The Efficiency Frontier

To see how connected strategies completely upend the traditional cost-quality trade-off, consider supermarkets, a $600 billion industry in the United States, $500 billion in India, and more than $700 billion in China. Sam, a typical shopper, is thinking about his weekly grocery trip to buy dairy, meat, and vegetables. Traditionally, Sam considers three options: a local farmers’ market, a supermarket chain such as Safeway or Tesco, and a discount market such as Aldi. What factors drive Sam’s choices? Perhaps for Sam, his happiness will be most affected by the quality of the available products. For instance, at the farmers’ market, the produce is organic, the meat is fresh, and the dairy comes from happy cows. Beyond the product attributes (e.g., organic vs. nonorganic), additional factors affect a customer’s happiness. There are lots of ways to delight a customer, and there can be many pain points that detract from the customer experience. For instance, do customers have to drive for long to do their grocery shopping, or can they walk there? If they have to drive, how easy is it for them to find parking? How long will it take to find all the items that they want? How long will it take to pay? The list goes on.

There are many dimensions that drive how much a customer likes a product or service, including performance, features, customization, ease of access, waiting time, ease of use, and so on. We lump all of these together into a single score (think of it as a grade point average) and label this score the willingness-to-pay of the customer. The more you like something, the higher the maximum price you would be willing to pay for it. Economists often refer to customer utility, which captures the same concept. It is important to distinguish between the willingness-to-pay that a customer has for a particular product and the actual price that a customer pays for this product. The price for a particular product will depend not only on the customer’s willingness-to-pay for this product but also on the willingness-to-pay that competitors create for their products and the prices they charge.

FIGURE 2-1

Efficiency frontier

To become more attractive to customers, firms want to increase their customers’ willingness-to-pay. But there is a countervailing force: the cost of creating and fulfilling such a customer experience, which we refer to as fulfillment costs. The better the quality of the product, or the more conveniently located the location, the higher the overall cost of fulfilling this customer experience. We can visualize this trade-off by plotting firms on a graph that has the customer’s willingness-to-pay on the vertical axis and the fulfillment costs for the firm on the horizontal axis. In figure 2-1, we have plotted Sam’s three grocery options. The farmers’ market lives in the upper left of the graph. It creates high willingness-to-pay for customers, but its fulfillment costs are also very high, since small farms do not have scale economies in production or distribution. Costs drop as we move from left to right on the cost axis. As a result, the discount market is on the lower right. Costs are low, but willingness-to-pay for this option is also low. Supermarkets exist in between the extremes.

When we connect the dots representing the firms that are farthest out on this graph, we get the current efficiency frontier for this industry. This line represents the frontier because firms on this line have maximized the willingness-to-pay they have created for customers for a given cost level. Conversely, for a given level of willingness-to-pay, these firms have minimized the costs at which they can create this willingness-to-pay. Firms that are not on the frontier are at a severe disadvantage. They face competitors who can either create a higher willingness-to-pay while incurring the same cost or create the same willingness-to-pay at a lower cost. In either case, the competitor is able to provide the customer with a better deal: either a preferable product at the same price or the same product at a lower price. The efficiency frontier also illustrates that firms face a trade-off: once the firm has reached the existing frontier, higher willingness-to-pay will come at higher cost; or, conversely, cost reductions will lead to lower willingness-to-pay.

Pushing Out the Efficiency Frontier

Despite countless cooking shows on television, consumers in most developed nations have lost their appetite for spending a lot of time on meal preparation. This has led to the emergence of an entirely new product category, enabled by the internet and low transportation costs: kits that contain the ingredients for meals in customized portion sizes, delivered right to the doorsteps of subscribers. In the United States, Blue Apron initially dominated this market segment, leading to an almost $2 billion valuation in its IPO in 2017. Launched first in Germany, HelloFresh has since surpassed Blue Apron in this category. Most recently, supermarket chains such as Walmart and Albertsons have joined the party. And, you probably guessed it, wherever there is money to be made online, Amazon is not far behind—the company now sells meal kits through Amazon Fresh.

