[In
a blog earlier this year, I reprinted a speech that I had given on challenges
which the electricity industry is facing due to technological change and
evolving consumer preferences. In this
blog, I discuss business transformation in general, and in particular some
of the ideas that I have personally found most helpful and enlightening in
providing guidance on how to deal with it.
Much of the following content appeared in an article that I authored for
Electricity Perspectives magazine entitled “The New and You”.]
Incumbent providers in many industries may have to
reinvent themselves in the years ahead, or risk getting sidelined by innovative
new competitors, and possibly even driven into oblivion. The lyrics from a popular song in 1969,
“Something in the Air”, come to mind: “We’ve
got to get together sooner or later, because the revolution’s here . . . We
have got to get it together, we have got to get it together now.” Change is definitely in the air, and it is
bringing both challenges and opportunities for providers of products and
services. In order to successfully ride
these waves of change, rather than be overrun by them, providers will have to
have a superior strategic focus. The
risks of not doing so will be particularly pronounced for incumbents, who may
be overly invested in business models that will become outmoded and
irrelevant. Unless their leaders “get it
together”, then change could lead to very unhappy consequences: established
business models could be upended, traditional revenue streams threatened, and
entire customer segments put at risk.
How does one plan for change? The very idea seems almost oxymoronic, like
being prepared to be surprised. If the
innovations that may overturn a particular industry are still unknown, then how
exactly can business models be developed to address them, and incorporate
them? Many business strategists have
contended with this question, and have come up with some interesting insights.
Jesse Berst, who has been observing and writing
about business transformation in the electricity industry (he shares his views
on his website, www.smargridnews.com),
has attempted to draw lessons from previous industrial transformations. He has noted that several industries
underwent fundamental change as new entrants challenged existing providers, including
transportation (i.e., the railroads), telecommunications, and retail
sales. The new market entrants – who in
some cases virtually supplanted the previous incumbents in their respective
industries – generally succeeded, according to Berst, by capitalizing on
“disintermediation”, a process whereby the new entrant provided the product
more efficiently (e.g., more quickly, more conveniently, at lower cost) than
the existing supplier(s). This was
generally done by capitalizing on some recent technological innovation which
had occurred: an innovation that was recognized by the new entrant (but not the
incumbent – at least not at first) as a means of introducing new efficiencies
into the market. The classic example is
Amazon.com, which introduced a more convenient and efficient way for persons to
buy books through the use of the internet.
Amazon did not invent the internet; but Jeff Bezos, Amazon’s founder,
recognized how the internet could be used to introduce disintermediation into
the book-buying value chain (and he then later expanded this market model to a
whole range of diverse products and services).
Similarly, Netflix used the internet as a tool for disintermediation in
the video rental business, and in doing so upended the traditional “brick and
mortar” stores that had been offering this service.
The Amazon and Netflix strategies have earlier
historical precedents. At the turn of
the last century, Sears Roebuck – the “original Amazon”, says Berst – became
the first company to create a virtual superstore using a new infrastructure
(the expanding rail system) for ordering and fulfillment and for undercutting
the generally more expensive mom-and-pop stores. The store’s famous catalog initially was
mailed to people in towns with railroad stops.
The railroads themselves found quick competition
with the new interstate highway system started by President Eisenhower in the
1950s. By the 1960s and 1970s, commuter
rail had almost disappeared (going from 2,500 in the mid-1950s to fewer than
500 by the late 1960s) and trucking ate into freight profits. The highly traditional, highly regulated, railroads failed to adapt.
But there is another process that has often played a
role in industrial transformation, and that is “disruptive innovation”, a term
introduced by Clayton M. Christensen in his book, The Innovator’s Solution (coauthored with Michael Raynor). In this and his earlier work, The Innovator’s Dilemma, Christensen
provides a number of examples where technological discoveries or advances
completely overturned existing markets.
Whereas disintermediation is the application of an existing technology
to improvements in the delivery chain (the process),
disruptive innovation capitalizes on improvements in the underlying product.
