Will Your Business Model Work in Tomorrow’s Market?
September 10 2010 by Ralph Mroz & Mitchell Goozé
Who has the greatest impact on a ship’s performance? The captain? The navigator? The engineer? Actually, none of the above. The person with the greatest impact on a ship’s performance is the designer of the ship! No matter what the captain directs, no matter what course the navigator specifies, and no matter what the processes in operations, the ship can do no more than it was designed to do. BMW Oracle brought this specific example home in the 2010 America’s Cup rout of Alinghi’s boat. “BMW ORACLE Racing Team’s revolutionary wing sail powered trimaran, USA, convincingly won Race 2 off Valencia today to win the 33rd America’s Cup match outright.”1 Likewise, the performance of your company is dictated by the design of your business model. No matter how effective your people or management are, trying to produce results with an inappropriate business model is futile. Operationally, your business model is the set of processes, procedures and capabilities that define your performance limits and profitability levels. Your business model is the element of your strategy that determines How you execute to serve your market(s). As an element of strategy, your business model is something that you actively decide; it is something over which you have complete control. Your choices in these above areas – and others – define the capabilities of your organization to deliver your What to your Who. No matter how attractive the customers you have targeted, and no matter how compelling your value proposition, without an effective way of getting the former to the latter, you cannot succeed. This should be clear by inspection. Assume you have the world’s greatest widget or service, and it’s just perfect for a set of customers who truly need and want it. You still need to go through the appropriate channels to reach that customer base; you may need strategic alliances to be of true value to your customers; you may lack the proper cash-flow structure to fund your customer acquisition efforts; the cyclicity of your product development process must mesh with the periodicity of your customer’s new product needs … and so on. Chiron In the early days of the biotech industry Chiron had a strategy and business model focused on genetic-based drug discovery. They did not believe they could gain access to the distribution channel for selling FDA approved drugs because, at that time, the big pharmaceutical companies “owned” that channel. Their strategy was based on a business model of partnering with these pharmaceutical companies as R&D partners, and serving small niche markets. Their initial partnership was with Ciba-Geigy. In 1986, Ed Penhoet, President & CEO of Chiron said2: “Our business strategy is to dominate small markets rather than take a small presence in a broad market.” They looked for markets that were “big enough to be interesting, but small enough to service with 40 salespeople.” Chiron was set up to provide the enabling technology for others to use under license, and Chiron was “as close to a virtual corporation as you can be”, with few fixed assets, but more relationships. Two unanticipated dynamics drove change to their business model and the resulting valuation of the company: Prior to 1988 Chiron recognized the need to change their business model from a specialized R&D partner to the large pharmaceutical companies and niche player, to becoming a pharmaceutical company. Their first two steps in this process were to form a joint venture company with Johnson and Johnson and Warner Lambert and to hire a CEO more suited to running a company with this new business model. These decisions, and subsequent others in alignment with this new business model, increased Chiron’s value until Novartis eventually acquired them. Your Report Card While your business model is the result of strategic decisions, your income statement – including Gross Margin, Overhead, Sales, CoGS, and Marketing expenses, etc. – is a reflection of it… and the net profit figure (or EBIDTA) is your report card on how well you execute it. For example, if you sell branded products, then typically your marketing expense will be higher than if you sell private label products, and your gross margin will be higher, too. Coca-Cola Company is the largest branded soft-drink company. Cott is the largest private label soft-drink company. Both make essentially the same thing, but their business models are different. If you choose to deliver your What to your Who with a high service-add, then your expenses will reflect that business model choice. Neiman Marcus is never confused with WalMart, and not just because of the merchandise selection. In truth, many of the so-called mid-market retailers have been squeezed for profit because they did not offer sufficient value-add to justify their price differences. Every industry has a set of income statement ratios that are benchmarks for that industry. Change is Inevitable When the characteristics of your business, your industry, your customers’ industry, or your environment change, it is just common sense that you will have to adapt to those changes. If any of those changes indicate a significant way in which you can, must, or are expected to deliver your What to your Who, then a fundamental change in your business – a change in your business model itself – is likely in order. This can also result in a need to re-position the company. Hewlett-Packard (HP) was once known as a premier instrumentation company. They migrated into computers; pioneered the development of the laser printer; spun-off the instrumentation business (Agilent); and today are known by most people as a printer and PC company. As their business model changed, their need to reposition also took resources. Other examples: if your existing sales process or choice of channels is no longer relevant to your customers, than you need to re-design them. If the capital structure of your business is no longer sufficient to fund your product development to a competitive level, than you need to realign your Who, What and therefore your How so as to match your capital capabilities. Perhaps the most famous example of the necessity of new business model thinking is the way in which the Internet changed customer’s expectations of how they interact with vendors. A leader in the assistive medical device industry built that position on two pillars: a powerful distribution channel using independent dealers, and leading edge products. These two pillars held them