Business Models based on “free”
A point of departure for discovery driven planning is the selection of a unit of business, which implies a particular business model. In a recent edition of Wired magazine, editor Chris Anderson created a useful taxonomy of a powerful new kind of business model, in which some aspects of the offering are free to the end user (although someone in the economic ecosystem is making money). The different models he lists are:
The freemium. In this model, basic versions of products (such as software) are given away for free, while premiums and upgrades are offered for a price. The reason that works is that the cost of providing the basic version is pretty low, and the profits made on the upgraded version are substantial. A clever version of this is currently offered by Classmates.com, a social networking site that provides information about people you attended school with. I’ve been bombarded recently with come-ons from that site, suggesting that I find out who signed my ‘guest book’. But to find out this interesting information—you guessed it—you have to subscribe and take out a ‘premium’ membership. I find that irritating. And no, I haven’t bought.
Advertising. This is probably the best known of the ‘free’ models and has formed the basis for many traditional industries, from newspapers to television. Where advertising dollars go now, however, has been subject to radical change which in turn has dramatically shifted the economic underpinnings of many industries, while creating great wealth for others. The core idea is that advertisers will pay to get your attention, regardless of the ‘free’ offerings you actually came to consume.
Cross-subsidies. These are the traditional loss-leaders well known to retailers. The idea here is that you give away one product (or portion of a product) in the pursuit of charging higher prices on others. So money-losing sale offers in the supermarket, low-priced CD’s at Wal-Mart or toasters at the bank are all provided to get you to actually buy the more expensive offers. The key assumptions to watch for here are that customers actually are open to cross-purchasing. Not always true. When Wal-Mart went into Germany, for instance, they discovered (much to their dismay) that German shoppers are happy to engage in ‘basket splitting’ - meaning they will go to multiple stores and scoop up the low priced items only, rather than buying everything from one place. Wal Mart eventually had to make a rather humiliating exit from that market. Ironically, business books fall into this category too. Very few people make a lot of money on business book sales—instead, the real money comes from speaking and consulting work.
Zero marginal cost. Software distributed over the web and digital music would fall into this category. While there is a cost to create the initial offer, the cost of distributing it broadly is very low. Sometimes, the free good is actually a come-on for another item. For instance, while it may be impossible for a singer to limit the distribution of songs in digital form, they may actually make their money on concert sales (a variant on the cross-subsidy idea).
Labor Exchange. In this model, marketers offer you something for free in exchange for your providing information or assistance to them. Anderson uses the example of Google providing ‘free’ directory assistance because they can use the calls to improve their voice-recognition technology, potentially opening the way to a huge market down the road.
Gift economy. In this model, things are given away for free out of altruism or because people simply enjoy doing the work required to create the goods. The classic examples here would be open-source software and Wikipedia entries. People voluntarily create and consume the free good.
While there is still room in the economy for premium-priced real goods, the ‘free’ based business models are becoming a force to be reckoned with.
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The Innovation Value Chain - Thoughtful, useful, concept
Colleagues Morten Hansen and Julian Birkinshaw posted a really solid piece in the June 2007 Harvard Business Review (which I’ve just gotten around to reading). Essentially, they argue that companies tend to focus their attention (and absorption of best practices) with respect to innovation on one part of the process, rather than the whole value chain of innovation, which includes idea generation, conversion to ventures, and diffusion of the innovations elsewhere in the organization. The article is:
Hansen, M. T., & Birkinshaw, J. 2007. The Innovation Value Chain. Harvard Business Review, 85(6): 121-130.
You can find any HBR article such as this one at their web site.
Among the valuable concepts in the article are the notion that specific interventions can help fix a broken innovation chain. These are:
For idea generation
- improve in-house idea generation
- cross-pollination with other innovation sources
- external sourcing of innovation
For Conversion to venture status
- improve selection
- Create better development disciplines
For Diffusion and spreading of ideas and learning
- Champion the idea past its ‘tipping point’
Among the references the authors recommend is a wonderful book by Zenas Block and my co-author, Ian MacMillan, called Corporate Venturing: Creating New Businesses Within the Firm (Harvard Business School Press, 1993).
Mac and I have actually been working for some time on a similar concept of managing the whole innovation pipeline. Similarly, Thomas Keil and I last year published an article that emphasizes management of the multi-step processes of innovation. That one is:
McGrath, R. G., & Keil, T. 2007. The Value Captor’s Process: Getting the Most Out of Your New Business Ventures Harvard Business Review, 85(5).
It’s available at the same site.
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- Posted Rita McGrath on January 02, 2008
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Fail Fast, Fail Cheap - Merck rewards scientists for failure
Bob Cooper, over at the Kellogg Innovation blog, draws attention to a Business Week article on Richard Clark’s efforts to turn Merck around. While the article itself is interesting, what caught my eye was the way in which he is attempting to reduce the cost of failure by having scientists stop doomed efforts earlier. Here’s the snippet I thought was interesting:
KILL FEE
Merck is rewarding scientists for failure.