And, based on his research, Christensen came to some very
counterintuitive conclusions about how existing businesses succumb to the
threat of disruptive innovation. He found, for example, that the technology
adopted by the new competitor resulted in a product that was usually inferior,
at least from the perspective of the incumbent providers’ existing business
model. If it was genuinely more highly
prized by any particular class of customers, these customers generally
comprised a small or low-margin segment of the business, whose loss was not
perceived to be a significant threat to the incumbents. In fact, the incumbent business model would
suggest that an investment in this new product would be unprofitable,
particularly if doing so would result in sales losses from the established
product line. Some examples illustrate
disruptive innovation at work:
·
The 5.25-inch disk drive was vastly inferior to the 8-inch drive, which
was the standard for minicomputers manufactured in 1981. But makers of this smaller drive marketed it
to manufacturers of the new desktop computer, where the size alone presented a
distinct advantage for the more compact machines. By the time the desktop market supplanted
that of minicomputers, many of the sellers of the larger 8-inch drive failed to
adapt quickly enough by creating their own versions of the smaller drive, and
fell by the wayside.
·
Minicomputers themselves were originally marketed as an inexpensive
alternative to mainframes, and were not perceived as a threat to mainframe
manufacturers, until their sales exceeded that of mainframes – a fate which in
turn befell the minicomputer market as personal computers grew in popularity in
the 1980s.
·
When the steamship was invented, its more expensive design (relative to
traditional sailing ships) seemed to only justify its applicability to inland
water routes, where its greater manageability made it a profitable
alternative. But after conquering the
inland water route market, steamships eventually supplanted sailing vessels for
long distance hauling as well.
·
Western Union, the dominant provider of long-distance communication
services in the 19th century, rejected an offer to buy Alexander
Graham Bell’s patent for the telephone (for $100,000). While it was clear that telephones could
serve the (at the time) relatively small market for short-distance electronic messaging,
for communication at longer distances, it was not considered to be an economic alternative
to Western Union’s existing nationwide network of telegraphs.
·
Manufacturers of music CDs abandoned the market for musical singles,
concluding that it had become “extinct”, or at least had become a market that
no longer presented a profitable way of being served. The market was not extinct, however, and
after the demand for singles was met through a new medium – downloadable MP3s –
providers in this new medium went on to capture a sizable chunk of the market
share that had been held by sellers of CDs.
The
important point made by Mr. Christensen in his writings is that the decisions
made by incumbent providers in the face of these innovations were generally –
from their perspective, and based upon sound business principles and analysis –
the
logical and correct ones to make.
Their business models hadn’t failed them: they were merely caught in a
paradigm that prevented them from seeing the transformational opportunities
that were only visible from the perspective of an outside entrepreneur. The actions of the incumbents were in fact
usually guided by what they perceived to be the interests and desires of their
existing customers – in other words, they were following what is generally
touted as the hallmark of a successful business: they were customer-centric and
customer-focused. And, when they did
begin to see some of their customer segments falling away (often those that
were considered less vital or profitable to serve), they concentrated even more
intently on their high-margin customer segments, and on specific strategies for
retaining them, but often with less than successful – or even disastrous –
consequences.
When presented with these cautionary tales, incumbent
providers respond with the logical question: “What can I do to prevent a loss of
sales to new market entrants, or, even better, how can I make sure that my
company is on the right side of change and innovation?” Unfortunately, it is easier to characterize
the underlying threats than it is to map out distinct solutions, and in many cases
consultants fall back on two clichéd recommendations: “Customers want choice,
find ways to provide more of it to them,” and “Learn to be more competitive,
because you will have to be in this approaching competitive environment.” I would now like to kick these two particular
sacred cows – at least a little bit – as I describe a third term that has been linked with very successful businesses: “creative monopoly”.
In a New York Times article (“The Creative Monopoly”, April 23, 2012),
columnist David Brooks described the life and philosophy of Peter Thiel, the
founder of PayPal. Having started his
career in the very competitive field of law, Thiel had been following a very
successful trajectory, getting into Stanford University, and then into Stanford
Law School, and becoming a clerk for a federal judge, but his promising career
had a setback when he failed in the particularly intense competition to obtain
a Supreme Court clerkship. He then changed
course in his life, becoming an entrepreneur, investing in many technology
startups that went on to success, and eventually starting his own hugely
successful company.
Thiel’s experiences led him to some interesting
conclusions, principal of which is that the benefits of competition are
overrated, particularly in the business arena.
