Acquisition Costs. The team put together their sales funnel and started testing demand.
The results were disappointing. The most optimistic estimates showed that the residential wind turbine market was less than $20m in year 5 and the costs to acquire the customers made this a money-losing business.
After regrouping the team decided that a major pivot was in order. Perhaps residential customers were the wrong target? Maybe the wind turbine they were building was better suited to a different customer segment? They had gotten feedback from consultants and industry experts that cities and utilities might be a more receptive audience. What if they redesigned the wind turbine to be embedded into street and highway light poles? Then they could serve cities, lighting companies and utilities. Using the business model canvas, the changes to their business were obvious.The business model can be a great tool for guiding innovation experiments.
Yesterday we mainly talked about how business models can be described. Once you’ve described your business model, then what? These are three ideas – you can use it to: test your organisation design, innovate the business model itself, and define innovation experiments to test the assumptions of your firm.
Mimeograph photo from flickr/nicksarebi under a Creative Commons License.
Eight Models of Business Models, & Why They’re Important
Posted by Tim in business models on 16 January 2012
The term Business Model is one that gets thrown around a lot these days. Even though it might sound like a buzzword to you, it’s important to understand what a business model is, and how they are useful.
One of the confusing things about the business model concept is that there are a wide variety of models of business models, and it seems as though everyone that talks about them makes up a new one. This can be frustrating if you are trying to figure out how to use the concept.
At their core, all business models address this questions: how do we sustainably deliver value to our customers? In this instance, the sustainable part refers to your organisation – how can you deliver value so that you’re still around in the future?
In a special issue of the journal Long Range Planning, Charles Baden-Fuller and Mary Morgan say that business models can serve three different purposes. They can describe different kinds and types of businesses. This is critical if we are trying to study them analytically. They can be short-hand descriptions of how firms operate – the primary value here is that you can use the business model to ensure that you have strategic fit across activities. Or they can be role models – you can use them to describe how you want your organisation to function.
More recently, Steve Blank has added another use – he says that business models are hypotheses about how your organisation might be able to create value for customers (see my discussion of this here).
To help illustrate some of the important points about business models, here are some of the models of business models that I’ve run across. The list isn’t comprehensive, so I apologise to anyone that I’ve forgotten – it’s simply due to my ignorance.
- Value Networks from Verna Allee: Verna was working with some of the basic concepts of business models in the 90s. One of the tools that she developed is Value Network Mapping:
Key points: value creation and exchange is at the core of understanding business models. You need to clearly articulate how you create value, and for whom. The other key point here is that value isn’t just about money. You can also create and exchange intangible value. You can see her latest work here in her book Value Networks and the True Nature of Collaboration.
- Henry Chesbrough: described business models in an article with Richard Rosenbloom and in his book Open Innovation. Here is what his business model looks like:
Key points: new innovations often require new business models. This is where the idea of business model innovation really started to gain traction. Chesbrough didn’t just describe business models, he also discussed how changing a business model can be an innovation just by itself. I’m beginning to suspect that all new innovations require new business models…
- Strategy Diamond: this is a strategy tool developed by Hambrick & Fredrickson. They talk about the importance of having an integrated strategy, which looks like this:
Key points: the first key point here is that a good business model is integrated. All of the elements need to be consistent with and support the others. If you change one element, it’s likely that you’ll need to change all of them. Second, this model illustrates how closely linked strategy and business models are. When you design a business model, you can’t do it without clearly articulating a strategy.
- Patrick Staehler: wrote a PhD called Business Models in the Digital Economy that was published in 2001. His business model looks like this:
Key points: the thing I like best about Staehler’s model are the three bottom boxes: Leadership Style, Relationship Style and Values. Think about that in relation to the point above about integration. If you change the relationship style within your organisation, you’ll likely need to change the rest of your business model as well. Furthermore, this business model innovation could be a source of competitive advantage. This is a very powerful point.
- Business Model Canvas: around the same time that Staehler was writing his PhD on business models, Alex Osterwalder as also writing a PhD on business model innovation. He developed a tool called the Business Model Canvas. He has subsequently published a book called Business Model Generation, which is all over the place now, along with a number of other analytical tools. Here is his version, as modified by Steve Blank:
Key points: this is where the business model concept has started to go mainstream – it’s astonishing how well this version of business models is doing right now. Osterwalder has done a great job of promoting the idea, and making it genuinely useful. This version of business models proves that it is a practical tool that you can use to figure out where your organisation should be heading.