As with any case study that you will see in this book, we are not endorsing particular companies, and you should certainly not use our work to pick the next stocks you buy. Blue Apron has struggled financially since its IPO, and Uber, to be discussed later in this chapter, has had its own share of legal and financial challenges. Whatever might happen to these companies, we believe that subscription-based meal-kit deliveries and ride hailing are here to stay. The fact that both Blue Apron and Uber are facing fierce competition is tough for them as individual companies, but it demonstrates the vibrancy of the newly created market segments and thus underlines the potency of their connected business models. We will speak more about connected strategy and competitive advantage toward the end of the chapter.

How do companies such as Blue Apron operate? Customers who sign up for a Blue Apron subscription are asked to specify their preferences. From then on, every week, Blue Apron sends the customer a box containing ingredients and recipes. Blue Apron sources sustainable produce directly from smaller, often family-owned farms. All of the meats and seafood that Blue Apron provides are free of hormones and antibiotics. Quite often, Blue Apron will also include ingredients that are not very well known, such as fairy tale eggplants or pink lemons. Blue Apron’s agroecologists advise farmers on crop rotation, planting dates, plant spacing, and pest management in order to enable them to cultivate unusual varieties of produce, yielding richer harvests and sustainable farming.

Why do so many customers sign up for this service? On the product side, its high-quality and sustainably sourced products put it on a relatively even level with products from a farmers’ market. In addition, Blue Apron raised customers’ willingness-to-pay by reducing a number of pain points along the customer journey. There is no need to spend time looking for recipes, to make a shopping list, to drive to several stores to find all the unique items, or to wait in line to pay. There are no leftover ingredients rotting in the fridge. On top of these advantages, customers learn how to cook unique meals with novel ingredients that they might not have used otherwise and might have had a hard time finding in stores. In sum, for many customers, the willingness-to-pay has increased.

But how about fulfillment costs? Despite its convenience, Blue Apron has lower fulfillment costs than a traditional farmers’ market. Part of this cost advantage results from its massive scale, especially when compared with traditional farming co-ops. For instance, for some ingredients, such as the fairy tale eggplant, Blue Apron purchases nearly the entire commercially available supply.

As far as retail operations are concerned, the subscription model of Blue Apron allows the company to forecast demand for ingredients with a high degree of accuracy. This reduces Blue Apron’s excess inventory. And Blue Apron does not have to worry about stock-outs, one of the major operational hassles for supermarkets. If avocados are scarce, the company can change the recipes of the week and customers will eat asparagus instead.

The forecasts also let the company help farmers manage their own businesses efficiently. Blue Apron often buys the entire crop of a farmer, providing a more predictable income stream than would be possible if the farmer attempted to sell a product at farmers’ markets, where demand varies. Lastly, Blue Apron eliminates two links of the supply chain—transportation from warehouses to grocery stores, and the grocery store retail sites themselves—thereby removing real estate, utility, insurance, and other costs. By creating a curated offering, Blue Apron has pushed up the willingness-to-pay of its customers. At the same time, by creating new connections between farmers and customers—a connection architecture we will call a connected retailer in chapter 7—Blue Apron has also been able to reduce its fulfillment costs. In sum, Blue Apron has pushed out the efficiency frontier, as we illustrate in figure 2-2. The dotted line in this figure corresponds to the increased competitive advantage that Blue Apron has gained relative to farmers’ markets due to its connected strategy.

Other connected strategies have arisen in the grocery space, creating an entirely new frontier in this industry. Consider the same-day delivery service Instacart. Instacart has focused on one particular pain point, the shopping itself. Instacart creates new connections between customers who need groceries and individuals who work as shoppers. It has created a connection architecture we will call a crowd orchestrator. Using the Instacart app, customers can shop virtually at a range of local stores, including grocery stores, pet supply stores, and pharmacies. Paid shoppers will then go to these stores and pick up the items the customer ordered. Deliveries can happen in as short as an hour or can be scheduled for later. This service raises a customer’s willingness-to-pay by saving him or her time. Given that shoppers can buy for more than one person at a time, the purchases are done more efficiently, driving down cost. As we depict in figure 2-3, the main result of Instacart is also a shift of the frontier. In this case, it pushes up the willingness-to-pay more than it reduces fulfillment costs.

FIGURE 2-2

Pushing out the efficiency frontier

Around the world, we are observing a range of experiments that use connected strategies to raise the willingness-to-pay by improving the customer experience and simultaneously reducing fulfillment costs. In India, a number of e-grocers, such as BigBasket, have sprung up that allow customers to order from over twenty thousand products, including fresh fruits and vegetables, via an app and have them delivered to their homes. For a smaller group of essential items, ninety-minute delivery is also available. Customers’ willingness-to-pay is increased, as the shopping can be done more quickly, while BigBasket does not have to invest in costly brick-and-mortar stores.

