New business models can be disruptive forces, wreaking havoc among the established order of firms. While new technologies in themselves sometimes do have disruptive potential, more often than not it is new technologies enabled by new technologies that are the true source of disruption.
Should investors care? We think so. Business model innovators clearly outperform product and process innovators according to a study from the Boston Consulting Group. The recent meteoric rise of disruptive business model innovators such as Uber and Airbnb in hitherto slow-moving industries like personal transportation and lodging shows that business model innovation can be an incredibly potent force of change.
It used to take a long time to build a global business and, once built, it tended to last for a long time. General Electric, Coca-Cola or Royal Dutch Shell, to name just a few international business giants, took decades to build their global franchises. However, over the last ten to fifteen years new global businesses are popping up seemingly overnight. Google was founded in 1998, Facebook in 2004 and Uber in 2010. At the same time, some of the most venerable and longstanding businesses are crumbling or have already collapsed. Kodak, founded in 1892, began to wobble in the nineties and had to file for bankruptcy in 2012. Nokia’s history goes back even further, to 1865. It dominated the market for mobile phones in the nineties and early part of this century, but sold its mobile phone business to Microsoft in 2013 after running into insurmountable trouble. Or take Sony, which traces back its history to 1949 and was phenomenally successful from the sixties to the early nineties, but has become synonymous with stagnation since.
Customarily, these tales of success and failure are attributed to new technologies that either power the advent of new businesses or expedite the demise of existing businesses. However, while new technologies often play a very important role in changing the dynamics of competition, more often than not, it is changes in business models that play a decisive role in determining which companies will succeed or fail. Why did Google succeed where AltaVista failed? Certainly Google’s superior PageRank search algorithm played an important part in its early success, but it was the introduction of the clever clutter-free family of advertising programs Adwords, Adsense and Doubleclick, a business model innovation, that was the key to the company’s success and subsequent market domination. In a similar vein Facebook outgrew first mover MySpace; not by using superior technology, but by providing a superior user experience by listening and quickly reacting to evolving user demands. Again, a business model innovation. According to popular notion the replacement of the film-based by the digital camera sunk Kodak. But it was Kodak that invented the digital camera. Clearly, it wasn’t the technology that lay at the root of Kodak’s demise, but the failure to design a business model that fit the new digital technology.
Many more examples of disruptive change driven by business model innovation can be given. One particularly arresting example that is playing out right now is the disruption of the traditional lodging industry by Airbnb. By simply connecting providers of private lodging space with seekers of lodging space through an online platform, Airbnb creates an immense increase of potential lodging supply. Traditional suppliers like hotels and bed & breakfasts will have to contend with this increased base of suppliers; especially during times of peak demand. Obviously this will have a very significant impact on peak demand pricing power; traditionally the most lucrative part of the demand curve.
In 2013 the McKinsey Global Institute published a report on the economically disruptive technologies of our time. Twelve major rapidly advancing technology areas, dubbed the ‘Disruptive Dozen’, were assessed in terms of their potential reach and scope and potential economic and disruptive impact. Examples are renewable energy, the Internet of Things, advanced robotics and next-generation genomics. These technologies have the potential, according to McKinsey, to transform the way we live and work, enable new business models, and provide an opening for new players to upset the established order. The common denominator and underlying force of almost all new technologies, however, is digitization coupled with connectivity.
Increasing digitization and connectivity are driving changes in the value propositions that businesses are offering along three dimensions:
We expect to see a continued proliferation of virtual market places, peer-to-peer networks and the weaving of physical assets into digitally accessible networks (i.e. the sharing economy). Given its disruptive potential, we see this trend as the most significant for investors.
The confluence of accelerating digitization and connectivity is having its greatest effect on businesses that employ value network configurations. Many industries can be characterized as networks: Telecommunication, Financial Services, Transportation, Social networks, Retailing, Wholesaling, Utilities, Travel, Education etc. Social and commercial interactions simply represent the largest part of our economy. Consequently, one can expect networkization to a higher or lesser extent in all network-like industries.
We see five categories of new business models gaining ground over the coming decade. The table below lists the five categories and summarizes our views on their likely impact.
Of the five categories, we deem peer-to-peer networks, online market places and ‘sharing economy’ business models to be potentially disruptive in nature. Personalization and ‘everything as a service’ business models are more likely to be sustaining innovations, which benefit incumbent firms.
The principal reason for this is that peer-to-peer networks, online market places and sharing economy business models have network characteristics. Once a critical size threshold is surpassed, they can potentially profit from non-linear network effects. Over time the platforms that are thus created tend to become very dominant. Incumbents find it very hard to compete as their traditional advantages of scale and scope tend to become irrelevant.
Conversely, we think that incumbents’ advantages of scale and scope will remain very relevant in the case of personalization and everything as a service business model innovation. From the incumbents’ point of view, competition in these traditional value chain configurations tends to evolve along familiar dimensions of cost and experience value. In addition, there usually is an installed base that can serve as a semi-captive launching pad for new products and services. Provided incumbents keep their eyes on the ball, they should be well-positioned to transition successfully to these new business models.
We see two important takeaways for investors. First, networks that have critical mass and network characteristics are extraordinarily valuable. They usually grow to dominate their industry and, once established, are extremely difficult to dislodge. Second, industries with physical assets that can either be digitized, digitally knit together into a network or both, are vulnerable to disruption.
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