- Long Range Planning: the special issue mentioned above makes a couple of important contributions. There is a new model of business models in the paper by David Teece, but it is more of a model to use in description if you are trying to study these academically. It’s not really one that you could use very easily within a firm for analysis.
Key points: the issue with the Teece model illustrates the point that Baden-Fuller and Morgan make about the different uses of the business model concept. Teece’s model is designed solely for description/classification. So you can run into approaches for business models that aren’t as practical. The second point in the special issue is this: about 2/3 of businesses surveyed in one of the papers can’t articulate what their business model really is. This is alarming. It also raises the point that every organisation has a business model, whether you have consciously thought about it or not. If you’re trying to develop business strategy, it is essential to actually give this some thought.
- Seizing the White Space: Mark Johnson works with Clayton Christensen, and Johnson’s book from last year has another model of business models. The website has a bunch of useful resources, and the book has some great stories about business model innovation. His model looks like this:
Key points: so now we have models of business models with 4,5,6,9 and 12 components. The same core elements keep turning up. For me, I don’t care which business model version you use, and picking the right one depends on what you’re trying to accomplish. Personally, I like the Chesbrough version because of the emphasis on networks, which I think is critical. On the other hand, the Business Model Canvas is getting easier to use now because of the substantial amount of resources that are building up around it.
People build their own model for different reasons, but it’s important to understand that they are all trying to find ways to get at essentially the same issues. There isn’t one that is absolutely correct. So pick whichever one resonates the most with you to use.
- Escape Velocity: the latest book by Geoffrey Moore is fantastic. In it he includes a 9-point Market Strategy Framework, which includes elements like Target Customer, Compelling Reason to Buy, Partners and Allies, etc. If you look at it, it’s outlining a business model.
Key points: like I said earlier, any time you start thinking about strategy, you’re thinking about business models. So even frameworks that aren’t being put forward as business models really are business models.
Business models are important. They are an important tool that can be used to augment product and service innovations, to link innovation to strategy, to co-ordinate activities within an organisation, and they can be a source of innovation as well.
There are many models of business models out there. You can use whichever makes the most sense to you. But it’s important to use one.
Follow up post: Three Things You Can Do With a Business Model.
Business Model Analysis & the Link to Strategy
Posted by Tim in business models, design, innovation strategy on 3 January 2012
What’s the best way to use business model analysis in larger organisations?
Steve Blank has done some outstanding work looking at how Alex Osterwalder’s Business Model Canvas can be used in entrepreneurial startups (see also this post and the ones that follow it). But there are still some questions about how to best use the concept in larger firms.
That is a problem on which I’m currently working.
I’m doing a project with a very large engineering firm. They provide an off-the-shelf product to the vast majority of their customers, however, there are an increasing number of customers that need bespoke solutions to problems. We are doing some work with the team that develops these solutions, and it Business Model Analysis has ended up being a very useful tool.
I’m working with Manny, whose team is in charge of developing futures analysis skills throughout the organisation. We are working with Moe, the manager of the Bespoke Solutions Team (BST), and the project is sponsored by Jack, who manages both Manny and Moe, along with several other teams.
When we spoke with Moe, he said that there were four different views within the firm of the role his teams should be filling:
- Change Agents: in this role the team identifies the problems that they should be working on, and develops solutions to these problems. They then turn the engineered solutions over to others within the firm who will manage delivery to customers.
- Service Provider: here the team has the problems specified for them by another group within the firm. They develop solutions (as they do in all four scenarios), and pass them on to the other group for execution.
- Service Delivery: in this role the team still works on problems specified by the second group, but after developing their solutions, they would be responsible for managing delivery as well.
- Profit Centre: is a full service role. The team would identify problems to work on, develop and deliver solutions. They may do this only for the parent firm, or they might be able to sell these solutions to others in the market as well.
There are a couple of dimensions along which these models vary. In a couple of them, the team is responsible for identifying the problems to address, while in two others the they are working to specification as the problems are defined for them. The other source of variation is project management: how much of the solutions development process should the team be responsible for?
Manny and I took these two dimensions and mapped out the four possible roles for the BST. Here is the map:
In each quadrant, there is an indication of the project management responsibilities: I1 = problem identification, I2 = solution development, I3 = solution delivery to customers.
In a lot of ways, these possibilities map onto the Four Roles for Your Innovation Team that I identified last year, with similar issues.
