15. Disrupting Yourself—Launching New Business Models from Within Established Enterprises

Brandy Fowler has been an innovation consultant to Fortune 500 companies for the past 8 years, helping companies define their innovation strategy, build capabilities, and launch new businesses. Brandy is currently an Associate Director of Insights and Strategy at Smart Design, where she straddles the worlds of consumer-focused design and business design. She helps teams analyze and synthesize primary and secondary research and pull out the most compelling insights to inform developing new innovations. She received her master’s from the Institute of Design in Chicago, where she studied user research methodologies, business strategy, and design.

Innovating solely in products and services has become a more mature capability within many organizations, making it less of a differentiator. Fortune 500 companies have been using top-tier innovation consultancies for a considerable length of time now to bring new and different products and services to market. Also, many companies now have their own internal innovation groups to help infuse innovation throughout the company. There remains room for continual improvement within innovating on product offerings; but it is now table stakes to play and unless done extremely well it provides most companies with only a temporary edge.

Further, in industries where dated and broken business models are the norm, it becomes increasingly difficult for companies to find new growth. Two notable examples are the healthcare industry and the television industry. Established companies like pharmaceutical and cable providers have yet to break ground in new business models. Small, not-yet-established companies are experimenting with new business models and will mostly likely end up redefining the industry for large players who are unwilling to change.

The perfect storm of fear of steep competition within industries defined by unsustainable business forces has led companies to explore business model innovation as a safety net against these pressures. When executed well, business model innovation can be very disruptive to a company and an industry and can provide significant new revenue growth. For example, in the 1990s when personal computers were on the cusp of commoditization, Dell pioneered a unique business model for personal computing that dramatically increased its profitability. Its computers were not, in and of themselves, particularly innovative or cutting-edge products, but they became very profitable from the business model it was using to sell those computers. It sold its computers online and assembled them after it received the order, which enabled it to collect cash before it had to pay suppliers. This lowered the amount of capital it needed to run the business. The method of just-in-time production increased its inventory turns to 7 days versus the industry average at the time of almost 50 days, which led to a significant reduction in its operating costs.

Business model innovation is extremely difficult to do and almost always requires a company to change how it is structured and the processes it uses to monetize value. Product innovations, by themselves, often do not require the company to change their general way of doing business. Introducing a new business model to a company with a well-established existing business model can also pose cannibalization risks to existing businesses within the organization.

This section provides tools and strategies that can help mitigate the risks to the existing business, provides direction on where to innovate with business models, and offers considerations for developing new business model innovations.

Figure 15.1 Three questions to explore to decide where to innovate with new business models.

When a company starts looking into where to innovate with new business models, inevitably, the topic of cannibalization comes up. Most established companies have a strong fear of cannibalizing their existing offerings with new ones. But cannibalization is not always a negative strategy for a company to pursue. Furthermore, new growth without cannibalization can be achieved only under three conditions: (1) the company and industry are experiencing steady or growing performance, (2) a new target market is being addressed and/or (3) new highly differentiated offerings are being developed, as depicted in Figure 15.2.

Figure 15.2 Three conditions need to exist for a company to avoid cannibalization of existing offerings with new ones.

If the first condition is not true and the company or industry is in fact shrinking, then it is worth considering whether a company should cannibalize offerings that are underperforming before deciding on the target market and offering type. In this case, business model innovation could be used to launch new offerings that replace areas of the business that are shrinking. The risk that cannibalization poses to a company is far less when replacing a shrinking business than if it were to launch business model innovations within parts of the business that were remaining steady or growing.

In assessing performance, it is important to look at the industry, the business, and individual business units to see which are shrinking, remaining steady, or growing, as depicted in Figure 15.3.

Figure 15.3 A closer look at the first condition: assessing industry and business performance.

If a company and the industry are performing well, but only one or more business units is underperforming, then a company has a choice to let those business units flame out or replace them with new ones. It really depends on how critical the business units are in providing revenue to the overall company and whether business model innovation efforts could potentially provide lift in those areas. An additional consideration is the strategic fit of the business unit to the company. Some companies maintain business units that offer strategic fit and advantage to other business units while not providing significant revenue.