In South Korea, Tesco, a grocery retailer based in the United Kingdom but with extensive global operations, experimented with novel ways to engage customers in new environments. Tesco faced the challenge of trying to market itself to young urban professionals who did not have time during their day to visit stores. Tesco decided to utilize the country’s high degree of smartphone adoption to reach these customers in places they do frequent: subway stations. Tesco created virtual stores on the walls of subway stations using life-size posters depicting grocery store shelves stocked with products. Customers felt as if they were standing in front of real shelves. The products featured in the posters displayed QR codes to be scanned by subway patrons using Tesco’s Homeplus app. Delivery would often be scheduled for the same day so that purchases arrived as customers got home from work.

With its Homeplus app, Tesco created a respond-to-desire relationship, making it easier to shop for and receive merchandise. Moreover, their product posters also served as a coach behavior platform, reminding customers to buy groceries at an otherwise idle time, during their wait for a subway. By easing the customer journey, Tesco raised the willingness-to-pay of time-pressed customers relative to traditional grocery shopping. At the same time, it increased its sales while avoiding the cost of additional storefront real estate. Putting it all together, we can see that Tesco Homeplus effectively pushed out the efficiency frontier. It raised the willingness-to-pay and simultaneously decreased costs (see figure 2-3).

In China, Alibaba operates an increasing number of Hema supermarkets. Using the Hema app, customers can buy fresh food from home, have it prepared by chefs, and then have it delivered to their homes—all in thirty minutes. For other grocery orders, in-store shoppers fill the customer’s order, putting the shopping bags on a conveyor belt that carries them to a delivery center adjacent to the store. If a customer prefers to pick his or her own food, especially fresh seafood, the customer can come and select it. Every item has a scannable barcode yielding price and product information, including the origin and even the backstory on the item. Customers use Alipay to pay at the checkout stand. Over time, Hema’s app learns the customer’s preference and creates more customized offerings.

FIGURE 2-3

New efficiency frontier in the grocery industry

Other shopping innovations include stores that have no checkout lines at all. Instead, cameras follow customers and automatically tally up the products that they remove from shelves. Both Amazon, with its Amazon Go stores, and JD in China are pursuing this. Customers’ willingness-to-pay is raised through reduced checkout hassles, while costs are reduced by lowering labor costs.

As our shopping trip around the globe reveals, grocers face a trade-off between customer delight, as captured in their willingness-to-pay, and fulfillment costs. Successful retailers should not accept the existing trade-off; they should break it.

The New Efficiency Frontier in Mobility

To see in more detail how connected strategies can relax the traditional trade-off between cost and quality, let us move from the world of grocery retailing to the world of mobility and take a deep dive into the ride-hailing industry. From Didi in China, Careem in the Middle East, Ola in India, Grab in Malaysia, and Yandex in Russia, to Uber and Lyft in the United States, these companies have fundamentally changed how people think about getting around town.

The reason why ride-hailing services have gained so much popularity is that they most often provide a better service to their customers than traditional taxis and do so at lower costs. Ride hailing has shifted the efficiency frontier in the mobility industry.

To see how ride-hailing services have pushed out the efficiency frontier, we can ask the following two distinct questions that go to the heart of connected strategies:

1. How can we change the way we connect with our customers?  How can we deepen the connections between the company, drivers, and customers? The parties being connected in this case remain the same, but the depth of their connections is increased, leading to lower costs and a superior customer experience. In essence, we put bigger information pipes between the existing entities.
2. Can we change whom we connect?  A typical cab company has a fleet of some fifty to five hundred vehicles to meet demand. Ride-hailing services, in contrast, have many thousands of privately owned vehicles available in metropolitan areas. Moreover, they can rely on crowdsourcing to ensure the quality of their drivers, as opposed to relying on government regulators to take on the task of vetting them. This second case is one of connecting entities that previously were not connected—that is, putting in new information pipes.