Manny and I have been working with Moe to map out Business Models for each of the four different roles. One thing that has become quickly apparent is that each role has a significantly different value proposition, which leads to differences throughout the business models, particularly in the areas of Key Activities and Key Resources, but also throughout the rest of the models.
The differences between the different business models are really important – since one of the critical issues is that a business model needs to be internally consistent. As we’ve continued to work on this, we have learned several important lessons:
- Two of the quadrants fail to provide stable solutions: all the way through the process, I’ve kept asking people “who owns the customer?” I think they’re sick of hearing this, but it’s a critical point. In the Change Agent role, the team is responsible for identifying problems, but they don’t handle solution delivery. Which means that two different teams need to know the customer very well. This never works. The same problem occurs in the Service Delivery role, but this time they are responsible for solution delivery, but not problem ID. Same issue – to work well, whichever team is delivering solutions needs to also be identifying problems. That way, they can get really close to the customers, and develop a deep understanding of what they need.
It makes a lot more sense to either be a Solutions Provider, with the other team responsible for both problem ID and solution delivery, or to be a Profit Centre, where the BST will be responsible for all of it. These are both more stable solutions, as ownership of the customer is clearly defined in both scenarios.
- You can’t pick a little bit of each business model: as we’ve started to map out the Key Activities and the Key Resources, it has become apparent that each business model requires a different set of skills within the BST. If we make a list of the skills that they currently have, they have some from each of the four possible models, but they don’t have all of the skills needed by any one o them. Using the Business Model Canvas should help us develop a skill development roadmap for the team so that they are able to work within one coherent business model.
- Why not use multiple business models? The BST currently has four distinct market segments in which they work. One question that has come up is why not use a different business model for each one? There are a few good reasons to avoid this. The main one is that it will be nearly impossible for Moe to manage four different business models within his team. Management attention is limited, and even though Moe is an excellent manager, every time I’ve seen someone trying to manage more than about two business models at the same time, trouble occurs.
The second reason is that if the team develops one business model, they will own several important skills that the firm needs. This will make it much easier to branch out into other market segments over time, or to develop into a genuine profit centre generating external revenue. Both of these will be much harder to achieve if they are running multiple business models.
- Which model is right is a strategic decision: this is the most critical point. There is no absolutely correct business model to use here. The best choice depends upon the firm’s strategy. This is where Jack is important – he has to decide on the direction that his teams are going go. Either the Solutions Provider or the Profit Centre model can work. Which one to pursue depends on how much of an external market there is for BST solutions, whether they have the skills and resources to pursue those opportunities, and, most importantly, where the firm wants to be going.
If growth and innovation aren’t that critical, then putting the team into the Solutions Provider role is fine. However, if the firm wants to drive growth through innovation, they will be better off with a dedicated innovation team, which is what they get with the Profit Centre business model.
This is just one way to use the Business Model Canvas in a larger firm. Paul Hobcraft’s post has many other suggestions.
But the bottom line is that it is an excellent tool, and every organisation should be thinking about their business model. And working on how to innovate it.
Three Ways to Kill a Business Model
Posted by Tim in business models, evolving economic entities on 21 December 2011
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)
Use Your Value Proposition to Avoid Fatal Business Models
Posted by Tim in business models on 13 December 2011
What do you think of when you think of Swiss Watches?
You probably think of high-end brands, that have been making well-crafted watches for many years. Brands like Rolex, or Patek Philippe, or George Clooney and his Omega:
Or maybe you think of innovations, like the perpetual calendar, or 24 hour timezone watch, or the tourbillon from Breguet:
For centuries, watchmakers in Switzerland made hand-crafted watches. And the competed on craft – inventing things like tourbillons to improve the accuracy of their watches.
Then quartz watches showed up. And for a fraction of the price, suddenly you could get a watch that was 10 times more accurate than the best, most expensive Swiss watch.
That innovation blew the business model of most of the high-end watch firms out of the water. Many of the top brands actually stopped making mechanical watches completely – Hamilton, which had dominated US manufacturing disappeared. So did Baume et Mercier in Switzerland. Rolex and Omega hung on, but they did it by changing their value proposition from “we make the most accurate watches” to “our brand tells people something about you when you wear our watch.”
The Swiss brands that survived continued to innovate, but only at the high end. Until Swatch came along with a business model innovation. Building on the idea that watches had really become fashion accessories, Swatches value proposition was “we sell fashionable watches that are so cheap, you can have a bunch of different ones for every occasion.”
