Johnson, Christensen and Kagermann (2008) Reinventing your Business Model, HBR_1b8821df73dc95c8c1b0e9bc68ed9e77.pdf

One secret to maintaining a thriving business is recognizing when it needs a fundamental change. 50 Harvard Business Review | December 2008 | hbr.org 1711 Johnson.indd 50 10/30/08 2:...

One secret to maintaining a thriving business is recognizing when it needs a fundamental change. 50 Harvard Business Review | December 2008 | hbr.org 1711 Johnson.indd 50 10/30/08 2:02:02 PM  Reinventing Your Business Model by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann IN 2003, APPLE INTRODUCED THE IPOD WITH THE ITUNES STORE, revolutionizing portable entertainment, creating a new mar- ket, and transforming the company. In just three years, the iPod/iTunes combination became a nearly $10 billion product, accounting for almost 50% of Apple’s revenue. Apple’s market capitalization catapulted from around $1 billion in early 2003 to over $150 billion by late 2007. This success story is well known; what’s less well known is that Apple was not the first to bring digital music players to market. A company called Diamond Multimedia introduced Jim Frazier the Rio in 1998. Another firm, Best Data, introduced the Cabo 64 in 2000. Both products worked well and were portable and hbr.org | December 2008 | Harvard Business Review 51 1711 Johnson.indd 51 10/30/08 2:02:12 PM  Reinventing Your Business Model stylish. So why did the iPod, rather than IDEA panies understand their existing busi- the Rio or Cabo, succeed? IN BRIEF ness model well enough – the premise Apple did something far smarter behind its development, its natural in- » Breakthrough, game-changing than take a good technology and wrap terdependencies, and its strengths and products rarely emerge from estab- it in a snazzy design. It took a good lished businesses. limitations. So they don’t know when technology and wrapped it in a great they can leverage their core business business model. Apple’s true innova- » That’s because a radically new and when success requires a new busi- product usually needs a new busi- tion was to make downloading digital ness model. ness model. music easy and convenient. To do that, After tackling these problems with the company built a groundbreaking » It’s possible to transcend the dozens of companies, we have found business model that combined hard- problem if you can: that new business models often look 1. Understand your existing ware, software, and service. This ap- unattractive to internal and external model at a granular level, so that proach worked like Gillette’s famous stakeholders – at the outset. To see you are in position to reinvent it. blades-and-razor model in reverse: Ap- past the borders of what is and into 2. Come up with a great way ple essentially gave away the “blades” to help people get an important the land of the new, companies need (low-margin iTunes music) to lock in job done. a road map. purchase of the “razor” (the high-margin Ours consists of three simple steps. iPod). That model defined value in a The first is to realize that success starts new way and provided game-changing by not thinking about business models convenience to the consumer. at all. It starts with thinking about the Business model innovations have reshaped entire industries opportunity to satisfy a real customer who needs a job done. and redistributed billions of dollars of value. Retail discount- The second step is to construct a blueprint laying out how ers such as Wal-Mart and Target, which entered the market your company will fulfill that need at a profit. In our model, with pioneering business models, now account for 75% of the that plan has four elements. The third is to compare that total valuation of the retail sector. Low-cost U.S. airlines grew model to your existing model to see how much you’d have to from a blip on the radar screen to 55% of the market value of change it to capture the opportunity. Once you do, you will all carriers. Fully 11 of the 27 companies born in the last quar- know if you can use your existing model and organization ter century that grew their way into the Fortune 500 in the past or need to separate out a new unit to execute a new model. 10 years did so through business model innovation. Every successful company is already fulfilling a real customer Stories of business model innovation from well-established need with an effective business model, whether that model companies like Apple, however, are rare. An analysis of major is explicitly understood or not. Let’s take a look at what that innovations within existing corporations in the past decade entails. shows that precious few have been business-model related. And a recent American Management Association study de- Business Model: A Definition termined that no more than 10% of innovation investment A business model, from our point of view, consists of four inter- at global companies is focused on developing new business locking elements that, taken together, create and deliver value. models. The most important to get right, by far, is the first. Yet everyone’s talking about it. A 2005 survey by the Econo- Customer value proposition (CVP). A successful company mist Intelligence Unit reported that over 50% of executives is one that has found a way to create value for customers – that believe business model innovation will become even more is, a way to help customers get an important job done. By important for success than product or service innovation. “job” we mean a fundamental problem in a given situation A 2008 IBM survey of corporate CEOs echoed these results. that needs a solution. Once we understand the job and all its Nearly all of the CEOs polled reported