Creating Deeper Connections among Existing Parties

To understand how deeper connections among existing parties can create more value, let’s summarize the pain points from the perspective of the customer and the inefficiencies from the perspective of the drivers. In chapter 4, we will more formally introduce the concept of a customer journey and how to spot such pain points. For now, let’s just see what a customer prefers about a ride-hailing company compared to a taxi cab—that is, how ride-hailing companies have pushed up the willingness-to-pay of customers:

Convenient ordering:  Using an app is far easier than hailing a cab from a street corner, calling a dispatcher, or lining up at a taxi stand. All of these require a fair bit of customer effort; hence, none of these modes is particularly customer friendly. This is especially true at the busiest hours for cabs. For example, in New York City, 70 percent of the cabs are utilized on Thursday evenings.

Convenient payment:  With cabs, each transaction begins with the pickup and ends with the drop-off. No payment information is stored beyond this. Ride-hailing companies do not require the customer to carry cash or to deal with (possibly broken) credit card machines within cabs, and payments, including tipping, happen within the app.

What about the driver? Cab drivers face several operational inefficiencies that add to the fulfillment costs without increasing the customer’s willingness-to-pay. The substantial capital outlay for a cab medallion means that cabs must be in nearly constant use to be profitable. (Even after the large price drop for a medallion caused by ride-hailing companies, each taxi that you see in New York has almost as much capital tied up in it as a Rolls-Royce Phantom!) If run well, ride-hailing companies can achieve significant advantages in utilization rates. For instance, in New York, Uber’s utilization rates exceed cab utilization rates by 5 percentage points. In other metropolitan areas, Uber is able to achieve more than a 20 percentage point advantage in utilization, which reflects three inefficiencies of cabs:

Finding a fare:  Many cab drivers spend a good chunk of their time waiting in line at taxi stands for a passenger. For instance, New York cabbies spend 50 percent of their time on the road without a passenger.

Routing:  Even worse for the cab’s efficiency is the situation in which the driver picks up a fare from a prespecified location. The meter starts running only when the customer enters the car. Human dispatchers are not only expensive, they are also limited in their computational power. Finding the optimal vehicle for a customer request requires smart algorithms and connections to the entire fleet in the market so that the best-positioned one can be chosen to fill a request—something that the cab company lacks and that leads to the lower utilization rate just mentioned.

Payment:  At the end of a ride, the passenger pays the driver. This might be the most rewarding part of the ride for the driver, but is a waste of capacity. Cabs make money from driving, not from standing still while waiting to process credit card payments.

Ride-hailing companies’ success in addressing these customer pain points and overcoming these inefficiencies is the first reason why they have been able to provide a superior service at lower costs. This brings us to the first question of a connected strategy: How can we deepen the connections between existing parties and get more information through these pipes?

For cab companies, this question has been answered by a number of apps, including GetTaxi, Curb, EasyTaxi, MyTaxi, and many more. These apps aim to improve the connection between a passenger and a cab; in fact, many of them were launched well before ride-hailing companies entered the market. Enabling customers to order a cab via the app turns every block in town into a virtual taxi stand. Also, payment can be streamlined as customer and company are connected through the download of an app, improving both the customer experience and the productivity of the driver in the form of higher utilization. Finally, a fleet management system can be introduced to connect all cabs in a fleet, enabling better matching between an incoming customer request and a driver, which reduces the amount of idle time, further improving driver productivity and utilization.

This improvement in connectivity is shown in table 2-1. We can think of the right-hand column in the table as a connected cab company. This company uses an app to better link to its customers and process payments, and it tracks its vehicles using GPS.

The use of technology to create deeper connections with customers can also be seen in many other examples we discussed previously:

Using the MagicBand makes food orders at Disney easier for visitors, leading to a higher willingness-to-pay, and the entire ordering and payment process is fully automated, leading to lower fulfillment costs.

Smart and fully digital textbooks are easier to produce than traditional paper books. Their embedded software also makes it easier for the school or university to grade homework assignments and exams, increasing faculty productivity.

Many health care systems now (finally) provide something that has long been a standard feature in most other industries: online booking of an appointment. Rather than going through the annoying and complex scheduling over the phone, patients can conveniently book appointments online. If more urgent care is needed, some hospitals now enable patients to videoconference with their care team directly.

Deepening the connections between the existing players can transform a business. Yet for all the enhancements implemented by the connected cab company, it is still constrained by its existing connection architecture. Let’s now look at the second key element of a connected strategy: creating new connections.

