Chapter 17
Figuring Out Where to Begin the Innovation Process
In This Chapter
Avoiding the mistake of simply adjusting your existing model
Using the crystal ball exercise
Getting past the fear of being wrong
Understanding the beauty of a cheap fast failure with upside
Learning to version your business model
How do you fix a business model? You innovate. Done right, innovation not only repairs a broken business model, but also makes it better than it was before. The innovation process for a business model is similar to any other innovation process. Innovation takes a dash of creativity, a dash of guts, some futurism, and a bunch of business experience put together to create a beautiful new model.
Many businesspeople understand the importance of fine-tuning the business model through innovation, but they don’t know where to begin. This chapter discusses the process to start improving your business model through innovation. I demonstrate why tweaking your old model rarely works, how failure can be your friend, and the importance of predicting the future.
Adjusting Your Old Model Rarely Works
Emily owns a spa in an affluent suburb. For the past ten years Emily has enjoyed a great deal of success. A few years ago Emily’s business dropped 20 percent due to the recession. Emily made a few changes to gain back some sales and aggressively cut costs. With these changes, her business was still quite profitable. Then a Massage Envy franchise opened down the street. Massage Envy uses a unique business model that doesn’t require appointments and uses a health club membership model rather than the standard pay-per-use model. More than 40 percent of Emily’s business was massage, and that segment of her business was cut by half.
Emily knew she needed to change her business model. She made a list of the customers she served and the types of services offered. Emily methodically analyzed how she could better serve these customers and sell more of these services. Emily came up with dozens of changes, very few of which worked.
The problem with Emily’s business model innovation plan wasn’t the quality of Emily’s ideas, it was the way Emily went about the innovation. All Emily did was play around the edges of the existing model. Much like sanding off the rough spots of a board, the wood is still the same length, width, and shape when you’re done sanding. It’s just missing the rough spots. Emily needed more than removal of the rough spots. She needed a vastly improved business model, and she wasn’t going to get one tinkering around with her existing model.
Looking forward, not backward
You achieve business model innovation by looking forward, not backward. Looking backward gets you what Emily got — sanding off some rough spots. If you’re looking for significant innovation, ignore your current situation and look into the future.
To look into the future, you must use a clean slate. When Emily innovated her business model, she made several presumptions:
Emily’s current lines of business should be grown and made more profitable. Did Emily consider the possibility that greater profitability could be obtained by shrinking or dropping some of these lines of business? Probably not, because she started with the presumption that she should grow the lines instead of using a clean slate.
The objective of the business model innovation was to fight back the advance of Massage Envy. This is a defensive position. Business model innovation done for defensive purposes yields different results than innovation done for offensive purposes. Typically innovation done in an attempt to lead a market is more profitable than innovation designed to fight back competitors. Emily would have been better served to design her innovation to leapfrog over Massage Envy with something spectacular rather than trying to catch them.
She must compete with Massage Envy. Because she started with the existing paradigm, several options never entered her mind, like co-locating with Massage Envy, buying a Massage Envy franchise, or partnering with them.
She must operate from a physical location. Over the past 20 years, many business models have been created for mobile operation of formerly fixed locations.
If Emily had used a clean slate and future focus, her business model innovation would have been significantly better.
Example: McDonald’s global business model
McDonald’s operates 31,000+ locations in more than 100 countries. Part of McDonald’s successful business model outside the United States is using a clean slate rather than dropping in a standard U.S. McDonald’s and tweaking it.
In Thailand, McDonald’s serves Samurai Pork Burgers and Thai Spicy Fish McDippers. In the Philippines, customers can purchase sugar-soaked spaghetti, tuna pies, and seaweed flavored fries. European McDonald’s serve beer. In the Northeast U.S., McDonald’s serves Newman’s Own coffee to cater to local preferences.
Some McDonald’s don’t serve Big Macs, French fries, or Coca-Cola. In fact, the most common item across all McDonald’s menus is a milkshake. Milkshakes are available in all of McDonald’s global markets except for Argentina, Paraguay, and Guatemala.
McDonald’s has been successful in a wide variety of cultures and geographic locations, because it designs a business model specific to each one.
Predicting the Future
Nothing is better for your business model than correctly predicting the future. By correctly predicting the future, I mean predicting the business environment variables that will affect you in the future. If you can accurately predict these key variables, your business model will be vastly superior to your competitors’. Here’s why. Your competitors likely won’t try to predict the future at all. Their meandering, combined with your correct prediction, equals a bonanza for you. If your competitors bother to guess and guess wrong, you win again.
When trying to predict the future business environment, look into the crystal ball. Then take action. After all, the best way to predict the future is to invent it.