the need to adapt their dimensions, including the full process for how to get it done, business models; more than two-thirds said that extensive we can design the offering. The more important the job is changes were required. And in these tough economic times, to the customer, the lower the level of customer satisfaction some CEOs are already looking to business model innovation with current options for getting the job done, and the better to address permanent shifts in their market landscapes. your solution is than existing alternatives at getting the job Senior managers at incumbent companies thus confront a done (and, of course, the lower the price), the greater the CVP. frustrating question: Why is it so difficult to pull off the new Opportunities for creating a CVP are at their most potent, we growth that business model innovation can bring? Our re- have found, when alternative products and services have not search suggests two problems. The first is a lack of definition: been designed with the real job in mind and you can design an Very little formal study has been done into the dynamics and offering that gets that job – and only that job – done perfectly. processes of business model development. Second, few com- We’ll come back to that point later. 52 Harvard Business Review | December 2008 | hbr.org 1711 Johnson.indd 52 10/30/08 2:02:21 PM  IDEA IN PRACTICE Profit formula. The profit formula is the blueprint that defines how the com- Established companies don’t suc- knew that sufficient profit would pany creates value for itself while pro- ceed with radically new product be generated through high volume viding value to the customer. It consists offerings unless they understand if the company could persuade of the following: exactly how the opportunity relates the huge number of nonconsum- Revenue model: price × volume to their current business model and ers – the scooter families – to buy. Cost structure: direct costs, indi- proceed accordingly. In the authors’ That goal required radical changes rect costs, economies of scale. Cost struc- formulation, that work happens in in the cost structure of making a ture will be predominantly driven by several steps. car. To build the Nano, a team of the cost of the key resources required by young engineers developed new the business model. Start by developing a strong cus- processes – outsourcing 85% of the tomer value proposition. Many car’s components, using 60% fewer Margin model: given the expected companies begin with a product vendors, and eventually employing volume and cost structure, the contribu- idea and a business model and then a network of assemblers to build tion needed from each transaction to go in search of a market. Success to order. achieve desired profits. comes from figuring out how to Resource velocity: how fast we satisfy a real customer who needs Compare the model to your need to turn over inventory, fixed assets, to get a real job done. current one to determine whether and other assets – and, overall, how well EX AMPLE: When Ratan Tata of you can implement it within your we need to utilize resources – to sup- organization or should set up a Tata Group looked out over the port our expected volume and achieve separate unit. streets of Mumbai, he saw motor- our anticipated profits. cycles in traffic carrying entire People often think the terms “profit EX AMPLES: Procter & Gamble families – father, mother, and formulas” and “business models” are introduced the game-changing children. What if he could provide Swiffer using its existing business interchangeable. But how you make a these scooter families with a safe, model because the profit formula profit is only one piece of the model. enclosed car at a price they could and key resources weren’t radically We’ve found it most useful to start by afford? That would be a powerful different from those of its other setting the price required to deliver the customer value proposition. household consumables. But when CVP and then work backwards from Dow Corning, a master at providing there to determine what the variable Construct a profit formula that high-margin silicone products with costs and gross margins must be. This allows you to deliver value to sophisticated technical support, then determines what the scale and re- your company. Then decide what sought to serve the low end with a source velocity needs to be to achieve resources and processes you’ll low-touch, standardized offering, the desired profits. need. A customer value proposition executive Don Sheets found that without a profit formula is just pie in he needed to set up a new business Key resources. The key resources are the sky, as many a dot-com start-up unit with a new brand identity. assets such as the people, technology, found out. Stuck? Start with a goal Simulations had quickly told products, facilities, equipment, channels, for total profits and work back from him that existing processes and and brand required to deliver the value there. entrenched habits would thwart proposition to the targeted customer. any attempt to implement the new The focus here is on the key elements EX AMPLE: In seeking to build a car model. that create value for the customer and for 100,000 rupees, or $2,500, Tata the company, and the way those ele- ments interact. (Every company also has generic resources that do not create competitive differentiation.) Key processes. Successful companies have operational define value for the customer and the company, respectively; and managerial processes that allow them to deliver value key resources and key processes describe how that value will in a way they can successfully repeat and increase in scale. be delivered to both the