Testing some key assumptions - second home market early warnings

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Fortune, in their April 28, 2008 issue, printed a little statistic that struck me as valuable in terms of the sort of data one could use to test assumptions, but which often go unnoticed.  They cite Dennis Gartman, of The Gartman Letter as noting that an American Research Group survey in March found that 16% of households have made summer vacation plans.  This is a big decline from last March, when 48% had such plans.

Gartman concludes that one implication of this is that fewer Americans will be renting holiday homes this year.  This in turn means that those who have purchased second homes and counted on rental income helping to finance them may be in for a big disappointment.  Indeed, if the rental income doesn’t come up to expectations, Gartment suggests we could be witnessing a “fresh selling panic.”

What I thought was particularly insightful about this piece is the way in which a small bit of data (a leading indicator if you will) can provide an early warning of a later difficult event.  If one were an owner of such a holiday home, you’d want to do some more investigation of whether the slowdown is likely to have an effect on your assets, and if so, start now to avoid the worst effects.  That’s the whole concept of using early warnings to test assumptions in a discovery driven way. 

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Yikes!  Putting your core business in discovery mode:  BlockBuster & Circuit City

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The unsolicited attempt by video rental chain Blockbuster to take over electronics retailer Circuit City looks like a pretty desperate move.  In short, a company that prospered with the rise of the whole rent-it-out couch potato ethos that began to flourish in the 1980’s, hasn’t been willing or able to renew its core business, even as its advantages were eroding under pressure from competitors with different business models (such as Netflix), buying DVD’s and greater availability of alternatives, such as movie downloads and video on demand from cable companies. 

Blockbuster’s CEO (who came out of retirement to turn the firm around after doing a good turnaround job at 7-Eleven) feels that cost savings and efficiencies will make the aggressive, indeed, bet-the-company move successful.  Interestingly, at least at this stage, there doesn’t seem to be any compelling new business model in the offing.  Circuit City stores would likely offer videos and games for rent (woo hoo - now there’s a big innovation) and Blockbuster stores might be able to sell hardware such as portable media players (ditto).  He seems to think that the movie rental and consumer electronics businesses are ‘converging’ and cites the Apple stores as a case in point, even going to far as to note that Apple’s stores could be a model for the post-merger Circuit City/Blockbuster bid. 

I’m not one to ever say ‘never’ but this one has me scratching my head. 

Missing:  Clearly defined customer segment with clearly defined needs

For starters, where is the market segment with a compelling need that this combined company will address?  Apple stores are not just stores—they are complete retail experiences that showcase truly breakthrough products in a dramatically different way than competitors.  Wal-Mart’s segment doesn’t value experiences so much as good value, so that is differentiating for them.  Best Buy has been brilliant at customer segmentation and has gone so far (with its acquisition of the Geek Squad and the emphasis on product knowledge among its ‘blue shirted’ employees) as to make the retailing-purchasing-installing-using experiences far superior to those at other retailers.  There doesn’t seem to be much customer focus here.

Assumption of ‘convergence’ or denial of reality?

A recent Wall Street Journal article notes that CEO Keyes believes that convergence between video consumption and consumer electronics is underway and that the merger will facilitate the postioning of the combined company to benefit.  Convergence?  Hardly.  What’s happening here is that the core of Blockbuster’s business—movie rentals—has been in decline for some time and is likely to simply erode as a source of future profits and growth.  Sure, there will be some customers who continue to use the service—just as for decades after deregulation meant you could purchase phones there were customers still renting them from Ma Bell—but if investors and other stakeholders are looking for growth, clinging to an increasingly obsolete core is not the answer. 

Not being smart or disciplined about managing a full growth portfolio

The Blockbuster saga, to me, is a repeat of what happens to many a successful company over time.  With the growth and success of the core business, more and more focus is placed there.  It’s all too easy to keep pumping investment and people resources into that business.  Financial tools and other conventional management practices make investments anywhere else look unattractive.  When conditions change, competitors copy or leapfrog and customers’ desires shift, a company that has over-invested in the core can find itself with few choices.  The next step is usually a desperate one—typically, the company will be acquired by another firm, often not for its declining core business, but for its other assets - such as brand, talent, or intellectual property.  Sometimes the lure is simply assets such as real estate!  The Blockbuster approach of Circuit City is simply this same process with a twist, the twist being that the CEO presiding over the declining-model company will be the one designing the strategy for revival (hmmm…). 

