Many people do not typically think of metrics and accounting as roadblocks to innovation, yet you call these out as potential problem areas. Why?
Many conventional metrics we use to estimate value are based on faulty assumptions. Net present value [NPV] is a case in point. The logic of NPV is to project cash flows into the future and then discount those flows back into today’s dollars at a given cost of capital. Given that money today is always worth more than money in the future, you are trying to establish what the future value of the investment will be in terms of that money’s value today. If it is positive, it’s thumbs up, if it’s negative, it’s thumbs down.
One problem is that NPV calculations tend to compare today with some future state. What they should be used for is to compare today with two different future states: one in which we do nothing and one in which we dosomething. Doing otherwise biases the business against innovation because what you are projecting may look unattractive relative to your business today.
Another well-known problem is that if you are a P&L leader in a publicly traded firm, you pay dearly for missing quarterly targets and don’t get dinged at all for failing to invest in the future. Imagine you’re the guy who was running the Walkman business at Sony a decade ago. Your career depended on that business going forward, and the numbers that mattered had to do with the performance of that business, not with Sony as a whole. So when the first little inklings appeared that there may be a shift from battery cassette players to solid state rechargeable digital music archives like the iPod, your incentive was not to embrace that reality but to eke out another quarter or two doing what you were already doing.
Given that some of these problems are rooted in people’s tendency to resist change, do newer firms have an advantage when it comes to creating the best new business models?
No. I don’t think so. My own research has shown that there are a number of big companies that have overcome these problems. But they do it very consciously. That makes all the difference. I’m thinking of HDFC Bank in India, Yahoo! Japan, Infosys, and Sagentia in the UK. All four companies have systematic ways of estimating how long a particular advantage is going to last, systems that nurture innovation, and processes that make sure the right people are at work on the business.
Companies that will eventually be wrecked by others’ innovations are operating on autopilot. They think their systems work, so they follow the adage, “If it ain’t broke, don't fix it.” The companies exist to exploit existing businesses, not to create new ones.
A new company’s advantage is that it doesn’t have that to fight against. But the disadvantage is that if you try something and it blows up, you’re dead. Established companies have the opportunity to do more experimentation if they commit to consciously embracing new models, because they have more resources to buffer themselves in the advent of adversity.
New product development is such a big piece of building new business, or so we are told. Why do you say that businesses really need to frame their priorities in terms of outcomes rather than having a myopic focus on products?
Businesses need to frame priorities around customer outcomes. If you are thinking about your product first, you have already made the assumption that what the customer is buying is what is in your product. But most of your customers don’t care. Products and services are merely vehicles to provide customers with a way to get the jobs that they want to get done, done. This is a perspective taken by my colleagues at consultancy Innosight.
Take a doctor’s office. What the doctor wants to get done is an efficient, organized practice, which runs with minimal continual inputs, with very little disruption. How can the doctor get that done? They can hire an individual to manage it, they can outsource the office management, they could sign up with a software service platform like Microsoft to run it for them. If I came at it from a product perspective, I would ask, how can I sell practice-management software, or how can I automate patient record-keeping? You’re not seeing the task that the customer is trying to get done and is willing to pay you for.
This matters because it can cause you to be blindsided. Surprisingly, big inroads in the physician office-management market are being made by non-traditional players, such as Best Buy’s Geek Squad. The traditional practice-management groups would not even have considered them to be competition, and yet in a very real way they are.
How does this perspective — jobs to be done — help firms create effective new business models?
Well, you’ve designed a business model, hopefully, that is so well adapted to getting the customer’s job done that the products or services it turns out become the obvious choice. You want something where the customer says, “Yeah, I could really use that to get this done, to make life easier.”
Now the other reason it matters to firms to understand the jobs customers want to get done is the collateral damage problem. We’ve now got a huge battle being fought in the area of payments. If I want to pay for something, I can pay cash. I’ve also got credit cards, I’ve got debit cards, or I can pay for something over the phone. Google Wallet comes along and doesn’t even charge me to make a payment because it wants my identity so it can more closely target me for advertising.
Google is not targeting the credit card business; they are targeting payment streams. If Visa and American Express are not focusing on who is competing to fill this need — the jobs the customer needs to get done — they could miss this opportunity in their competitive analysis.
What makes one business model more attractive than another?
An attractive business model is one where the customer has a reason to stick with you, the service is essential not optional, the problem they need to solve is ongoing so they need your help for a while, and there is some kind of relationship that is embedded in an ecosystem, where you don’t have to reinvent your relationship with customers everyday. That’s a more powerful model than something that is purely transactional.
In bond trading, there is no relationship, bond prices today have little to do with bond prices tomorrow, and I could completely change my positions overnight. It is among the most transactional of all businesses. That’s a harder business model to sustain than installing an ERP [enterprise resource planning] system. My whole company depends on it. I have to keep investing in upgrades, and it’s deeply embedded in my systems. It is inherently a more attractive business model. [Download McGrath’s Scoring Business Model Attractiveness (PDF, 50KB)]
What are the big assumptions that firms and managers should shed when looking to create a new business model?
One, eliminate the assumption that because we’ve always done that is a good reason to keep doing it. Most business models grow up in an era when certain kinds of constraints are difficult to overcome. Take newspapers. Fifteen years ago, what was a news executive thinking about? The cost of paper, how hard trucks are to schedule, union agreements — a whole series of things that constrain your ability to do things. Now, as you move toward digital production, those constraints change. And people forget that when constraints change around one thing, they need to look at the implications for the rest of the business — where else constraints have changed in the business.
Two, don’t assume that your firm or even your industry has the answers. Firms should remember that flattery and imitation are worthy. A great place to look for new models is in adjacent industries or even entirely different industries.
A lot of companies are very unimaginative on this count. It happens all the time — I’ll meet an executive and they’ll tell me, “Well, you don’t know our industry,” as though there was nothing to be learned by venturing beyond the boundaries of the industry as it is today. It drives me crazy and is very shortsighted. Instead, what we invariably find when we mix together people from different industries (as we do in my Executive Education course) is immense learning because people question why certain practices are maintained. Further, many problems are common across industries and a solution that works for, say, the chemicals industry may be surprisingly relevant in a financial services context.
Finally, it’s really striking how quickly and frequently people change their business models today. It’s much more common than it used to be. Be prepared. Just because your model hasn’t changed much yet doesn’t mean that it won’t.
Rita McGrath is associate professor in the Management Division and a faculty member at Executive Education at Columbia Business School
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