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- Posted Rita McGrath on December 20, 2007
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Fascinating study on R&D Spending and return on innovation by Booz Allen & Hamilton
My colleague, Gray Hammond, drew attention to this year’s installment of the fascinating study of innovation conducted annually by Booz Allen and Hamilton. To access the study click here
Synopsis:
Booz Allen Hamilton’s annual study of the world’s largest corporate R&D spenders finds two primary success factors: aligning the innovation model to corporate strategy and listening to customers every step of the way.
They have also identified three types of innovators among firms that spend the most on R&D. To quote their study:
Need Seekers: These companies actively engage current and potential customers to shape new products, services, and processes; they strive to be first to market with those products.
Market Readers: These companies watch their markets carefully, but they maintain a more cautious approach, focusing largely on creating value through incremental change.
Technology Drivers: These companies follow the direction suggested by their technological capabilities, leveraging their investment in research and development to drive breakthrough innovation and incremental change, often seeking to solve the unarticulated needs of their customers.
Perhaps the most important finding that emerged from the study was that no one of these strategies performed consistently better than any other — indeed, high-leverage innovators can be found in each of the strategy categories. The most significant performance differences correlated not with their innovation strategies but with those critical factors mentioned above: strategic alignment and customer focus. Over the past three years, companies that say their innovation strategies are tightly aligned with overall corporate objectives boasted 40 percent higher growth in operating income and 100 percent higher total shareholder returns than those whose innovation strategies are less aligned. Companies more focused on customer insight or market needs are also more successful than their less-customer-focused peers. In particular, companies that directly engaged their customer base had twice the return on assets and triple the growth in operating income of the other survey respondents.
There are loads more interesting statistics and conclusions in the report. Worth having a look at!
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- Posted Rita McGrath on December 12, 2007
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Business Model Change as an industry sector evolves
Both Clayton Christensen and Geoffrey Moore have noted that players exploiting different business models are advantaged in different stages of a categories’ evolution. I’ve build on their thinking to argue the following:
Stage I categories: Most offerings aren’t yet good enough, interfaces aren’t standardized, and a strong hand needs to be exerted on value chain players to ensure that customers and end users have an acceptable experience. Current examples would include the iPod ecosystem, and Nokia’s vertically integrated approach to handset design and development throughout the 90’s. Search, dominated by Google, too, appears to have many characteristics of a Stage I ecosystem. Advantage in these cases go to vertically integrated players or to those who can more or less control the key elements that create the user experience. Over time, interfaces become more standardized, different players chafe at the control exerted by the dominant player, and the category moves to stage II.
In Stage II, the most profitable players are those that control a key layer of functionality, while leveraging the infrastructure of ecosystem partners to create a complete solution. Focusing on one horizontal layer makes sense here. The best known examples here would include the “Wintel” dominance of the software and chip layers for PC’s. Eventually, however, the functionality of these layers gets to the point where it simply doesn’t need improving (at least for most customers). It becomes increasingly difficult for dominant players to persuade customerst to pay for further improvements (witness Forbes columnist Peter Huber referring to the attempts to improve the operating system and office software by Microsoft as “Blunder 2007"). Facebook has this feel to me (which is one reason Google is treating the social-networking site as such a threat). What happens next? Advantage goes to those who can deal with the remaining problems users have, often by specializing on key process technologies or on price, leading to…
Stage III: In this stage, advantage goes to those firms who are spectacular at process innovations (such as Dell in supply chain management) or to those who control a key component, and can in effect ‘sell bullets to the combatants’. The key point here is that they make money on solving problems that are sufficiently interesting to enough customers that they will gladly pay to have those dealt with. Inevitably, however, technological development, firm strategies and the relentless quest for new spaces to compete in leads to…
Stage IV --> Stage I: The Empire strikes back. here, an entirely new category emerges, with interfaces that are not ‘good enough’ and the race once again goes to key players that can control all the necessary interfaces.
I was fascinated therefore to read about Verizon Wireless opening its network to many different kinds of devices - which is an interesting move from trying to dominate in a walled garden (a Phase I strategy) to trying to develop a business model that emphasizes domination of a layer (a Phase II strategy). As Business Week (December 10, 2007 edition) reports, Verizon “had built the most profitab le U. S. wireless business by tightly controlling the devices and programs, such as games and maps that could operate on its network. How tightly? The examples are legendary, but just this summer Verizon disabled the GPS navigation capability built into a Blackberry device; in November, it introduced its own similar service.” Perhaps the company is anticipating the category transition that is likely to make the current business model of mobile operators irrelevant.
Microsoft is potentially also sparking a shift from a Phase I to Phase II category in portable music with the continuing development of its Zune player. Although few would argue that it is at the stage to topple Apple’s iPod yet, there is already clear evidence that Apple’s partners (such as music and movie companies) are beginning to chafe at its category dominance and would be willing to support alternative approaches. Stephen Wildstrom, Business Week’s Tech & You columnist, suggests that the future of on-line music is likely to be a monthly subscription that allows users to play all their music on any device. Such a system would spark a massive horizontalization in the music business as well.
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- Posted Rita McGrath on December 03, 2007
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