customer and the company. These may include such recurrent tasks as training, devel- As simple as this framework may seem, its power lies in opment, manufacturing, budgeting, planning, sales, and ser- the complex interdependencies of its parts. Major changes vice. Key processes also include a company’s rules, metrics, to any of these four elements affect the others and the whole. and norms. Successful businesses devise a more or less stable system in These four elements form the building blocks of any busi- which these elements bond to one another in consistent and ness. The customer value proposition and the profit formula complementary ways. hbr.org | December 2008 | Harvard Business Review 53 1711 Johnson.indd 53 10/30/08 2:02:26 PM  Reinventing Your Business Model How Great Models Are Built The Elements of a To illustrate the elements of our business model Successful Business Model framework, we will look at what’s behind two compa- Every successful company already operates according to an nies’ game-changing business model innovations. effective business model. By systematically identifying all of its Creating a customer value proposition. It’s not constituent parts, executives can understand how the model possible to invent or reinvent a business model with- fulfills a potent value proposition in a profitable way using certain out first identifying a clear customer value proposition. key resources and key processes. With that understanding, they Often, it starts as a quite simple realization. Imagine, can then judge how well the same model could be used to fulfill for a moment, that you are standing on a Mumbai road a radically different CVP – and what they’d need to do to con- on a rainy day. You notice the large number of motor struct a new one, if need be, to capitalize on that opportunity. scooters snaking precariously in and out around the cars. As you look more closely, you see that most bear whole families – both parents and several children. Customer Value Proposition (CVP) Your first thought might be “That’s crazy!” or “That’s Target customer Offering, which satisfies the the way it is in developing countries – people get by problem or fulfills the need. Job to be done to solve an This is defined not only by what as best they can.” important problem or fulfill an is sold but also by how it’s sold. important need for the target When Ratan Tata of Tata Group looked out over customer this scene, he saw a critical job to be done: providing a safer alternative for scooter families. He understood that the cheapest car available in India cost easily PROFIT FORMULA five times what a scooter did and that many of these Revenue model How much families could not afford one. Offering an affordable, money can be made: price x safer, all-weather alternative for scooter families was a volume. Volume can be thought of powerful value proposition, one with the potential to in terms of market size, purchase frequency, ancillary sales, etc. reach tens of millions of people who were not yet part of the car-buying market. Ratan Tata also recognized Cost structure How costs are allocated: includes cost of key that Tata Motors’ business model could not be used to assets, direct costs, indirect costs, develop such a product at the needed price point. economies of scale. At the other end of the market spectrum, Hilti, a Margin model How much each Liechtenstein-based manufacturer of high-end power transaction should net to achieve tools for the construction industry, reconsidered the desired profit levels. real job to be done for many of its current custom- KEY RESOURCES Resource velocity How quickly ers. A contractor makes money by finishing projects; needed to deliver the resources need to be used to sup- customer value proposition port target volume. Includes lead if the required tools aren’t available and functioning profitably. Might include: times, throughput, inventory turns, properly, the job doesn’t get done. Contractors don’t People asset utilization, and so on. make money by owning tools; they make it by using Technology, products them as efficiently as possible. Hilti could help con- Equipment tractors get the job done by selling tool use instead of Information the tools themselves – managing its customers’ tool Channels inventory by providing the best tool at the right time Partnerships, alliances and quickly furnishing tool repairs, replacements, Brand and upgrades, all for a monthly fee. To deliver on KEY PROCESSES, as well as that value proposition, the company needed to cre- rules, metrics, and norms, that make the profitable delivery of the ate a fleet-management program for tools and in the customer value proposition repeat- process shift its focus from manufacturing and distri- able and scalable. Might include: bution to service. That meant Hilti had to construct Processes: design, product a new profit formula and develop new resources and development, sourcing, manu- facturing, marketing, hiring and new processes. training, IT The most important attribute of a customer value Rules and metrics: margin re- proposition is its precision: how perfectly it nails the quirements for investment, credit customer job to be done – and nothing else. But such terms, lead times, supplier terms precision is often the most difficult thing to achieve. Norms: opportunity size needed Companies trying to create the new often neglect for investment, approach to customers and channels 54 Harvard Business Review | December 2008 | hbr.org 1711 Johnson.indd 54 10/30/08 2:02:48 PM  to focus on one job; they dilute their efforts by at- tempting to do lots of things. In doing lots of things, they do nothing really well. One way to generate a precise