Swatch was quite successful with this new value proposition, and this led a resurgence in the Swiss watch industry. By 1984, employment in the Swiss watch industry had fallen from a peak of around 100,000 people down to about 33,000. In the years since, it has climbed back up to nearly 50,000.
It’s likely that when you think of Swatch, you still think of flashy looking plastic watches like the ones in the picture. But as they’ve become more successful, they’ve led an astonishing concentration in the industry. They bought up many of the brands that had gone out of business, like Hamilton, Longines, Breguet the inventor of the tourbillon and even Omega. And they started manufacturing mechanical movements in bulk, selling them to smaller watchmakers – often very high-end ones.
Swatch now owns several movement manufacturers – ETA, Frederic Piguet, Lemania, and Nouvelle Lemania. Which means that nearly every major watchmaker in the world now uses movements manufactured by a Swatch company. Some exceptions include Rolex, Zenith, Seiko, Lange and, ummmm, not many others.
One consequence of this is that you can buy high-end mechanical watches that cost from $500 to over $10,000 using the movement in the picture, the ETA2824.
So what’s the value proposition for these brands?
That question just became a whole lot more important, because it turns out that Swatch may now need all of their movements for their own brands. There is a fascinating story about this in the NYTimes.
Swatch is being sued for taking advantage of monopoly power. But this is really a story about building suicidal business models. If you’re making a watch that sells for $10,000 why would you try to cut the price of the movement in half by buying it from Swatch? That’s the choice that was made by all of the watchmakers that are now upset about this latest move.
There is enormous risk involved in outsourcing a key part of the value chain – this is one of the things that you must consider when building a business model.
Olivier Müller, an independent watch consultant who also runs Laurent Ferrier, a boutique watch firm, said he expected Swatch’s arguments to prevail.
“This whole battle is the result of people completely underestimating the risk that at some stage Swatch could cut off rivals, which is a legitimate decision to make in a free market,” said Mr. Müller, who was a Swatch executive until 2001.
Swatch, he added, established “a quasi-monopoly not because of any ambition to control the market,” but because “everybody else was perfectly happy to spend everything on marketing rather than building up their own production.”
One company that realised this was a bad choice is Hublot:
Thanks to Swatch, “there is no other industry with such cheap entry costs,” said Jean-Claude Biver, who spent 12 years on Swatch’s executive committee before becoming chairman of Hublot, which is now part of LVMH Moët Hennessy Louis Vuitton, the world’s largest luxury goods company and one of Swatch’s main rivals.
Hublot has been using Swatch components, but since 2007 it has invested 40 million francs to develop its own manufacturing capacity. It is on track to ensure that 75 percent of its revenue will come from watches made entirely in-house within three years, compared with 37 percent now.
The real problem here though is in the value proposition. If you have built a watch brand based on making watches with parts that are identical to those of 90% of your competitors, what sets you apart? What unique value are you delivering to customers?
There may be a bit of schaudenfreude in seeing this happen to big luxury brands. But those two questions are essential for every organisation to answer. If you can’t answer them, your business model is suicidally fatal.
What sets you apart? What unique value are you delivering to customers?
The Property Ladder Theory of Bubbles
Posted by Tim in business models, complex systems on 1 November 2011
I’ve always thought that the BBC show The Property Ladder provided the perfect illustration of how bubbles worked. The show ran from 2002-2006 and it was hosted by Sarah Beeny. The show profiled aspiring property developers who bought properties, renovated them, then tried to sell them for a profit.
If you’ve never seen it, this will give you a flavour of how it worked:
That show that included Sian Astley – who was atypical in that she went on to become a successful property developer. The normal pattern in the show is that the developer-to-be buys a property, then spends most of the show ignoring the advice given by Beeny (because otherwise it wouldn’t be nearly as interesting).
Inevitably, the projects run way over time, and way over budget. Nevertheless, the properties always ended up selling for a substantial profit, and they nearly always ended with the new developer planning to move on to their next development project.
The reason that it’s the perfect example of a bubble is this: the reason that the properties always made a profit is not that the developers did a great job, it’s that the UK house market was red-hot throughout the time the show was made, so every house went up in value. In fact, running over time helped the developers out, because it gave the properties more time to appreciate.
What happened to all these “property developers” once the GFC hit? There’s a hint in that the revised series is now called Property Snakes & Ladders. I suspect that unlike Astley, nearly all of them went bust.
