The Path to Growth

By Norman T. Sheehan and Ganesh Vaidyanathan

March 3, 2007

Even the most successful business models erode over time. Microsoft Corp. is under threat from Web-based software such as Google Inc.’s Writely and open-source offerings such as Linux. Coca-Cola Co. is facing challenges from bottlers flexing their muscle and increasingly health-conscious consumers. Manufacturers across the board are struggling with the new dominance of China, and professional firms are similarly threatened by the growing presence of India.

The key to thriving under such tough conditions is adaptability. Many companies get stuck in a rut, coming up with just one way to make themselves valuable to customers and sticking with it no matter how much the market changes. Instead, companies must continually update their business model in response to threats and opportunities.

When faced with these challenges, most managers consider a host of conventional approaches, such as copying competitors or finding unexplored niches to exploit. But there’s another way to approach the problem, a method that can uncover new and unexpected ways to boost business: Look at value-creation strategies.

The idea is simple. All of the possible methods of bringing customers value—anything from more-efficient production lines to new products and services—boil down to just three fundamental strategies. All business models can be seen as one of these three things, or a combination of two or more. In that light, the best way to tweak a business model is to find a new combination of building blocks that better fits market conditions.

Here are those three fundamental strategies, as developed by Charles Stabell and Øystein Fjeldstad, professors at the Norwegian School of Management:

• Industrial efficiency, which creates value by producing standardized offerings at low cost. Manufacturers and fast-food restaurants rely on this approach.
• Network services, which creates value by connecting clients to other people or other parts of the network. Telephone companies, delivery services and Internet middlemen such as eBay use this method.
• Knowledge intensive, which creates value by applying customized expertise to clients’ problems. Law firms and medical practices are prime examples.

Looking at business models this way can bring insights—and new ways to compete—that the regular methods miss. Let’s say you manufacture industrial parts. If the market got tougher, you’d probably try to find a way to make your products more cheaply or differentiate them more strongly from your competitors’ offerings. You wouldn’t ordinarily consider using the network-services approach—that is, giving your customers new ways to connect to you or to each other.

But that’s exactly what many big industrial companies have done to boost their business—even if they haven’t looked at it in those terms. Car makers, for instance, have created “networks” of dealerships across the U.S. that provide after-sales service and parts support. General Motors Corp. has gone even further, partnering with OnStar. When customers buy a GM vehicle equipped with the service, customers are buying not only a car, but also an online network that ensures they get help whenever and wherever they are.

Of course, companies produce successful left-field strategies using conventional approaches. But focusing on the three value-creation strategies can help produce those insights regularly by forcing managers to look at their business and their options in a novel way.

What follows is a closer look at how companies can use the value-creation strategies more creatively to keep up with a changing market.

INDUSTRIAL COMPANIES

Companies that rely on industrial efficiency sell large volumes of low-cost, standardized products or services. Prices are primarily influenced by market forces, so the company’s profitability typically depends on management’s ability to manage costs. The category includes companies in commodity industries, such as petroleum refining, as well as near-commodity ones, such as generic label goods. The category also covers service companies such as fast-food restaurants and copy shops.

The big threat for pure industrial companies is China, whose companies are beginning to dominate the low-cost, standardized segment for most products. At times, Chinese companies offer better quality at prices as much as 30% lower.

To meet this challenge, industrial companies can apply one of the basic value-creation strategies:

• Increase industrial efficiency. The first option for industrial companies is to further increase efficiency. General Mills Inc., for instance, is attempting to cut $1 billion from its supply chain in part by using processes from other industries. In one case, the company reduced the turnaround time on the Betty Crocker production line by over 90% by incorporating ideas from a Nascar pit crew.

The upside is greater profitability. However, it’s tough to keep ahead in this game: Competitors could come along with a new, cheaper production method that makes the old one obsolete—and then quickly steal market share.

• Increase knowledge-intensiveness. Industrial companies can also offer their customers more “knowledge intensiveness,” which in this case means more customization. A company, for instance, might invest in a customer-relationship database to keep track of what clients order and when, and what special requests they make. This would allow salespeople to provide much better service.

The next level of customization involves segmenting the market and producing customized products for each segment, as Nike does with its shoes and big auto makers do with their vehicles. An even higher level of customization lets customers personalize their offerings by choosing from a menu of choices, as Lands’ End does with its clothing.

Companies adopting this approach may increase margins and customer loyalty. The risk is that rivals may find a way to offer similar quality at an even lower price—forcing companies to spend more money to distinguish their products.

• Increase network services. Industrial firms can also try to connect customers to other suppliers, or to each other. For instance, a company might ensure that complementary products or services are available for its goods—a “network” that customers can tap to get more value from their purchase. Apple Inc.’s iPod, for instance, rules the MP3 player market not only because it is technically superior, but also because there are a wide range of supporting products, such as the iTunes music store and attachable speakers from Bose and JVC.

Another option is to ensure after-sales service is widely available, as with car makers and their dealer networks. In North America, one advantage of buying a Chrysler, GM or Ford vehicle instead of a Fiat, Renault or Peugeot is that you know you’ll be able to get it repaired easily.

Companies can also connect customers to each other. A simple way to do this is to create virtual communities online. Amazon.com lets readers share reviews and post lists of their favorite books; Vespa has created a blog where owners can get together and share scootering experiences.

The upside of this tactic is that it may lock in customers. The potential downside is that a large portion of the value is created by users or other companies. If, say, Amazon customers stop posting reviews—or, worse, if individuals start posting fake ones—the network effect may be lost.