customer value proposition is to think about the four most com- mon barriers keeping people from getting particu- lar jobs done: insufficient wealth, access, skill, or time. Software maker Intuit devised QuickBooks to fulfill small-business owners’ need to avoid running out of cash. By fulfilling that job with greatly sim- plified accounting software, Intuit broke the skills barrier that kept untrained small-business owners from using more-complicated accounting packages. MinuteClinic, the drugstore-based basic health care provider, broke the time barrier that kept people from visiting a doctor’s office with minor health issues by making nurse practitioners available with- out appointments. Designing a profit formula. Ratan Tata knew the only way to get families off their scooters and into cars would be to break the wealth barrier by drastically decreasing the price of the car. “What if I can change the game and make a car for one lakh?” Tata wondered, envisioning a price point of around us$2,500, less than half the price of the cheapest car available. This, of course, had dramatic ramifications for the profit formula: It required both a significant drop in gross margins and a radical reduction in many elements of the cost structure. He knew, how- ever, he could still make money if he could increase sales volume dramatically, and he knew that his target base of Oftentimes, it’s not the individual resources and processes consumers was potentially huge. that make the difference but their relationship to one an- For Hilti, moving to a contract management program re- other. Companies will almost always need to integrate their quired shifting assets from customers’ balance sheets to its key resources and processes in a unique way to get a job done own and generating revenue through a lease/subscription perfectly for a set of customers. When they do, they almost model. For a monthly fee, customers could have a full comple- always create enduring competitive advantage. Focusing first ment of tools at their fingertips, with repair and maintenance on the value proposition and the profit formula makes clear included. This would require a fundamental shift in all major how those resources and processes need to interrelate. For components of the profit formula: the revenue stream (pric- example, most general hospitals offer a value proposition that ing, the staging of payments, and how to think about volume), might be described as, “We’ll do anything for anybody.” Being the cost structure (including added sales development and all things to all people requires these hospitals to have a vast contract management costs), and the supporting margins collection of resources (specialists, equipment, and so on) that and transaction velocity. can’t be knit together in any proprietary way. The result is not Identifying key resources and processes. Having articu- just a lack of differentiation but dissatisfaction. lated the value proposition for both the customer and the By contrast, a hospital that focuses on a specific value propo- business, companies must then consider the key resources sition can integrate its resources and processes in a unique way and processes needed to deliver that value. For a professional that delights customers. National Jewish Health in Denver, services firm, for example, the key resources are generally its for example, is organized around a focused value proposition people, and the key processes are naturally people related we’d characterize as, “If you have a disease of the pulmonary (training and development, for instance). For a packaged goods system, bring it here. We’ll define its root cause and prescribe company, strong brands and well-selected channel retailers an effective therapy.” Narrowing its focus has allowed National might be the key resources, and associated brand-building and Jewish to develop processes that integrate the ways in which channel-management processes among the critical processes. its specialists and specialized equipment work together. hbr.org | December 2008 | Harvard Business Review 55 1711 Johnson.indd 55 10/30/08 2:02:53 PM  Reinventing Your Business Model Traditional Hilti’s Tool Fleet Power Tool Company Management Service Hilti Sidesteps Sales of industrial and Customer Leasing a comprehensive Commoditization professional power tools and value fleet of tools to increase con- accessories proposition tractors’ on-site productivity Hilti is capitalizing on a game-changing opportunity to increase profitability Higher margins; asset heavy; by turning products into a service. Low margins, monthly payments for tool Profit formula high inventory turnover maintenance, repair, and Rather than sell tools (at lower and replacement lower prices), it’s selling a “just-the- tool-you-need-when-you-need-it, no- Strong direct-sales approach, repair-or-storage-hassles” service. Distribution channel, low-cost Key resources contract management, IT sys- Such a radical change in customer manufacturing plants in devel- and processes tems for inventory manage- value proposition required a shift in oping countries, R&D ment and repair, warehousing all parts of its business model. For Tata Motors to fulfill the requirements of its customer is not a half-hour sale; it takes days, weeks, even months of value proposition and profit formula for the Nano, it had to re- meetings to persuade customers to buy a program instead of a conceive how a car is designed, manufactured, and distributed. product. Suddenly, field reps accustomed to dealing with crew Tata built a small team of fairly young engineers who would leaders and on-site purchasing managers in mobile trailers not, like the company’s more-experienced designers, be