Creating New Connections

The success of ride-hailing companies is not a result of being a better and more connected cab company. Their success is mostly driven by their ability to connect previously unconnected parties. Most cities have several cab companies, each with its own fleet. Ride-hailing companies, in contrast, do not own and operate vehicles. Instead, they connect individually owned vehicles throughout town to form a virtual fleet. They merely act as orchestrators, something that we discuss further in chapter 7. This virtual fleet is much larger than any cab company could ever be. This makes it easier for the ride-hailing company to cover the entire town, which increases the likelihood that a vehicle is close to a customer in need of a ride, resulting in shorter customer wait times and the higher utilizations mentioned before. Utilization is further increased because drivers don’t waste time picking up and dropping off vehicles at the beginning and end of their shifts, since they simply use their own car.

Ride hailing and vehicle utilization are also improved through the practice of surge pricing. Not only are all active drivers for a ride-hailing company connected, but so are those who are currently inactive, doing other things. Ride-hailing companies often institute surge pricing in the evenings, but only at particular times. It often happens in the early evening (when folks head out), less frequently around eight o’clock at night (when folks are out), and then peaks at eleven o’clock at night (when folks want to get home). As passengers, we find surge pricing a nuisance. But it is an important component of ride hailing, just as revenue management (aka dynamic pricing) is part of selling airline tickets and hotel rooms.

Adjusting pricing in real time has two benefits. We are familiar with the first one from the airlines. Management consultants and other business executives rarely fly on Saturday afternoon. But the airlines have fixed capacity and would waste a lot of money if their planes sat idle on Saturday afternoons, so they offer steep discounts. The same happens in reverse on Monday morning when the partner in the consulting company really needs to meet that CEO in Cleveland and is willing to pay double the price. As a result, our consultant flies on Monday, and the college student heading back to Ohio State travels on Saturday. Markets are more efficient in the coordination of resources if they let prices adjust. Because the regulated cab market does not allow for price adjustments, cab owners cannot imitate this strategy. Many ride-hailing companies, however, have fully embraced dynamic pricing.

In the case of ride hailing, there is another benefit of dynamic pricing. An airline has a fixed capacity. It would love to have extra planes and pilots on Monday morning, but the costs of that capacity are too high, so there is no flexibility. Ride-hailing companies, however, have flexible supply. For the typical twenty dollars per hour, a ride-hailing driver might prefer to take the evening off. But for forty dollars per hour, during surge pricing, things are different. Previously inactive drivers get into their cars and provide the ride-hailing company and its passengers with the capacity exactly at the time they are most needed.

A remarkable aspect of surge pricing is that it not only reacts to real-time changes (when it rains, more passengers need a ride), but it can also be very targeted toward specific locations. This further helps activate and direct capacity to where it is needed the most. Surge pricing puts the right incentives in place in order for the drivers to do what is best for the overall system. When demand is low, drivers switch to other tasks, including other work and personal time off. As a result, not too many drivers are sitting idly in their vehicles and waiting for passengers, which avoids wasting labor costs. When demand picks up again, drivers provide the needed capacity and start driving. This activates capacity when needed, which avoids long waiting times for passengers.

Besides restricting entry to the taxi industry, cab medallions have traditionally served a secondary role. They provided customers with at least a modicum of trust in the car and driver. Historically, it was the role of the municipality to create trust by requiring cab operators to acquire a medallion. How are the quality and the safety of the vehicle in the ride-hailing industry ensured now that (almost) anyone can be a driver? Again, creating new connections has a role in this. Because customers rate their ride through the app, ride-hailing companies connect passengers to each other, allowing them to share their experiences. This is a much cheaper mechanism of certification than the city authority selling high-priced medallions. Driver reputation and trustworthiness are crowdsourced. Similarly, ride-hailing drivers also use the app to rate their passengers, which can help protect other drivers from picking up potentially unpleasant fares—a benefit not available to traditional cab drivers.

Building a huge virtual fleet of privately owned vehicles, adjusting fleet size to demand through surge pricing, and replacing the expensive medallions with a mechanism for crowdsourcing reputation all require a delivery model that is built on creating new connections. Such a connected strategy simply cannot be imitated by the cab companies because no company using medallions can start employing just anyone with a car who wants to be a driver.