NETWORK-SERVICE COMPANIES

Companies that focus on network services sell connections: They let customers transfer goods, information, risk or money to other members of the network. The revenue model is based on charging for access to and use of the network. This category includes telecommunications companies, overnight delivery services and investment brokers, as well as Internet companies such as eBay Inc.

Network-service companies face a number of threats. As government regulators release their grip on network industries, such as telecommunications, new competitors are entering the field and existing companies are jostling to expand their networks. The Internet, meanwhile, has jolted a host of network-service industries, such as travel agencies and employment firms, as low-cost rivals spring up online.

To meet this challenge, network-service companies can apply one of the basic value-creation strategies:

• Increase network services. Network-services companies could offer their customers better connections, in two ways: increase the reach of the network or increase the richness of the network.

FedEx Corp., for one, improved its reach and profitability by offering more places to ship overnight in South America, India and China. Desire to increase reach has also been a significant driver of merger-and-acquisition activity between banks and telecommunications providers.

The upside of this option is seamless connectivity. The downside is that the network may be too costly to operate and not all network nodes may be profitable—a fact that many airlines learned about their sprawling routes.

Another option is increasing network richness. MCI and AT&T Inc. recently began offering software hosting and computer-security services to their business customers. FedEx and United Parcel Service Inc. moved into supply-chain management, taking over logistical responsibilities for many companies. The advantage of this approach is that it may win over early adopters. But rolling out the infrastructure may prove costly and cut into profits.

• Increase industrial efficiency. Network-service companies can move to a larger scale, offering less choice and less-personalized service. Internet-only banking firms, such as ING Direct, have no physical branches, so they offer far fewer services than brick-and-mortar institutions. But the cost per transaction is correspondingly lower. EBay provides less service than a physical auctioneer, but offers lower prices and more buyers, which in turn attracts more sellers. Southwest Airlines, meanwhile, increased its efficiency by offering only short-haul flights point to point, and just one class of service, one type of plane and minimal food service.

The advantage to this approach is, obviously, lower costs, which may lure more customers. But this model can be trumped by network-service firms that better meet customers’ needs for certain specialized transactions. An online bank might begin offering stock-trading services, for instance, to get a leg up on bare-bones rivals.

• Increase knowledge-intensiveness. A network-service company may increase its knowledge-intensiveness by counseling its members on what connections to make. A bank might offer wealth-management services to rich clients; a headhunter might also advise you whom to hire. The upside is higher fees. The downside is that many customers may prefer to keep such services in-house to save money.

KNOWLEDGE-INTENSIVE COMPANIES

Knowledge-intensive companies sell expertise. The revenue model is based on charging for know-how, and value is created by experts who identify problems, investigate them and recommend solutions. The category includes professional-service companies such as architecture, engineering and law firms.

These types of companies have struggled in the past few years. The dot-com meltdown erased lots of business for lawyers, investment bankers and other advisers to tech firms. In the wake of 9/11, many companies cut costs by cutting consultants. More recently, consultants have been threatened by the growth in outsourcing of expertise to India.

To meet this challenge, knowledge-intensive companies can apply one of the basic value-creation strategies:

• Increase knowledge-intensiveness. This means increasing the depth of specialization, such as law firms that specialize in M&A or tort litigation. The upside of specializing is that the company can address specific needs very well. The downside is that the company may do more work than necessary to prove it isn’t selling generic, “off the shelf” solutions. A pricey tax-law firm, for instance, might do exhaustive work on each tax return to demonstrate that it isn’t a low-cost provider like H&R Block Inc.

On the other hand, companies might broaden their problem domain, such as law firms that practice in all areas of law, or doctors who are general practitioners. The advantages include a bigger target market and a smaller chance that your area of expertise will become obsolete. The disadvantage is that it can be costly to gain and maintain expertise in a number of areas.

• Increase industrial efficiency. Companies can also move toward the industrial model by reducing the level of customization they offer. A company essentially solves a problem once and then resells the solution many times. This increases efficiency, which allows the firm to reduce its fees. H&R Block’s tax-preparation services typify this business model, as does Shouldice Hernia Center, a hospital that specializes in hernia operations.

The upside of this model is efficient service. The downside is that clients may have complex problems that lie outside the scope of the pre-existing solutions. And when you only have a hammer, every problem looks like a nail.

• Increase network services. With this approach, the knowledge-intensive company becomes what management guru David H. Maister labeled a prime contractor—the company that wins the work and then contracts out the individual problem-solving activities. In construction, for example, the building contractor is hired to manage a building project and then evaluates which sub-trades should be hired to complete the building.

The advantage to this approach is that the company can promise clients access to the best problem-solving expertise. But some clients may balk at paying for the facilitation services.

Of course, combining business models takes work. Managers first need to identify pockets of target customers who will respond to more than one value-creation technology. For instance, an industrial company needs to figure out if there are enough customers who also want customization and connectivity—and how much they’re willing to pay for it.

Managers must also be prepared to face the complexity of juggling two or more skill sets. For example, successfully managing the industrial approach involves wringing out cost savings by maintaining volume and standardization, while a knowledge-intensive method means enhancing value in the eyes of customers.

It may be better for companies to focus on mastering one value-creation method before moving on to others. It is easier for both employees and customers to understand the model and the offerings as everyone is on message, all the time. Then, when companies do add another method to the mix, they should be sure to train their managers and workers thoroughly. They might even consider acquiring another company that already uses the method, to bring that expertise quickly under their roof.

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