A couple of shrinking industries where companies should consider cannibalizing existing businesses are the print newspaper and magazine industries, as illustrated in Figure 15.4. Many newspaper and magazine organizations have for years provided print papers and magazines to people’s homes and offices and have been reluctant and slow to move into the digital age even when all the numbers are clearly pointing to a downward spiral.

Figure 15.4 Current state of the print newspaper industry and individual businesses.

The New York Times is an example of an organization making some headway in moving from the print business to the digital business, but it is taking a pretty conservative approach. It was only in 2011 that the New York Times started experimenting with digital business models as it instituted a pay wall for access to digital content. It has increased revenues from its digital business, but like many newspaper organizations, it is reticent to go too far for fear of cannibalizing its print business, because its print business, while shrinking, still provides the Times with superior ad revenues compared to digital. This is where decades of development and optimization around the core offering has led to superior profitability. Businesses are often reluctant to explore new frontiers in discovery and formulation especially when it could compete with their carefully honed and optimized business.

The Atlantic magazine took a bolder approach, which was to fully invest in digital whether that meant cannibalizing its print business or not. It had been faced with ongoing financial failure and realized it had to make major changes to survive. Two notable changes it instituted were to (1) allow the sales team to hit their advertising sales targets regardless of whether it was for print or digital and (2) focus on creating engaging digital content that would draw in both consumers and advertisers. The impact of this strategy is that now the Atlantic’s digital advertising revenues account for a little over half of its total revenues. It is one of the few companies that has had financial success transitioning from print to digital. Now that it has a strong foothold in the digital business, it is experimenting with providing paid premium content to supplement existing advertising revenues.

Although time will tell how successful transitioning to new digital business models will be for newspaper and magazine organizations, some of the more innovative ones such as the Atlantic are at least starting to see their business turn the corner from shrinking to growing through exploring digital business models.

It is important for companies to take a more proactive approach in assessing whether all the industry, business, and/or parts of their business are shrinking, remaining steady, or growing. They can then get in front of the problem to decide whether they need to find new incremental growth to replace the losses or cannibalize current businesses to stay relevant.

We have looked in detail at the first condition to assess whether an opportunity exists to cannibalize poorly performing offerings in shrinking industries. But if a company is in a healthy industry and all or most of the company is performing steadily or growing, then finding new growth through business model innovation that will not cannibalize the business can come from the second two conditions: new target market(s) and/or new differentiated offerings.

Companies often struggle when trying to go after a market they currently do not target and creating offerings that are truly differentiated from their current offerings (Figure 15.5). They inadvertently end up cannibalizing existing offerings because they did not stretch far enough out from their existing market and offerings. At a minimum, companies not looking to cannibalize existing offerings should target markets and offerings that are new to the company.

Figure 15.5 Assessing how far to stretch into new markets and offering types.

LAN airlines avoided cannibalization through business model innovation that targeted very different markets. What is unique about LAN airlines is that it operates these two distinct businesses using the same type of aircraft. One airplane can deliver high-end cargo while also functioning as a normal passenger airline. Its passenger business is roughly 70% of its revenues, with the cargo business providing close to 30% of its revenues.¹ The cargo business has created incremental revenue growth that does not erode its passenger business and allows LAN to weather business fluctuations more effectively than its competition because of its additional revenue stream.

What LAN pulled off is very hard to do. A company has to be extremely nimble to run two distinct businesses that are closely intertwined. Most companies either fail at reaching a new market because it is too unknown to them, or create offerings they think are differentiated, but to consumers and customers are not, and end up replacing versus adding revenue.

When implementing new business models, the company needs to decide whether it should develop the offering internally, externally, or through a hybrid model (see Figure 15.6).

Figure 15.6 Developing internally, using a hybrid model or externally.

Most companies that are not highly innovative are best suited to develop externally or use a hybrid model in which internal resources are leveraged, but the new business model innovation does not need to fit within an existing business unit. Otherwise, their ingrained processes and orthodoxies for the way business is done will usually squash anything remotely innovative that needs to be developed using different processes and assessed by different metrics. Highly innovative companies like Google are good at internally developing and launching new innovations because their culture is infused with innovation capabilities. It is part of their DNA. However, most established companies need help in thinking through how to develop new business model innovations that will make it past ideation all the way to launch.