Here’s the problem: if you start a business in a bubble, it’s easy to make money, but it’s very hard to define the value that you provide. If you fail to provide clear value, whenever the bubble bursts, you’re out of business.
I ran into two examples of this in conversation today. The first was talking with Nancy on our drive in to work. She recently joined the board of directors for an association that for years made money from their conferences. How? By getting lots of sponsorship from drug companies. Now that the pharmaceutical sponsorship bubble has burst, they have no idea how to make up the lost revenue.
But their real problem isn’t how to make up the revenue – it’s that they don’t appear to have any idea what value they actually provide to their members. If they could answer that question, then they could figure out how to make up the money.
The second example came from an energy consultant. He told us about all the companies that formed in New South Wales to take advantage of the government subsidies designed to get people to switch to compact fluorescent lightbulbs. While the subsidy was in place, they all made money. When the subsidy disappeared, so did they.
Again, they didn’t have a clear value proposition.
If you don’t have a clear value proposition, you can’t build an effective business model. Without the value proposition, all the other business model factors are incoherent.
This is one of the reasons that more successful firms are founded during depressions than they are during bubbles. To be successful when times are tough, you have to have a clear value proposition.
Don’t just surf the rising tide. To figure out how to last, figure out how you provide value to people. This is the first, essential step to building a successful business model.
Twitter’s Business Model Innovation
Posted by Tim in business models on 22 August 2011
In an excellent article on the impact of twitter on the Arab Spring revolutions, Blake Hounshell makes an important point about twitter itself:
But five years since its founding, Twitter has hit a critical mass of activists and casual observers on the ground, journalists in the office and in the field, and analysts behind their desks. Twitter today is always buzzing with news, ideas, rumors, speculation, and juicy gossip. (It was Twitter itself that understood this shift from vanity tool to news platform earlier than anyone else, when in November 2009 it changed its prompt from “What are you doing?” to “What’s happening?” One of the fastest ways to tell whether someone’s not worth following is if they’re still answering that first question.)
This is true in politics, and it is true in other fields as well (on a related point, you can also tell which critiques of twitter aren’t worth reading – they are the ones that criticise the stream of tweets answering the “what are you doing question”). It is certainly the case that there is a thriving discussion of innovation on twitter now too.
If you think about it, that change in question actually represents a business model innovation on the part of twitter. Once the question being answered changes, so does the value being created.
And once the value created changes, you have a new business model.
If changing one small question can change the business model for twitter, what might change the business model for your organisation?
It’s a question worth thinking about…
Why (Almost) Everything is Lousy
Posted by Tim in business models, innovation on 21 August 2011
I recently read an article on BNet by Geoffrey James called “Top 5 Totally Useless Business Experts“. James usually writes an interesting column, and even in this one he makes some good points. But he also uses a form of argument that is deeply flawed.
Here is part of the post:
Useless Expert #1: Management Consultant
These are the vampires of the corporate world. They latch onto a corporate artery (usually a C-level exec) and then use the management fad du jour to set up dozens of meetings where they provide mountains of unwanted and unneeded advice. At the same time, they neatly remove themselves from any responsibility for results. If something bad happens, it’s because you didn’t follow their advice carefully enough. If something good happens, well, you know…
I personally watched McKinsey suck $2 million in blood money out of an engineering budget inside a company on the verge of major layoffs. And that was just the direct cost of the consulting. The lost opportunity cost was probably in the order of $10 million more.
The project that he discusses is horrible – it’s an example of terrible consulting. And in fact, in my experience, most management consultants are lousy. Many of them do things that harm their clients rather than help.
Or they come back with meaningless buzzwords that don’t actually help with anything. Tom Fishburne illustrates this with his latest post (and you should be subscribed to his RSS feed – he’s doing consistently fantastic work):
But here’s the thing – Nothing is always absolutely so. That’s Sturgeon’s Law, and it is even more important, though less widely known than Moore’s Law. Here’s is what Sturgeon wrote in Venture in 1958:
I repeat Sturgeon’s Revelation, which was wrung out of me after twenty years of wearying defense of science fiction against attacks of people who used the worst examples of the field for ammunition, and whose conclusion was that ninety percent of SF is crud.
Using the same standards that categorize 90% of science fiction as trash, crud, or crap, it can be argued that 90% of film, literature, consumer goods, etc. are crap. In other words, the claim (or fact) that 90% of science fiction is crap is ultimately uninformative, because science fiction conforms to the same trends of quality as all other artforms.