Table 2-2 summarizes this approach of connecting previously unconnected entities in an industry. Again, this part of connected strategy—putting in new information pipes—is by no means limited to transportation:

Airbnb connects travelers to empty rooms, houses, and the people who want to play host part time or full time. This idea really goes back to prior sites such as HomeAway (which includes VRBO, Vacation Rental by Owners) that leveraged empty vacation homes (owners of vacation homes are not in their vacation homes all year). Importantly, this capacity is inexpensive because it would otherwise be unused.

ZocDoc allows physicians to post open appointment slots online, where they can be booked by patients. When an appointment is made, the patient is pleased to have found care, while the physician is happy to bring in an extra patient.

In the same way OpenTable matches restaurant tables with eaters, Kayak matches travel capacity in the form of airline seats with those who want to book a flight, and StubHub helps fans find tickets for games and concerts while also increasing the occupancy of the stadiums.

In sum, similar to innovators in the grocery space, ride-hailing companies have effectively shifted out the efficiency frontier: the superior customer experience comes with lower costs. This is what has made ride-hailing companies such a game changer in the transportation industry in many markets around the world.

Further Shifting the Frontier by Creating New Connections

How can we reduce costs further still? As a passenger waits for a ride from A to B, chances are that there are many cars driving almost the exact same route. Most of them are likely to only have one person in the car. In the United States, the average number of passengers in a vehicle is about 1.5. Why add another car (and pay for the car and the driver)? Why not just help some of these drivers who own their vehicles and are already driving with the aim of getting from A to B make some quick cash? This is the idea of BlaBlaCar.

BlaBlaCar is a European carpooling company in the business of connecting potential passengers with empty seats. Carpooling is an old idea that has been used for decades by parents, commuters, and college students. But, thanks to improved connections, carpooling has seen tremendous growth. The driver of the car is driving the distance no matter what, so the cost of adding a passenger is extremely low.

Instead of paying for labor and ownership of the vehicle, all that needs to be paid for is the gas. If the driver shares this expense with one or even multiple passengers, costs come down even more. BlaBlaCar leaves pricing at the discretion of the driver, but common price points are between ten and twenty-five cents per mile, which is about a tenfold improvement over traditional ride-hailing and even more compared to cabs. Technically speaking, the fulfillment costs are limited to the extra fuel consumption that results from adding a passenger and the added time for the extra pickup and drop-off.

Note that BlaBlaCar is doing much more than connecting potential passengers with drivers. Instead of ride-hailing companies’ virtual fleets of drivers acting as service providers, every vehicle on the street can now be seen as a potential service provider. In this business, the lines between passengers and drivers have become blurred. In chapter 7, we will discuss such new business models based on connecting individual customers to each other as peer-to-peer networks. The following examples show the extensive reach of these connection architectures:

What BlaBlaCar is to Uber, Couchsurfing is to Airbnb. Today, Mike sleeps in your apartment, and tomorrow, it might be the other way around.

PatientsLikeMe connects patients to others who have similar conditions, facilitating information exchange regarding treatment options and outcomes and forming a powerful network. Initially focused on chronic conditions, such as ALS and lupus, the company has expanded to accept any patient with any condition, currently serving more than six hundred thousand members. Patients are able to learn and improve their outcomes based on previous experience for free, while researchers can gather data about what is working and develop better treatments.

Online dating platforms such as eHarmony and Match.com are now the starting point for an estimated 5 percent of all new marriages in the United States, not to mention that well over one million babies have been born because their parents were matched by a computer algorithm. When it comes to loving relationships, both partners are, pardon the wording, customers and suppliers. Both request and respond. So, having two lonely hearts sitting at home and wishing for a partner is a waste.

To be fair, unless you are super social and enjoy being with other people rather than playing around with your phone, the willingness-to-pay for a BlaBlaCar is likely to be lower than for a ride-sharing car. Beyond the potentially chatty company in the car, finding a vehicle that gets you where you want, when you want may also require some compromise in destination or travel schedule.

Connected Strategy and Competitive Advantage

In this chapter, we saw how the grocery and ride-hailing industries are being transformed by firms using connected strategies. In both settings, we saw how connected strategies can lead to more convenience: Having the right groceries delivered to your doorstep or using the walls of a subway station as a virtual supermarket is making grocery shopping more convenient. Ordering a car via an app with automatic payment processing is likewise increasing convenience.