The upshot:  Invest in growth options before you need them!

What should the good folks over there at Blockbuster have done differently?  Well, if there is trouble in the core business, the obvious answer is that you have to discover or find adjacent businesses to renew or create a new core.  How do companies do this?  I’ve argued that they need to think about investing in portfolios of opportunities.  The chart gives an illustration. 

If you think of your investments as distributed across dimensions of uncertainty, with market uncertainty extending across the bottom of the graph and technical or capability uncertainty going vertically to the left of the graphic, you have a way of picturing the activities you are investing in.  Each boxes’ worth of activities serve different strategic purposes. 

  • Core enhancements are clearly those things you do to keep the current core business healthy.  That’s essential, as without a healthy core you don’t have a lot of other options (as the Blockbuster scenario makes all too clear)
  • Platform launches are next-generation businesses - you can think of them as candidates to form a new core business
  • Options, just as the name suggests, are small investments you make today that give you the right but not the obligation to make a bigger investment going forward

My guess is that Blockbuster (and Circuit City, which isn’t in great shape itself) under-invested in the options that could have been crucial to the discovery of a new business model.  Now, it’s trying the risky and difficult route of putting its core business into discovery mode - a practice that is likely to lead to expensive disappointments rather than the small, contained-downside, experiments that options represent. 

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Discovery Driven Strategy:  Options investments enable the right kind of failures (Amex Express Pay)

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American Express has just announced that it is discontinuing the “Express Pay” offering that allows contact-less payments by consumers, along the lines of the popular Speedpass payment systems that were successfully implemented by gas stations to facilitate making purchases there.  The payments are linked to a key fob, which users wave at a receiving device to make a payment.  Unlike the Speedpass offer, however, the Express Pay device didn’t seem to get much traction. 

Surprisingly, according to an Amex Executive quoted in today’s Wall Street Journal, “We have actually found that our customers prefer to use the contact-less technology through our traditional cards” rather than the key fob.  What did Amex spend to learn this lesson?  Although the article isn’t specific, it notes that the fobs were only available to customers in a few markets—New York and Phoenix, among them.  Contrast this limited-downside, learning-rich experience with what might have happened had Amex gone after this as a big-bang investment, convinced that this was the Next Big Thing.  They could easily have blanketed the country with promotional materials, spent millions on ads and more millions on give-aways to entice consumers to try to carry the device.  The lesson would have probably been the same, but the tuition would have been much steeper. 

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Business Models based on “free”

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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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Revlon’s “Vital Radiance” - a failure to spark innovation led growth with some interesting lessons

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In a bitter fight to grow against formidable rivals such as Proctor and Gamble and L’Oreal, cosmetics manufacturer Revlon tried the innovation route, with a new line of cosmetics called “Vital Radiance,” introduced in January of 2006.  The products had a lot going for them.  They were targeted at an older demographic of women, who are generally enthusiastic about any product that makes them look younger, right away.  According to users, the products helped make them look younger, right away.  The research behind the offer was formidable, and it was introduced with great fanfare, including a web-based personalization campaign.  Many users developed quite a passionate affection for the products.

So what could have possibly gone wrong?  Although it’s hard to know in retrospect, the assumptions underlying the major launch were not borne out.  Specifically:

  • Women would respond well to being targeted by age (the products are intended for “prime time” women over 50.  Our research suggests that you are much better off targeting consumers by attitude and behavioral patterns, not by demographics.  A classic mistake.
  • The products would not need to leverage the Revlon brand.  In a move which baffles me, the whole product line was introduced with its own identity, failing to leverage the powerful and very well known Revlon brand.  It’s basically leading the product to be set up like a startup, failing to leverage the company’s investments in brand-building.
  • There was no need to use a well-known spokesperson for the brand.  Other manufacturer’s use models such as Diane Keaton and Christie Brinkley to represent their products, again leveraging on names customers will recognize
  • The products were introduced at fairly high price points

Had the company done some discovery driven planning, they might have caught some of these assumptions early.

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