Rather than being a good competitor, he contends, it is often better to
be a good monopolist. Brooks sums up the
Thiel philosophy this way:
Competition has trumped value-creation . .
. the competitive arena undermines innovation.
You know somebody has been sucked into the
competitive myopia when they start using sports or war metaphors. Sports and
war are competitive enterprises. If somebody hits three home runs against you
in the top of the inning, your job is to go hit four home runs in the bottom of
the inning.
But business, politics, intellectual life
and most other realms are not like that. In most realms, if somebody hits three
home runs against you in one inning, you have the option of picking up your
equipment and inventing a different game. You don’t have to compete; you can
invent.
Thiel’s
observations may sound like they fly in the face of basic economics, and even a
little heretical. After all, isn’t
competition at the base of the free enterprise system – isn’t it the engine of
capitalism, motivating individual businesses to provide superior products and
services at the lowest price possible?
Yes . . . and no. In truly competitive markets, where there are
many suppliers selling an identical product, profit margins are virtually
nonexistent, and there are little or no interesting differences in the level of
product quality or service between the competing suppliers. Think of the market for agricultural
commodities, or certain basic raw materials, such as cotton. There is little profit to be made here.
By contrast, think of some of the
largest and most successful companies that have appeared on the landscape in
recent years: Apple, Amazon, Netflix, Facebook, and Google. These companies were successful, not because they
rose to the top of a heap of companies selling identical products or services,
but because each carved out a niche for itself – or in some cases created a
market niche where none had even existed before. Their success – and corresponding
profitability – laid in their ability to become creative monopolists.
In strict economic parlance, a monopoly is a company
with a dominant market share, generally obtained through exercising market
power over potential rivals, but for Thiel, the term means something a little
different, with a more positive connotation.
A monopoly is a company with a customer base loyal to its product. The monopoly “owns” its market, not through
nefarious means, but through some combination of branding, scale cost
advantages, network effects, or proprietary technology. Apple is an example of a company that has all
four.
While it is true that customers love variety, and
the ability to express themselves and their personal tastes through the
selection of alternative product offerings, it does not follow that providing
customers with more choices – including choices of alternative suppliers – is a
panacea for customer satisfaction. The
creative monopolist succeeds, in fact, by doing the opposite: by establishing a relationship with its
customers in which choice becomes unnecessary, or even undesirable.
When I walk into the grocery store and buy cola, for
example, I don’t have to – and don’t want to – think about choices. I don’t have to compare the prices of all the
competing brands. I look for Coca Cola,
and I buy it. For customers like me,
Coca Cola has succeeded in becoming a monopolist. The other brands in the cola universe are
invisible to me. And to the extent that
any cola brand (Pepsi, for example) can do the same thing, they also enjoy,
among their sphere of committed customers, the benefits of a monopolist. They can charge more for their product,
compared to generic colas, and they can enjoy a fairly predictable earnings
stream based upon customer loyalty. It
truly is a “relationship”, based upon the customer’s faith that they are
receiving a quality product or service at a reasonable price. It is only when the customer’s faith is
shaken that this relationship becomes threatened
This can happen in many ways. For Coke, in fact, it nearly happened in the
1980s, when it attempted to replace its long established formula with a new
one, which had been developed based upon blind taste tests. Many of its loyal customers were ready to
abandon Coke, and would have, had Coca Cola not quickly corrected its misstep,
by reintroducing the original brand as “Coke Classic”. America
Peter Thiel now teaches a course at Stanford, where
he shares his ideas and theories on what make a successful creative monopolist,
such as the following:
The best
kind of business is thus one where you can tell a compelling story about the
future. The stories will all be
different, but they take the same form: find a small target market, become the
best in the world at serving it, take over immediately adjacent markets, widen
the aperture of what you’re doing, and capture more and more. Once the operation is quite large, some
combination of network effects, technology, scale advantages, and even brand
should make it very hard for others to follow.
This is the recipe for building valuable businesses.
. . . Of
course, putting together a completely accurate narrative of your company’s
future requires nothing less than figuring out the entire future of the world,
which isn’t likely to happen. But not
being able to get the future exactly right doesn’t mean you don’t have to think
about it. And the more you think about
it, the better your narrative and better your chances of building a valuable
company.