Gazing into the crystal ball
A fortune teller looks into the crystal ball and tells you your future. To innovate your business model, you need to do the same thing. Look into your crystal ball and make your best guess regarding these variables:
Interest rates: Not long ago the interest rate for business borrowing was nine percent. Businesses have been spoiled by historically low lending rates. A significant increase in the prime rate could have a significant impact on your business model.
Economic growth: Will the economy grow or shrink, and by how much? How will the local economy be affected by the national economy?
Real estate values: Many businesses are affected by the value of real estate. Will real estate prices in your area rise or fall? How does this fluctuation affect your business? What can you adjust accordingly?
Price and availability of labor: Will a sufficient labor pool with the skills you need be available? Will the cost of this labor work within your existing business model?
Price and availability of extremely talented labor: McKinsey & Company made the term “war for talent” famous. McKinsey’s research showed there will be worldwide competition for the most talented employees. It doesn’t matter if you’re a biotech company or a landscape contractor, extremely talented employees are rare and difficult to find. Will you be able to find such employees? If you can’t, how do you need to change your business model?
Technological changes that affect the industry: Many experts feel the days of credit cards are numbered. Near-field communication chips in cellphones may take the place of credit cards. How does this change affect the business model of companies like Walmart, American Express, and banks? Every industry is affected by technology. Don’t think you’re not affected just because you’re not a technology company. Mobile restaurants have been very disruptive to brick-and-mortar restaurants.
General technological changes: Ten years ago, no one had a smartphone or an iPad. Now every business must deal with these technological tsunamis. How will society’s technology habits change and affect your business model?
Changes in buyer behavior: In 1978 Americans ate out 15 percent of their meals. By 1995 this percentage rose to 29 percent. This trend is great for restaurants but bad for grocery stores. What significant trends in buyer behavior can you foresee?
Demographic changes: The massive buying power of the baby boomers created entire industries. How do upcoming demographic changes affect your business model?
Changes in marketing methodologies: Direct mail is dying. The post office may not even be around in ten years. Telemarketing to consumers is illegal in many states. Online advertising can be tricky. Social media advertising feels like a crapshoot. How will you navigate the changing landscape to market your products? What new trends do you foresee? How can you capitalize on these trends?
Overall growth of your industry: Will your industry grow or shrink?
Growth of your niche: Will your niche grow or shrink?
Potential competition entering the market: Do you see competition entering the market? Who? Don’t forget indirect competitors.
Convergence of industries: No one predicted that cellphones would compete against digital cameras ten years ago. What industries have the potential to converge with yours? If a battle ensues, who will win?
Success of your current initiatives: Which of your current initiatives works well and which doesn’t? How does this answer affect your future business model?
In order for this exercise to work, you must guess. Saying something like, “I think the economy will be okay” isn’t a guess. “I think the economy will grow two to three percent” is a guess you can take action on.
Overcoming the fear of being wrong
Businesspeople don’t like the crystal ball exercise in the previous section, because they don’t like being wrong. Here’s the rub; guessing wrong is almost always better than not guessing. Your guesses aren’t chiseled in stone. You’ll just be heading in a new or different direction. If it becomes clear you made a wrong turn, you can correct it.
Perhaps the crystal ball exercise can be categorized under trying too hard versus not trying hard enough. Failure to guess at the future is not trying hard enough and doesn’t yield the best business model innovation. If you’re brave enough to engage in the crystal ball exercise, most of your guesses will be close to correct. That alone will put you light years ahead of the competition.
Practicing trend extrapolation with a dose of creativity
Sometimes analytical types, like accountants and engineers, have a hard time performing the crystal ball exercise. Sorry ladies and gentlemen, you still need to do it. If you’re having a hard time being creative, try to creatively extrapolate a current trend. Bill Gates and Paul Allen didn’t invent the PC operating system that made them rich. They saw an article in Popular Mechanics touting an operating system for the Altair computer. Gates and Allen took this nascent trend and extrapolated it, a lot. As it turns out, they were right. The trend was huge and their correct prediction created a powerful business model.
Predicting home security trends
Back in 2005, despite his reluctance, I made a client in the home alarm business go through the crystal ball exercise. He spent the first 30 minutes of our meeting complaining about several negative trends appearing in the industry. Several cities had instituted large fines for initial false alarms and misdemeanor offenses for excessive false alarms, and police had become reluctant to respond due to the high rate of false alarms. The city of Las Vegas stopped responding to alarms altogether, forcing homeowners to employ private security companies to do so.
I asked the client to look into the crystal ball and paint me a picture of what the home security business would look like in five years. Here’s what he said:
All cities would operate like Las Vegas, with no police response to alarms.
High fines would continue and most likely get worse.