influ- found themselves staring down CEOs and CFOs across confer- enced and constrained in their thinking by the automaker’s ex- ence tables. isting profit formulas. This team dramatically minimized the Additionally, leasing required new resources – new people, number of parts in the vehicle, resulting in a significant cost more robust IT systems, and other new technologies – to de- saving. Tata also reconceived its supplier strategy, choosing to sign and develop the appropriate packages and then come outsource a remarkable 85% of the Nano’s components and to an agreement on monthly payments. Hilti needed a pro- use nearly 60% fewer vendors than normal to reduce transac- cess for maintaining large arsenals of tools more inexpen- tion costs and achieve better economies of scale. sively and effectively than its customers had. This required At the other end of the manufacturing line, Tata is envision- warehousing, an inventory management system, and a sup- ing an entirely new way of assembling and distributing its ply of replacement tools. On the customer management cars. The ultimate plan is to ship the modular components of side, Hilti developed a website that enabled construction the vehicles to a combined network of company-owned and managers to view all the tools in their fleet and their usage independent entrepreneur-owned assembly plants, which will rates. With that information readily available, the manag- build them to order. The Nano will be designed, built, distrib- ers could easily handle the cost accounting associated with uted, and serviced in a radically new way – one that could not those assets. be accomplished without a new business model. And while the Rules, norms, and metrics are often the last element to jury is still out, Ratan Tata may solve a traffic safety problem emerge in a developing business model. They may not be fully in the process. envisioned until the new product or service has been road For Hilti, the greatest challenge lay in training its sales rep- tested. Nor should they be. Business models need to have the resentatives to do a thoroughly new task. Fleet management flexibility to change in their early years. Pursuing a new business model that’s not new or game-changing to your industry or market is a waste of time and money. 56 Harvard Business Review | December 2008 | hbr.org 1711 Johnson.indd 56 10/30/08 2:02:59 PM  Dow Corning Embraces Established Business New Business Unit the Low End Customized solutions, Customer value No frills, bulk prices, Traditionally high-margin Dow negotiated contracts proposition sold through the internet Corning found new opportunities in low-margin offerings by setting up a Spot-market pricing, low separate business unit that operates High-margin, high- overhead to accommo- in an entirely different way. By funda- overhead retail prices pay Profit formula date lower margins, high mentally differentiating its low-end for value-added services throughput and high-end offerings, the company avoided cannibalizing its traditional IT system, lowest-cost R&D, sales, and service Key resources business even as it found new profits processes, maximum orientation and processes automation at the low end. to refine existing products more and more, increasing commod- When a New Business Model Is Needed itization over time. A jobs focus allows companies to redefine Established companies should not undertake business-model industry profitability. For example, when FedEx entered the innovation lightly. They can often create new products that package delivery market, it did not try to compete through disrupt competitors without fundamentally changing their lower prices or better marketing. Instead, it concentrated on own business model. Procter & Gamble, for example, devel- fulfilling an entirely unmet customer need to receive packages oped a number of what it calls “disruptive market innovations” far, far faster, and more reliably, than any service then could. with such products as the Swiffer disposable mop and duster To do so, it had to integrate its key processes and resources in and Febreze, a new kind of air freshener. Both innovations a vastly more efficient way. The business model that resulted built on P&G’s existing business model and its established from this job-to-be-done emphasis gave FedEx a significant dominance in household consumables. competitive advantage that took UPS many years to copy. There are clearly times, however, when creating new growth 4. The need to fend off low-end disrupters. If the Nano is requires venturing not only into unknown market territory successful, it will threaten other automobile makers, much as but also into unknown business model territory. When? The minimills threatened the integrated steel mills a generation short answer is “When significant changes are needed to all ago by making steel at significantly lower cost. four elements of your existing model.” But it’s not always that 5. The need to respond to a shifting basis of competition. simple. Management judgment is clearly required. That said, Inevitably, what defines an acceptable solution in a market we have observed five strategic circumstances that often re- will change over time, leading core market segments to com- quire business model change: moditize. Hilti needed to change its business model in part 1. The opportunity to address through disruptive innovation because of lower global manufacturing costs; “good enough” the needs of large groups of potential customers who are shut low-end entrants had begun chipping away at the market for out of a market entirely because existing solutions are too high-quality power tools. expensive or complicated for them. This includes the