Peter Thiel is cognizant of
the fact that most of the successful creative monopolies that have come into
existence have done so on the heels of innovation, disruptive or
otherwise. But he warns that it is
dangerous to come into an industry that is currently undergoing technological
change: come in too early and your particular innovations will be quickly
superseded by others (as happened in the floppy disk market); come in too late,
and there will be nothing new left to offer.
However, “if nothing has happened in an industry for a long time, and
you come along and dramatically improve something important, chances are that
no one will come and do that again, to
you.”
Many of Peter Thiel’s insights echo those of an earlier
business strategist, Michael Porter. In
a seminal article published in the Harvard
Business Review (Nov.-Dec. 1996) entitled “What is Strategy”, Porter
identified two distinct means by which businesses attempt to gain and sustain a
competitive edge. The first, which he
called “operational effectiveness”, comprises all of those activities that a
business undertakes to outperform its rivals.
These are the classic “competitive” strategies that all companies rely
upon in some form or another: benchmarking, total quality management, “six-sigma”, outsourcing, efficiency
improvements, cost reductions, etc.
While Porter acknowledges that such activities are necessary, he
contends that they are not sufficient to ensure a lasting competitive
edge. At worst, they consign a company
to constantly running to stay in place with its competitors. The key to a more endurable competitive edge,
said Porter, is to engage in “strategic positioning”. In essence, this means finding a means to
establish a lasting, significant difference between oneself and one’s
competitors, a way of doing things that is difficult to imitate. Southwest is an example of an airline that
has done exactly that. The theme of
establishing a difference, rather than simply engaging in competitive behavior,
has also found expression in a book published in 2005 by W. Chan Kim and Renée
Mauborgne entitled Blue Ocean Strategy,
where a “blue ocean” is a metaphor for an uncontested market space (as opposed
to a “red ocean”, where competitors are engaged in an ongoing struggle with
each other to gain an edge through superior performance). All of these theories share a common theme:
that to find true, long-lasting success in any market, one must establish a
niche: in the “brand” of the product itself and/or in the process by which the
product or service is provided.
But what if a company has a “niche” – a unique product or
service that has provided a virtually uncontested market share – and finds that
its market is no longer a growing one? A
common model illustrating this phenomenon is the “S-curve”. A newly-introduced product or service might
exhibit slow sales growth at first, as it is purchased only by that segment of
the population that likes to risk trying new things (“early adopters”). However, as more and more of these
risk-takers buy it and express satisfaction with it, then its popularity
expands into the general population, and sales growth increases dramatically –
in fact, exponentially. But there comes a day when this sales growth tapers off, just as dramatically. This might simply be due to product
saturation: everybody who could have bought it, already has. On the other hand, sales could evaporate
because something else has come along to replace the existing product or
service – something that is seen as better, or trendier, in the eyes of consumers. How does one contend with this dreaded
“S-curve”? Pamela Morgan, a consultant
and former electric utility executive, has proposed one possible strategic
solution. In an article published in Electricity Policy magazine entitled
“From VHS to DVD: Need for a New Business Model for the Electricity Industry in
the 21st Century” (September 21, 2010), Morgan suggests that what is
needed is a broadening of strategic vision.
Companies, she argues, are often too wedded to the particular products
or services that they are offering, and neglect to understand what the broader
needs of their customers are which these products and services are
answering. She cites VHS
player/recorders as a classic example.
These devices definitely exhibited an “S-curve”, with slow sales growth
that eventually became phenomenal sales growth, but which was then followed by
rapidly declining sales, as the VHS was superseded by the rise of the DVD. This in turn, is also seeing its rapid growth
undercut by the subsequent rise of video streaming services. Morgan suggests that none of these
transformations needed to be catastrophic for the business that had a
sufficiently broad vision of what service it was providing: on-demand home
video entertainment. Such a business
would have kept abreast of technological development and thereby found the
means to envision what the next potential “S-curve” could be. With this type of strategic focus,
technological change presents an opportunity for continual rebirth and
evolution, rather than a threat of catastrophic demise.
These, then, are some of the most salient strategies, I
think, for facing technological change and industry upheaval. The greatest successes, both recently and in
decades past, have found ways to use innovation to create niches for themselves
– in the design of their product or service, or the channels that they have
used to deliver it, or both – and in so doing have ensured their long-term
survival and profitability.