These two factors would discourage homeowners from getting alarm systems. I had him guess at the percentage decrease in installations this change would cause. He estimated a 30 to 50 percent decrease.
Wireless technology would allow unskilled installers to easily equip homes. This issue was significant because his business catered to high-end homes with complex installations done by a highly skilled staff. Wireless technology would make less skilled installers competitive with his highly skilled staff.
Recently, Internet Protocol (IP) IT companies began competing in the video surveillance business. Video surveillance represented 25 percent of his business. At the time, he hadn’t lost many significant bids to an IT company. However, because cameras were IP devices for most users, some prospects viewed the IT company as having superior skills with this technology versus his company’s video expertise.
This report doesn’t sound very positive, does it? It was clear that his existing business model was in danger of stagnation or erosion. However, he had a profitable business built around the existing infrastructure in which the wired-system-based alarm company installed the system, a monitoring company responded to intruders and filtered false alarms, and the police arrested the perpetrators.
Everyone in the existing ecosystem was happy except the police. It was also clear that wired technology would eventually be replaced with wireless technology, rendering the client’s most skilled workers under-utilized and under-valued by the marketplace. The client needed to create a new business model that leveraged the changes in the marketplace instead of fighting them.
After brainstorming for an hour, we hit up on an interesting topic — self-service monitoring. Anyone who has had an alarm has had a false alarm. The homeowner wants to call the police only if there’s an intruder. Unfortunately, alarm technology was based upon window sensors and motion sensors, both of which are blind. A motion sensor has no idea whether a bird went down your chimney or an intruder is stealing everything you own. The alarm just goes off. The concept of self-service monitoring involves using streams of video of your house to every smartphone you designate. You can take a quick look to see whether it’s an intruder or a bird and push a button to notify the police if it’s an intruder. Effectively, the call center that monitors alarms and automatically calls the police is replaced by the customer. This new business model solves the Las Vegas problem, plus it provides a variety of additional features because of the video feed. I’m sure you’ve seen commercials on television for systems like this one, but they didn’t exist in 2005.
By looking into the crystal ball and extrapolating current trends, this business owner was able to accurately predict the future and create a business model to capitalize upon it.
Failure Can Be Your Friend (As Long As It’s Cheap and Fast)
Inside Silicon Valley, failure is viewed as a badge of honor. A failed entrepreneur is thought to have battle scars and wisdom that can’t be attained through the easy road of success. Everywhere but Silicon Valley, failure is a Scarlet Letter — a sign of a poor businessperson.
I dare you to name a business model that worked perfectly on the first try. You can’t do it because there isn’t one. The first version of every business model fails. Doesn’t this fact make you feel better? Knowing that whatever model you roll out will have something wrong with it is a relief. It takes the pressure off and makes perfectionism seem silly. Why bother trying to make the model perfect when it’s impossible?
Rather than try to make your business model perfect, try to get to the perfect version faster. Business models are iterative. You try, you fail, you tweak. Rinse and repeat. Eventually, after many iterations, you get your perfect model. The savvy business model designer moves through the iterations quickly rather than focusing on perfection.
I suggest you follow a rule I call “cheap fast failure with upside.” As long as your business model tweak has some upside, limited downside, doesn’t cost a lot, and can be tested quickly, go for it.
Redefining failure
I suggest that you redefine failure. All the revisions to your business model will be “failures” if you define failure as non-perfection. Instead, define failure as something that doesn’t eventually move you forward.
If you still believe in your overall business model concept, and you try a business model revision that doesn’t work, take the Thomas Edison approach; consider yourself one step closer to success because you’ve eliminated that option.
Even trials that end in “failure” can sometimes be the most valuable learning experiences on the path to even greater success. If you read interviews with successful businesspeople, many list “failures” as key in their ultimate success. Many times, success isn’t as good a teacher as failure. Find a way to pull the silver lining from failure, and apply it to the next version of your model.
Examples: Failure as the first step toward success
After spending $100 million to develop the Newton tablet computer, Apple appeared to be left with nothing but the distinction of coining the term “PDA.” The Newton was an abject market failure. Apple scrapped the project but had learned many valuable lessons, including handwriting recognition and creation of a new operating system.
Conventional wisdom at the time said Newton was ahead of its time. Apple took this wisdom into account and applied the Newton technology to a Macintosh tablet computer. Apple applied for several patents for this tablet but never released it. This Macintosh tablet later turned out to be the Apple iPad, which currently runs Apple’s proprietary iOS System Software, a direct descendant of the Newton operating system.
Ice cream entrepreneurs Ben Cohen and Jerry Greenfield originally opened an ice cream parlor in a renovated gas station. Two months later they closed down, realizing they had the wrong business model. They shifted their focus to packaging pints of ice cream and franchising stores as a model instead of running their own ice cream store. This new model created an empire. Ben and Jerry have never been afraid of experimentation as some of their oddball ice cream flavors — like Oh Pear, Economic Crunch, Peanut Butter and Jelly, and Schweddy Balls — make clear.