A notable example of internally developing and launching a business model innovation is Procter & Gamble. It wanted to sell razor blades in India. Emerging markets such as India, China, and Brazil have become a focus for many Western companies as a new market to penetrate. Emerging markets have complex dynamics and distinct user behaviors, which go beyond selling their existing products more cheaply. The product has to change, as well as how it gets delivered to market. Rather than strip down any of their many existing or prior offerings, Proctor & Gamble sent a team of designers, engineers, and ethnographers to India to understand how the product is distributed, purchased, used, and discarded. They integrated all of these considerations of both the design of the product and the business model. In the year following the launch of the Gillette Guard, the product achieved 50% market share.² P&G is great at developing new business model innovations internally because it has heavily invested in building up its innovation capabilities and processes. It has an internal group called FutureWorks, which focuses on developing transformational new business models. FutureWorks collaborates across the organization and is connected to P&G leaders and the overall company strategy, which helps ensure its success.

In contrast, Apple’s insularity has hurt it in being able to successfully launch some of its new business model innovations. Apple is notorious for its secrecy, developing everything in-house and posing many third-party limitations. Apple’s tendency toward tight control has been extremely successful in the Western world, but less so in emerging markets where its competitors have been more successful. Most people living in emerging markets use prepaid plans versus in the U.S., where plans are contract-based. Because of this, Apple is unable to get subsidies from wireless carriers in emerging markets to offset its cellphone costs for consumers. The product is too expensive and the business model is new to Apple. Apple is currently trying out new business model strategies such as allowing users to pay in installments to make the iPhone more affordable, but it still has some major ground to cover in catching up to competitors like Samsung and Nokia. Apple probably would have benefited from developing its emerging market products more externally through a separate development team and leveraging external partnerships. It just goes to show that even a company as innovative as Apple can also struggle with developing new business model innovations.

Looking at the first condition of assessing whether the industry and company business were growing, remaining steady, or shrinking was the easy part because the client company was already acutely aware of the performance of the industry and its business. The pharmaceutical industry and its business were remaining steady; however, that was not going to hold for long, and it was already seeing shrinking performance in its primary care business. It knew it was not going to go out of business tomorrow, but the longer-term outlook was not too rosy, as depicted in Figure 15.7.

Figure 15.7 The performance of the pharmaceutical industry and the client organization.

Since the client had already framed the performance issues it was faced with, we helped it think through the next two conditions: what market to target and what offering type to bring to market.

Because primary care drugs were shrinking, the client was not concerned with cannibalizing these existing offerings as long as the new offerings had good margins and revenue. Therefore, we decided to focus on a chronic condition market the company currently targets through its primary care business. Although the target market would be an existing focus for the client, the offering type was new to the company (see Figure 15.8). Instead of selling a prescription pill, the offering would be a holistic lifestyle program offered to employees of large employers to help with specific chronic conditions. If this program worked well and helped people get a handle on their chronic conditions, they would no longer need the type of prescription medication the pharmaceutical company makes.

Figure 15.8 Business model innovation focused on an existing market, but with an offering that was new to the company.

The offering type and business model were extremely different from the core capabilities of the organization. Instead of selling a prescription pill paid for by insurers, they would be selling a health-and-wellness program to large employers. The main revenue stream would be from a per-member-per-month fee (PMPM) for those employees who enrolled.

Because this was a big stretch for a company that spent so many years optimizing cost and revenue structures around selling drugs, the last phase of the project was to support it in thinking through how it was going to bring the new business model innovation to market and run the business after it was launched. It was self-aware enough to realize that if the business model innovation was developed internally, it likely would not make it through the organization’s stage gate processes. The organization would essentially kill it before launch. It also recognized that it did not have a great history of developing initiatives solely externally using agencies and establishing partners. Therefore, the best fit for this company was to use a hybrid model (see Figure 15.9).

Figure 15.9 Developing a new business model innovation through a hybrid model.

By using a hybrid model, it could leverage its internal innovation group to act as the project champion with oversight from business unit leaders. It would still do some development externally through partner agencies to help develop aspects of the program and oversee establishing partnerships. After the business was launched, it would still have oversight from business unit leaders, but it would not financially be attached to an existing business unit.

2. P&G 2011 Annual Report, http://www.pg.com/annualreport2011/innovating/gillette.shtml.