But connected strategies are not only about convenience and the resulting higher willingness-to-pay. Unless we provide products and services efficiently, we might not be shifting the efficiency frontier. Here is where a deep dive into the operations that create and deliver the products or services is required. In both grocery retailing and ride hailing, we saw that costs are driven by many activities, some of which might not be adding value to the customer experience. Having a large store might look nice, but if what the customer wants is simply a visual display of groceries, any wall coupled with augmented reality will do the job. And why pay a fortune for a cab medallion if what customers really want is trust, which can be produced through crowdsourcing at a much lower cost?

The efficiency frontier will be our guiding compass throughout the remaining chapters. If a firm is able to shift the frontier—that is, if a firm is able to widen the gap it creates between the willingness-to-pay of its customers and the fulfillment costs it incurs—it has taken an important step toward creating a competitive advantage.

But, unfortunately, shifting the efficiency frontier does not always guarantee that you will achieve a competitive advantage that is sustainable at least for a few years. Why not? While it is easy to see how Blue Apron has shifted the frontier and might win out over having to shop at farmers’ markets, it is much more difficult to figure out why Blue Apron’s willingness-to-pay/cost gap is larger than that of HelloFresh or meal kits that Amazon or Walmart offers. As a matter of fact, Blue Apron has been struggling to retain its customers because these competitors were able to occupy a very similar location on the new, pushed-out efficiency frontier.

Likewise, it is much harder to see how Uber’s willingness-to-pay/cost gap is larger than that of other ride-hailing companies—a problem that Uber was not able to overcome in China, where they lost against Didi. Just creating connected experiences is often not enough to achieve a sustainable competitive advantage. Once you’ve shown the world a new trick, other firms will imitate you. In order to create a sustainable competitive advantage, not only do you need to create connected experiences, you also need to create connected relationships—the heart of a connected strategy.

As we will see in chapter 5, it is especially through the repeat dimension of connected strategies that you can build a sustainable competitive advantage for your firm. Through repeated interactions, you are able to continuously refine your ability to recognize the needs of your customers, to translate those needs into a request for an optimal solution, and to have the ability to respond to these requests. Powerful positive feedback effects allow you to create long-lasting relationships with your customers and such scale economies in your connected delivery model that competitors will have a very hard time offering a better value proposition to customers.

We would like to emphasize one more point: we are convinced that not creating a connected strategy is a road to eventual extinction for most firms. Technological and innovative forces all point toward increased connectivity. At the same time, customer expectations are moving toward increased personalization created by deeper connections. As mentioned before, increased connectivity will become table stakes in many industries. As a result, not providing customers with connected relationships will lead to significant competitive disadvantages for your organization.

Connected Strategy and Privacy

Connected strategies are fundamentally based on a rich information flow between the customer and the firm. It is this information that allows a firm to personalize the customer relationship and to gain efficiencies in its delivery model. At the same time, customers—be they firms or individuals—are naturally wary about sharing this information. As a result, trust and privacy concerns are central to creating long-lasting connected strategies.

In the right hands, previously privately held information can be used to create value-enhancing transactions—for example, by being able to design products that better fulfill customer needs. But in the wrong hands, this information can be very harmful to customers. We find it helpful to distinguish among three types of costs that customers might incur:

1. There typically exists some personal information in our lives that we would prefer not to share with others. This might include our financial situation, medical information, our sexual preferences, our political views, or our grades in college. Even though our life might not change a lot if our neighbor knew that we only got a C− in accounting, we would prefer to keep this information to ourselves. If this data can be used by firms, individuals, or governments to harass or persecute us, or to target us in order to influence our behavior with misleading information, the damage can be tremendous. Thus, there exists a potential cost of reducing personal (emotional) safety when data is used beyond the purposes for which it was originally sanctioned by the customer.
2. Besides an emotional cost, sometimes data can be used against us to cause a monetary loss. We might have a genetic condition that would prevent us from getting life insurance; we might get higher quotes from our plumber if he knew the balance of our bank account; or we might receive offers for risky financial investments right after we left a bar where we consumed one too many drinks. In a business-to-business setting, we might worry that our data will leak to competitors, or that our supplier, after finding out that we have a severe shortage, will use this information against us by raising prices.
3. Personal information might also be exploited by criminals. When we book a flight to Hawaii and this information becomes public, we basically put up an Open for Business sign for the local burglar community. Likewise, if our Social Security number falls into the wrong hands, we open ourselves up to the risk of identity theft.