oppor- Of course, companies should not pursue business model tunity to democratize products in emerging markets (or reach reinvention unless they are confident that the opportunity the bottom of the pyramid), as Tata’s Nano does. is large enough to warrant the effort. And, there’s really no 2. The opportunity to capitalize on a brand-new technology point in instituting a new business model unless it’s not only by wrapping a new business model around it (Apple and MP3 new to the company but in some way new or game-changing players) or the opportunity to leverage a tested technology by to the industry or market. To do otherwise would be a waste bringing it to a whole new market (say, by offering military of time and money. technologies in the commercial space or vice versa). These questions will help you evaluate whether the chal- 3. The opportunity to bring a job-to-be-done focus where one lenge of business model innovation will yield acceptable does not yet exist. That’s common in industries where compa- results. Answering “yes” to all four greatly increases the odds nies focus on products or customer segments, which leads them of successful execution: hbr.org | December 2008 | Harvard Business Review 57 1711 Johnson.indd 57 10/30/08 2:03:05 PM  Reinventing Your Business Model Can you nail the job with a focused, compelling customer automate, the new business would have to be far more stan- value proposition? dardized, which meant instituting different and, overall, much Can you devise a model in which all the elements – the stricter rules. For example, order sizes would be limited to a customer value proposition, the profit formula, the key few, larger-volume options; order lead times would fall be- resources, and the key processes – work together to get the tween two and four weeks (exceptions would cost extra); and job done in the most efficient way possible? credit terms would be fixed. There would be charges if a pur- Can you create a new business development process chaser required customer service. The writing was on the wall: unfettered by the often negative influences of your core The new venture would be low-touch, self-service, and stan- business? dardized. To succeed, Dow Corning would have to break the Will the new business model disrupt competitors? rules that had previously guided its success. Creating a new model for a new business does not mean Sheets next had to determine whether this new venture, the current model is threatened or should be changed. A new with its new rules, could succeed within the confines of Dow model often reinforces and complements the core business, as Corning’s core enterprise. He set up an experimental war Dow Corning discovered. game to test how existing staff and systems would react to the requirements of the new customer value proposition. He got How Dow Corning Got Out of Its Own Way crushed as entrenched habits and existing processes thwarted When business model innovation is clearly called for, success any attempt to change the game. It became clear that the lies not only in getting the model right but also in making sure corporate antibodies would kill the initiative before it got off the incumbent business doesn’t in some way prevent the new the ground. The way forward was clear: The new venture had model from creating value or thriving. That was a problem for to be free from existing rules and free to decide what rules Dow Corning when it built a new business unit – with a new would be appropriate in order for the new commodity line profit formula – from scratch. of business to thrive. To nurture the opportunity – and also For many years, Dow Corning had sold thousands of silicone- protect the existing model – a new business unit with a new based products and provided sophisticated technical services brand identity was needed. Xiameter was born. to an array of industries. After years of profitable growth, how- Identifying new competencies. Following the articulation ever, a number of product areas were stagnating. A strategic re- of the new customer value proposition and new profit formula, view uncovered a critical insight: Its low-end product segment the Xiameter team focused on the new competencies it would was commoditizing. Many customers experienced in silicone need, its key resources and processes. Information technology, application no longer needed technical services; they needed just a small part of Dow Corning’s core competencies at that basic products at low prices. This shift created an opportu- time, emerged as an essential part of the now web-enabled nity for growth, but to exploit that opportunity Dow Corn- business. Xiameter also needed employees who could make ing had to figure out a way to serve these customers with a smart decisions very quickly and who would thrive in a fast- lower-priced product. The problem was that both the business changing environment, filled initially with lots of ambigu- model and the culture were built on high-priced, innovative ity. Clearly, new abilities would have to be brought into the product and service packages. In 2002, in pursuit of what was business. essentially a commodity business for low-end customers, Dow Although Xiameter would be established and run as a sepa- Corning CEO Gary Anderson asked executive Don Sheets to rate business unit, Don Sheets and the Xiameter team did not form a team to start a new business. The team began by formulating a customer value proposi- tion that it believed would fulfill the job to be done for these When the Old Model Will Work price-driven customers. It determined that the price point had to drop 15% (which for a commoditizing material was a huge re- You don’t always need a new With your