in good stead for many years. However, new competitors, looking to find a leverage point, used these two pillars against the leader. By creating products that could not effectively be distributed through the existing distribution channels, new competitors put pressure on the leader to choose between their channel and competitive products. Rather than make the choice, the company chose instead to change their business model. The new model envisioned new distribution (adding a field sales organization and a direct order channel), product (licensing products from other companies and forming strategic alliances), and capital strategy (using prepaid services to create substantial cash flow) that leveraged the existing strengths while blunting the newcomers’ new methods. While none of these changes are revolutionary to the world of business, their combination is a sea change for their industry and “changed the rules of the game” for their new and existing competitors. In the 1980s the semiconductor industry was comprised of vertically integrated companies that had their own factories (fabs) to make semiconductor devices. This resulted in competition based on process technology, design expertise, sales and marketing. Additionally, factory capacity was an issue because the demand for semiconductors is cyclical and the lead-time to build a new factory is long. The capital needs to compete in this industry have always been substantial. But, as Jerry Sanders, then CEO of Advanced Micro Devices, was known to say, “Real men have fabs.” Over the last 20+ years this business model has made way for an alternative model that uses out-sourced wafer fabrication companies and created so-called “fab-less” semiconductor companies that are effectively design, marketing, and sales focused firms. Semiconductor factories that sell manufacturing capacity to “all comers” have always been available, but these factories had generally been small and/or used trailing edge technology. The advent of modern, large-scale factories that use leading-edge technology available to “all-comers” such as Taiwan Semiconductor Manufacturing Corporation (TSMC) has changed the industry. It no longer takes billions of dollars of capital to be an effective competitor in the semiconductor industry. What allowed the change to create large-scale, technically modern, “contract” manufacturing facilities was the desire by developing nations to be seen as mainstream players. Having your own airline was no longer the defining capability. Now, a country needed a world-class semiconductor manufacturing capability. Companies like TSMC (initially and largely funded by the Taiwan government) allowed fab-less semiconductor companies to compete with leading edge designs. In 2009 Advanced Micro Devices spun off its manufacturing unit into a separate company that combined with Chartered Semiconductor, originally a Singapore government sponsored contract semiconductor fab. This does not suggest that fab-less is the only model, as Intel (itself undergoing a business model change in terms of if and how they should/can influence the use of semiconductor devices through the end-product user) is still a vertically integrated semiconductor manufacturer. You Have to Seek Out Change Your Who, What and How are the three crucial elements of your strategy. Therefore, they should be under constant review during your strategic planning cycle. The following situations, for example, always warrant a re-evaluation of your business model: Apple is a classic business model change. So much so that the company changed its name from Apple Computer to just Apple. Apple’s strategy, since the launch of the Mac, was to sell cool computer products. Their business model was similar to the other computer companies of the day. Always a niche player in the computer business, the Mac solidified their position and allowed them to be a survivor (albeit with a large cash investment from Microsoft). Their strategy during the late 1980s and 1990s was to introduce innovative products. Most of these products failed to gain acceptance in the market. Steve Jobs returned to Apple in 1997 and continued the product innovation strategy, albeit with a bit more success. However, his real breakthrough was changing Apple’s business model. These business model changes included opening their own retail stores and creating iTunes. The iPod is an innovative product. iTunes was the business model change that created a dominant market position for Apple. The finishing touches of the business model change (at least so far) include the introduction of the iPhone. All of the i-products (iPod, iPhone, iPad) have the iTunes foundation to drive significant revenue. If it was easy… Business models have to change periodically. Yet business models are particularly resistant to change. Why? Because your business model is instantiated in your company’s operations – your people’s skills, your processes, your capital equipment…and most important, “in the way things are done around here”. People’s skills change only with training or new people – and both are slow processes. Corporate processes take on a life of their own and, as human phenomenon, are notoriously resistant to change. And new or different equipment is expensive. All this and more conspire to make changing “the way we do things around here” a frightening task to contemplate and a difficult one to execute. Do you have the right business model for today’s market? What about tomorrow’s? How can you tell, and what can you do about it? You can only tell by undertaking a thorough examination of the assumptions that form the basis of your existing business model. One way to do this as a first pass is to look at each line in your going-forward income statement and genuinely ask yourself, “What assumptions are we making when we project this number? Are they really still true, and will they be?” If this was easy, you could be replaced by software. Notes Ralph Mroz and Mitchell Goozé are principals with Customer Manufacturing Group www.customermfg.com, a Santa Clara, CA based business process improvement consultancy focused on demand chain processes. They are also co-authors of the recent book, “Value Acceleration: Secrets to Building an Unbeatable Competitive Advantage.”At the strategy level, you make three crucial choices:
A business consists of a multitude of things including, and not limited to:
1 http://33rd.americascup.com/en/actualite/news/usa-win-33rd-america-s-cup-match-19-2827
2 “Biotechnology Spotlight Shines on Chiron”, New York Times, October 9th