Social stigma, various forms of discrimination, and outright criminal activity are all good reasons for protecting the privacy of those who have entrusted us with their data. This is true for all types of data, but it is especially important for data obtained as part of a connected strategy. One reason for this is that data created in a connected relationship tends to be richer, more current, and more confidential than data obtained in episodic relationships (if any data is collected at all in those interactions). Another reason is even scarier. Because of the automated nature of some elements of the connected relationship, customers are not only at risk of having strangers access their data, but hackers could also control the temperature of their houses, open and close the doors, control their connected cars, or steal money out of their bank accounts.

To create a connected strategy, trust between the firm and the customer becomes an essential element. A loss of trust will damage or end long-term relationships with customers very quickly. Data collection can either engender trust or destroy it. A core question you need to ask is, How do our data collection and usage affect our customers’ trust in our company? Best to ask it early—and often.

When firms don’t get the trust equation right, connected strategies can backfire. Remember the well-publicized story of Target inferring the pregnancy of a young woman from her buying habits and sending her coupons for maternity clothing, making her dad confused and angry because he didn’t know about the pregnancy, or the questionable and unauthorized use of Facebook data by Cambridge Analytica to affect voting in the 2016 US presidential election, or various Google apps tracking location information despite a user’s having turned off location history. Such missteps can be very costly and cause your customers to lose their trust in your ability to keep their data confidential and to use it responsibly.

Moreover, firms developing novel connected strategies can find themselves in regulatory gray zones. Should drivers for ride-hailing companies be considered employees or independent contractors? Should staying in an apartment rented via Airbnb be considered an illegal short-term rental? Should recordings gathered automatically by Amazon’s Echo devices be able to be requested as evidence in court cases? These are all legal issues that are currently being worked out. As you develop a connected strategy for your firm, you must stay abreast of the regulatory changes that affect you.

The Disruptive Potential of Connected Strategies

We covered a lot of ground in this chapter. In the next chapter, we will guide you through a workshop that will allow you to start applying the first concepts of connected strategy to your own organization.

To summarize, we first introduced the concepts of willingness-to-pay and the efficiency frontier of an industry. The attributes of your product or service and the way you interact with your customer affect your customer’s happiness, which translates into willingness-to-pay. At the same time, you incur fulfillment costs in trying to create this customer experience. In other words, there is a trade-off between willingness-to-pay and fulfillment costs. Different firms will strike a different balance between willingness-to-pay and cost; they will position themselves differently in the marketplace. By plotting firms and their various positions, we can identify the efficiency frontier in an industry. The efficiency frontier is defined by those firms who are furthest out in the willingness-to-pay/cost space. These firms are able to achieve the maximum willingness-to-pay given their level of fulfillment costs (or, conversely, they are able to minimize cost given their level of willingness-to-pay).

Connected strategies are so disruptive because they allow innovative firms to push out the efficiency frontier. From the perspective of other firms, it looks as if the firm with a connected strategy has completely broken the traditional trade-off between willingness-to-pay and cost. Firms with connected strategies are able to break the existing trade-off by fundamentally changing how they connect with their customers and whom they connect. Blue Apron reshaped how a customer thinks about grocery shopping for cooking: rather than finding a recipe, making a shopping list, and driving to various stores, a customer receives recipes and the exact ingredients at home. At the same time, Blue Apron created new connections between local farmers and end customers through its meal boxes. Likewise, ride-hailing companies redefined how customers interact with ride service providers. Rather than hailing a cab or calling a dispatcher, customers order a ride via an app and pay for it seamlessly. And ride-hailing companies created many new connections between previously unconnected parties: individual drivers with cars and riders with mobility needs.

While pushing out the efficiency frontier is a key step toward achieving competitive advantage, it is not sufficient. The main question is whether other firms can easily replicate your strategy and follow your move to the new position outside the old efficiency frontier. We will have more to say about this topic at the end of chapter 5, when we talk about the repeat dimension of connected strategies. As we will see, the repeat dimension holds a key source of sustainable competitive advantage.

Lastly, we touched on the crucial issue of data privacy, a topic we will repeatedly return to throughout this book. Connected strategies fundamentally rely on a trust relationship between customer and firm. Customers send, actively or automatically, data to firms with the expectation that firms utilize this data to create a superior customer experience. Failing to uphold this trust puts both the strategy and the firm at risk.