current profit duction). As the team analyzed what that new customer value business model to capitalize on formula proposition would require, it realized reaching that point was a game-changing opportunity. Using most, if not all, going to take a lot more than merely eliminating services. Dra- Sometimes, as P&G did with its of your current key resources and processes matic price reduction would call for a different profit formula Swiffer, a company finds that with a fundamentally lower cost structure, which depended Using the same core its current model is revolutionary metrics, rules, and norms heavily on developing a new IT system. To sell more products in a new market. When will the you now use to run your faster, the company would need to use the internet to auto- old model do? When you can business mate processes and reduce overhead as much as possible. fulfill the new customer value Breaking the rules. As a mature and successful company, proposition: Dow Corning was full of highly trained employees used to delivering its high-touch, customized value proposition. To 58 Harvard Business Review | December 2008 | hbr.org 1711 Johnson.indd 58 10/30/08 2:03:10 PM  What Rules, Norms, and Metrics Are Standing in Your Way? In any business, a fundamental under- FINANCIAL OPERATIONAL OTHER standing of the core model often fades Gross margins End-product quality Pricing into the mists of institutional memory, Opportunity size Supplier quality Performance demands but it lives on in rules, norms, and met- Unit pricing Owned versus out- Product-development rics put in place to protect the status quo Unit margin sourced manufacturing life cycles (for example, “Gross margins must be at Time to breakeven Customer service Basis for individuals’ 40%”). They are the first line of defense Net present value Channels rewards and incentives against any new model’s taking root in calculations Lead times Brand parameters an existing enterprise. Fixed cost investment Throughput Credit items want to give up the incumbency advantage that deep knowl- has actually supported the main business, allowing Dow Corn- edge of the industry and of their own products gave them. ing’s salespeople to more easily enforce premium pricing for The challenge was to tap into the expertise without importing their core offerings while providing a viable alternative for the the old-rules mind-set. Sheets conducted a focused HR search price-conscious. within Dow Corning for risk takers. During the interview pro- cess, when he came across candidates with the right skills, he Established companies’ attempts at transformative growth asked them to take the job on the spot, before they left the typically spring from product or technology innovations. Their room. This approach allowed him to cherry-pick those who efforts are often characterized by prolonged development cy- could make snap decisions and take big risks. cles and fitful attempts to find a market. As the Apple iPod The secret sauce: patience. Successful new businesses story that opened this article suggests, truly transformative typically revise their business models four times or so on businesses are never exclusively about the discovery and com- the road to profitability. While a well-considered business- mercialization of a great technology. Their success comes from model-innovation process can often shorten this cycle, suc- enveloping the new technology in an appropriate, powerful cessful incumbents must tolerate initial failure and grasp business model. the need for course correction. In effect, companies have to Bob Higgins, the founder and general partner of Highland focus on learning and adjusting as much as on executing. We Capital Partners, has seen his share of venture success and fail- recommend companies with new business models be patient ure in his 20 years in the industry. He sums up the importance for growth (to allow the market opportunity to unfold) but and power of business model innovation this way: “I think impatient for profit (as an early validation that the model historically where we [venture capitalists] fail is when we back works). A profitable business is the best early indication of technology. Where we succeed is when we back new business a viable model. models.” Accordingly, to allow for the trial and error that naturally accompanies the creation of the new while also constructing Mark W. Johnson ([email protected]) is the chairman a development cycle that would produce results and demon- of Innosight, an innovation and strategy-consulting firm he co- strate feasibility with minimal resource outlay, Dow Corning founded in 2000 with Clayton M. Christensen (cchristensen@ kept the scale of Xiameter’s operation small but developed an hbs.edu), the Robert and Jane Cizik Professor of Business Ad- aggressive timetable for launch and set the goal of becoming ministration at Harvard Business School. They are both based profitable by the end of year one. in Boston. Henning Kagermann (henning.kagermann@sap. Xiameter paid back Dow Corning’s investment in just three com) is the co-CEO of SAP AG, in Walldorf, Germany. Johnson is months and went on to become a major, transformative suc- the author of Seizing the White Space: Business Model Inno- cess. Beforehand, Dow Corning had had no online sales com- vation for Transformative Growth and Renewal, forthcoming ponent; now 30% of sales originate online, nearly three times from Harvard Business Press in 2009. the industry average. Most of these customers are new to the Reprint R0812C To order, see page 135. company. Far from cannibalizing existing customers, Xiameter hbr.org | December 2008 | Harvard Business Review 59 1711 Johnson.indd 59 10/30/08 2:03:17 PM