The United States of America failed at its original business models, including the Articles of Confederation. Eventually, the model was changed to the Constitution and the existing structure of government with success.
Steve Jobs purchased the Graphics Group from the Computer Division of Lucasfilm limited. George Lucas was going broke funding the exciting technology and couldn’t turn it into a profitable business model as a toolkit for movie special effects. Jobs paid Lucas $5 million and put another $5 million of working capital into the Graphics Group and renamed it Pixar Studios. The business model and technology created by Lucas were changed from a special effects focus to an animation focus and yielded many profitable movies.
The Post-it Note was created with a glue formulation that failed its original purpose.
Hundreds of successful companies were jettisoned from larger organizations as losing business models only to thrive as independent businesses. Stock market darling Intuitive Surgical purchased the intellectual rights to the da Vinci Surgical System from nonprofit research institute SRI International. SRI was trying to create a device that could perform remote battlefield surgery. This model failed but Intuitive Surgical has been wildly successful selling the system for laparoscopic surgery.
Pipeline powerhouse Kinder Morgan was created because of founder Richard Kinder’s philosophical business model differences with Enron’s Ken Lay. Kinder was the President and COO of Enron from 1990 to 1996 and helped Enron build a small pipeline division. Lay wasn’t interested in “hard asset” businesses because they didn’t offer the astonishing profits Enron was making by trading energy. In 1997 Kinder left Enron to start Kinder Morgan. It turns out Kinder’s hard asset business model was vastly superior to Enron’s. Today Kinder is the 41st richest person in the U.S., worth more than $9 billion.
Former Pepsico divisions Frito-Lay and Yum Brands (Taco Bell, KFC, and Pizza Hut) are functioning better with an independent business model versus as a division of a larger corporation.
The lesson from these examples is that sometimes apparent failures are merely bumps in the road on the way to success. These bumps are failures only if you stop innovating.
Staying viable with business model versioning
In order to stay viable, all business models must undergo constant innovation. Much like the evolution of software, business models have versions. Every time you make a change or adjustment to your business model, you’re creating a new version.
The software versioning process goes something like this:
Dot.0 releases represent significant changes to the software. Windows 7 had significant updates, changes, and technology from its predecessor Windows XP.
Point releases represent upgrades or tweaks to a dot.0 release. The lower the numeric value of the point release the less its significance. Windows 3.1 was the first significant improvement to Windows 3.0, whereas Windows 3.11 was a much smaller change. Software releases such as Windows 3.1118 are minor and probably represent nothing more than a bug fix.
The business model versioning process is exactly the same. Large sweeping changes to your business model are similar to dot.0 software releases. Smaller changes are just like point releases.
Figure 17-1 shows the business model evolution of a lawn and garden equipment manufacturer. Several significant business model changes have been made over the company’s long history. In addition to these dot.0 changes, the company made many point releases to its business model.
There’s no right answer to how often you should version your business model. The only certainty is that not versioning your business model will eventually destroy it. Generally, a new dot.0 release of your business model should occur every ten years or less. Each year you should make some point release change or changes to your business model in order to keep it fresh.
Apple’s business model versions
I could write an entire book on Apple’s business model and a detailed analysis of its gyrations. Here I do a quick review of Apple’s business model history instead.
Version 1: Garage computer company. Only 200 Apple I computers were built. Steve Wozniak hand built each of them. The experiment worked, and Apple moved on to Version 2 of its business model.
Version 2: Burgeoning PC manufacturer. It wasn’t clear whether personal computers were for consumers or businesses at this time. The Apple II computer wasn’t the top- selling brand. It was in third place behind Commodore and Tandy, but Apple caught a lucky break. The Apple II was selected as the platform for VisiCalc software. Many experts credit the rise of the PC to the “killer application” VisiCalc.
Version 3: Entry into business computers. The success of the IBM PC made it clear that business use of PCs would exceed home use. Not wanting to miss this large market, Apple made two failed attempts at this market — the Apple III and the Lisa.
Version 4: Finding a niche. The failed Lisa computer led directly to the successful Macintosh. Unable to compete against IBM PCs and their clones, Apple found devoted and loyal niche users in graphics-intensive industries. These loyal Apple users carried the company through its most difficult decade.
Version 5: Gadget company. As iPod sales eclipsed Macintosh sales, Apple continued to focus on profitable consumer device sales such as iPhones (an iPod with a phone) and iPads (a giant iPod) for record profits.
Figure 17-1: Business model versioning example.