It’s the same in business. There are lots of stories about bad consultants, because 90% of consultants are crud. Lots of companies fail using social marketing, because 90% of social marketing initiatives are crud. And so on…
Nothing is always absolutely so.
Now, that’s a really bad point to try to build a blog post around. It’s always a lot harder to explain why there are exceptions to every rule. It’s easier to make big categorical statements. It’s more fun, it’s easier to make lists out of them, they get more tweets, and +1s, etc.
It’s a lot harder to figure out how to identify the 10% of something that isn’t crud. But if you’re looking for a management consultant, here are some of the questions you can ask that might help:
- Do they have experience with my type of problem?
- Do they use one-size-fits-all tools or do they really learn about what’s going on inside an organisation?
- Do they only focus on the easy part (pointing out what’s wrong), or do they have useful things to say about execution as well?
That’s just a start, and you can build a similar list of questions for everything.
The good news about Sturgeon’s Law though is that 90% of your competitors are crud too! So how can you get into the 10% that’s good?
It takes some work. For one thing, this is a good argument against benchmarking, doing what everyone else in your industry does, or using the same business model as everyone else.
This is a huge innovation opportunity. What can you do that is genuinely different? You need to write your own map for that.
Sturgeon’s Law explains why almost everything is lousy. It also explains why you can’t take anecdotes (or even trends) and use them to categorically dismiss something. You have to figure out a way to identify who in a field might provide you with genuine value.
More importantly, it means that you have a real chance to set yourself apart by providing genuine value.
Little Innovations Matter!
Posted by John in business models, innovation, innovation strategy on 29 July 2011
Here’s a question for you.
What’s better…. a lot of little innovations or one big innovation? If we had to choose, would it better to have an economy made up of a lot of firms trying to make small improvements to their business or do we want a game-changer like Apple or Google?
The big innovations are glamourous and they become part of business folklore. Governments then spend a lot of effort trying to replicate the success of these companies by supporting businesses that might turn into the next Microsoft, GSK or Samsung. The trouble is that we need to go through a veritable haystack of businesses to eventually get these needles that grow from nothing to become global leaders in their industry.
In hindsight we can say that Apple was always going to become a great business but hindsight is a misleading science. Someone who pointed to two strange kids (Jobs and Wozniak) at the Homebrew Club for computing enthusiasts in the 1970s saying that this is the beginning of one of the most influential businesses of the early 21st century would be laughed at. Pity we can’t put a bet on a horse at the finish of the race.
But what about the little innovations that go unnoticed in typical businesses around town? These are often experiments in products, supply chains or production processes that can be the beginning of new business models. While they don’t attract the attention of the big innovations, they are extremely valuable and when many businesses start accumulating innovations we can see a new growth industry appear that creates wealth for those businesses and other supporting industries in the region.
Personally, I love the little innovations where a small business has found an ingenious way to tackle a problem or position themselves differently in the market place. Why? Because most businesses in any region employ less than 100 people. Learning from these firms and then sharing this learning with other small businesses is a great way to encourage innovation.
Last week we launched the Brisbane Innovation Scorecard and a major part of the report was the survey that showed that 65% of a random sample of 372 Brisbane organizations had introduced some form of innovation in the past three years. Like any city, the majority of these organisations were small businesses. The scorecard launch itself was a celebration of innovation, which attracted a lot of attention from both businesses and goverment in the Brisbane region. The following YouTube video is a nice little summary of the launch.
Most innovation awards focus on the high tech and although there was one business in the featured group of companies that is genuinely high tech, the others were in industries such as construction, hospitality, not for profit and mining that are usually overlooked when we think about innovation. In all cases they had innovated to improve critical areas of the business. Mining companies with step changes in processing technology, restauranteurs with novel approaches to organising food supplies and safety training packages for electrical contractors were all featured. Looking at these successes enables other managers to think about changes that could be made to their own businesses. The following link is a radio interview that I did late last week talking about these case studies.
ABC radio interview with John Steen on Brisbane Innovation Scorecard
For those of you who can make it to Brisbane on Tuesday 23rd of August, Tim and I will be running a masterclass on successfully managing innovation. Thanks to support from Enterprise Connect, there is no charge for the workshop. We will start at 7:30am with a keynote talk over breakfast and conclude at midday. The masterclass will be held at the UQ Business School city facility at Central Plaza 1 on the corner of Creek and Queen Streets. Seats are limited so you will need to reserve your seat early. Please register your interest with an email to d.burke@business.uq.edu.au
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