‘Innovate!’ has become the global mantra against a backdrop of intensified competitive environment. But focusing on product innovation alone is no guarantee of success; neither is bundling products with services in order to offer meaningful differentiation. Below, Michael Yaziji considers another approach – creating a radically unique business model to drive growth and market share.
Death by Product Innovation
The more you try to innovate your products, the harder it becomes to be different. Across the globe we hear the call to ‘innovate!’ in order to protect value proposition and margin, and not fall into the price erosion trap. You innovate and innovate, yet no sooner have you launched your new, different product, then so does the competition. Alarmingly, there is often little difference in the eyes of the customer, and then you are back to square one.
From Product Orientation to Service/Solution
There must be another way. Some firms have taken to bundling products with services to offer ‘solutions’ in their attempt to offer differentiated products. ‘Solutions’ sound sexy and hold out the promise of higher profit margins. They also offer benefits to the firm that product innovation doesn’t. The first benefit is a greater understanding of customer needs. There is no doubt that firms become closer to their customers and can thus generate benefits particularly in terms of a more useful flow of information back to the firm of what customers really want. Firms are also able to create switching costs for customers. The more time and money invested in the relationship, the harder it will be for customers to change. Yet there is nothing particularly long-lasting about these advantages. They are essentially defensive, and focus on the status quo rather than offering something radically different.
The biggest benefit to the firm is that a successful move to service/solution requires changing your business model. The complexity of doing this involves changing both cultural and internal processes. Yet the results of a successful transition are a longer-lasting source of competitive advantage in terms of customer attraction and retention, and a value proposition that is meaningfully differentiated from that of product-focused competitors. Many firms have seen higher profit margins when taking this approach.
Nearly But Not Enough
There is a ‘but’. Moving to service/solutions only really offers major advantages when there are limited numbers of competitors in the marketplace. The pace of competition means that it is inevitable that many firms are already moving to offer service/solutions. Moving to this model is also costly and complex. Some of the financial advantages are likely to be lost when making the transition.
So what can firms do to ensure they gain rather than lose? How can they capture sustainable advantage? The answer is derived from the competitive strategy – when everyone is turning right, turn left – effectively do something radically different.
Stand Out from the Crowd
Desso, Google, Mobility, NetJets, REI – all these companies have one thing in common. In their search to innovate, they have found a way to become meaningfully different, by opting for a radically different solution. In so doing they are offering real and differentiated value to their customers. These companies and others have looked inside themselves and developed unique business models that are far harder to replicate; models that make them stand out in their industries.
Desso Case Study: Cradle-2-Cradle
When Stef Kranendijk became CEO of Desso, it was a mid-sized European carpet tile manufacturer. No one would describe carpets as a ‘wow’ industry or even particularly attractive. It wasn’t a firm or an industry you would necessarily choose to work for. There was little or no product differentiation and intense price competition for manufacturers to sell tiles to contractors. Desso had captured 15% of the market but produced only 1% EBITA margins. Yet by the time Kranendijk had completed his transformation, Desso would become a sexy, innovative company that top talent were fighting to work for. New multiple revenue streams replaced a single revenue stream and relationships with customers changed dramatically, becoming closer and long term, offering real opportunities for future growth and product differentiation.
A Radical Transformation
Kranendijk decided to radically transform the business model around a single design concept, the concept of Cradle-2-Cradle (C2C). The C2C concept is an approach to designing products that are built entirely of subcomponents. This means they can be endlessly assembled and disassembled without loss of quality – effectively recycling the product. It is an entirely different way of doing business requiring considerable changes within the firm, as illustrated in the following table.
Bet-the-Company
Essentially Kranendijk transformed the entire firm – supplier relationships, customer relationships, internal processes – to embody C2C. It wasn’t easy and it wasn’t without risk. It was an untested value proposition that had to be implemented across the entire firm, with no possibility of partial changes – effectively a bet-the-company, all-or-nothing move.
The changes from old to new business model required major organisational transformation, almost a complete redesign of the firm. These included: tighter integration of the R&D and marketing departments, fundamental redesign of the production process and working closely with suppliers to co-design inputs. With new processes and procedures, new skills would be required across R&D, production, marketing and sales2.
Internally, barriers that had to be overcome included: vested interests, cynicism, established management practices and behaviors as well as a culture used to a linear product-push approach. Externally, obstacles appeared across the entire value chain. Existing suppliers were challenged by higher quality standards, often testing relationships. Relationships with new customers, architects and designers, had to be developed. Desso had to both inspire and educate the new customers about the radically different value proposition and how it would benefit them.
And Win…
Despite the risks and objections, the transformation of Desso was completed. Such was the success that the firm is recognized as the industry leader in design. It attracts the best and brightest of graduates who fight to work for sexy innovative Desso. Aside from recognition, growth and profitability grew considerably as a result of the transformation. From 2007 to 2011 Desso’s profit margin grew from 1% to more than 9%. Market share increased by 8% to 23%.
Interestingly, no other competitor in the industry has opted for the same approach. Most likely this could be because in following Desso, differentiation would be reduced and along with it anticipated profit margins.
Getting the Right Preconditions
Of course, the transformation of Desso would not have been possible without two vital ingredients. First was Stef Kranendijk, who is a talented leader, able to inspire confidence in an organization undergoing enormous change and keep it focused. Kranendijk is both an evangelist and salesman of Desso and the C2C approach to design. His combination of skills is hard to duplicate. He also enjoyed considerable support from the private equity owners of Desso. The freedom they gave him to pursue a risky and long-term strategy is not necessarily one the leader of a publically listed company would enjoy.
Inspiration to Develop Your Own Unique Business Model
Is it possible to do the same in your industry? To gain sustainable advantage in changing your business model clearly requires taking a radical approach to identifying what might work in your specific industry.
Where to start? One approach is to work with your team to imagine new business models. This requires creative thinking and moving away from existing mindsets. An inexpensive step to the brainstorming process is to first look at different industries to see what has worked there. The following examples could provide some inspiration:
Apple Ecosystem Competition – Apple’s powerful value proposition is its ecosystem made up of computers, iPhone, iTunes, iPod, and the app developer community to populate the devices. Consider whether your firm could create a fully integrated ecosystem. Could you do this by bundling complementary products? Or closer integration across your value chain? Warning: This works for dominant firms; smaller industry players end up in ecosystem enclaves without the clout to leverage the advantage.
EasyJet and Southwest Airlines: Radical Yield Management
– if you incorporated a form of yield management, could your firm approach 100% asset utilization?
Google: Non-Paying Users – already players in other industries are attempting to use the model of ‘advertiser-pays’. Could your new business model be based on the assumption that it will not be the end-user who pays?
Holcim alternative fuels for cement manufacturing: Multiple Revenue Streams, Suppliers Pay – Getting rid of industrial waste is expensive and time consuming. Holcim takes other industries’ waste streams for payment and uses them as a negative cost input to their own products. Could your business model derive its profits from someone other than your customers?
Intrade: Market-Making – Network Effects – Intrade, the internet-based betting system, has created a simplified yet highly liquid market mechanism, whereby it takes a cut on every transaction. Transactions are generally lower cost, so more attractive. Are there incomplete or inefficient markets within your industry that your firm can address?
Mobility CarSharing: Automated Customer Interface – many industries are now using the Internet as a lower-cost, simpler, value proposition for customers. These include Airlines, hotels, car rentals, travel agencies, insurance, grocery stores, container shipping and others. Can you imagine a business model where customers in your industry find this value proposition attractive?
NetJets: Fractional Ownership – fractional ownership has been applied to small jets, cars, and property, allowing access and use of expensive assets for a percentage share rather than owning outright. How might this model of ownership work in your industry?
P&G Children’s Safe Drinking Water Program: Cross-Sector Collaboration – this model works particularly well in bottom of the pyramid contexts where several players collaborate to meet otherwise unmet needs. Creating successful cross-sector partnerships are challenging to achieve, but are extremely difficult to copy, and offer you the benefit of new markets for your products and services.
REI: Customers as Owners – research suggests that employee-owned firms generate greater total value than capital-owned firms. They enjoy loyalty and increased performance of the key stakeholders – the employees. Can you imagine an employee-owned model for your firm? Other, less radical steps, are adding employee or customer representatives to your board, or introducing a super-charged loyalty program based on customer capital investment and profit-sharing.
In Summary – Innovating from Product to Solutions to Radically New Business Models
The speed at which competitors can match your innovative, differentiated products is increasing, resulting in price competition. Many firms are now bundling services with products in an attempt to differentiate on a unique competency that is harder to match. Yet it often doesn’t go far enough to produce sustainable advantage. When multiple firms follow the same path, it is more than likely they will end up in the same place with similar business models! Anticipated profit margins and other benefits are then unlikely to be realised.
The Desso case and others illustrate how creating a radical business model for the firm leads to a more sustainable competitive advantage. Brainstorming new business models can be energising for a team. Simulating how models in different industries might work in yours can potentially lead to major transformation, increased growth and profitability. Become an industry leader – take the leap!
About the Author
Michael Yaziji (PhD Strategy & Management; PhD Analytic Philosophy) is Professor of Strategy and Organizations at IMD. He teaches in the areas of strategy, nonmarket strategy, ethics, stakeholder and change management, and governance. He is the author of numerous articles, case studies and projects. Additionally, Michael consults for many Fortune 100 corporations in the areas of strategy formulation and implementation, nonmarket strategies, public-private partnerships, organisational values, shared-value business models, and stakeholder management
The Author wishes to thank Lisa Duke, Research Associate, for her assistance in producing this article.
References
1. Modified from Business Model Generation, A. Osterwalder, Yves Pigneur, Alan Smith, and 470 practitioners from 45 countries, self-published, 2010.
2. For a fuller description of the key levers of organisational design see Designing Organizations, J. Galbraith, Jossey-Bass Publishers, San Francisco, 1995.
