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BUSINESS MODEL RENEWAL
HOW TO GROW AND PROSPER BY DEFYING BEST PRACTICES AND REINVENTING YOUR STRATEGY
By LINDA GORCHELS
The McGraw-Hill Companies, Inc.Copyright © 2012Linda Gorchels
All rights reserved.
Defy Best Practices
When I was contracted to go to Eastern Europe to teach managers after the fall of the Berlin Wall, I took with me my toolbox of best practices. I addressed the principles of business acumen, segmentation, and planning. The classes in Poland and Hungary consisted of individuals from various management levels in a broad cross section of industries, yet the approach to strategy fit and benchmarking against world-class competitors was appropriate. I was impressed by the entrepreneurial drive of the audience members; it came not from a high-tech innovative perspective but from a desire to start their own businesses.
Several years later I taught a series of classes in Shanghai and Beijing. The managers in the audience were from multinational corporations, and many had received their degrees in Australia and Europe. They were interested in developing more skills based on Western business practices to apply in very large organizations.
Although these situations were different in many ways, the common element was the thirst for best practices, and the capacity to learn and grow from them was incontrovertible. Yet a lot has happened over the last two decades—significant technological metamorphosis, transnational fluctuations, demographic shifts, and other upheavals—that has prompted a rethinking of business as usual. This doesn't mean that everything from the past must be thrown out, but it does imply a more nuanced approach to the basics.
Best practice is an elusive term. Some people use it to define actions (often taken by exemplar firms) that are presumed to be the reasons for a firm's success. Others use it to justify following a prescribed set of protocols that they believe improve performance. In some cases these best practices are indeed linked to superior performance, and in other cases they are based on historical interpretations or assumptions of cause and effect.
Although there are arguably examples of best-practice tactics or best-practice processes, can the term be applied to strategies and business models? That becomes more challenging since there so many interrelated pieces to the puzzle. Businesses operate within ecosystems that influence (although they do not necessarily predetermine) success or failure. The outcomes of a firm's strategy or a business model are not independent of its environment. Yet many executives and managers examine key success factors (perceived best practices) in excruciating detail without really exploring the interrelationships among the factors or between the factors and the environment. Peter Drucker once pointed out that "eventually every theory of the business becomes obsolete and then invalid" (cited at the Drucker Institute website). Thus, chances for success are increased when executives become contextual leaders, making and implementing decisions on the basis of the context of the situation.
Traditional approaches to strategy assumed a fairly stable and predictable world. This is no longer the case, and market leadership no longer guarantees profitability. Companies increasingly need an adaptive corporate culture, along with acceptance and appreciation of experimentation, to have a competitive advantage. Since experimentation necessarily produces failures (along with wins), there must be a tolerance of failure.
CONNECT STRATEGIES AND BUSINESS MODELS
Let's revisit my definitions of strategy and business model from the prologue. A strategy is a long-term plan of action to achieve a goal. A business model refers to the totality of the way a firm produces value, including strategy, organizational design, infrastructure, culture, and operational processes. It implicitly takes into account the ability to execute strategy profitably and is consequently broader and more comprehensive than a strategy.
However, sometimes the relationship between a strategy and a business model is confusing or inconsistent. Here are a couple of examples. Many years ago I worked for a company that was being considered for acquisition by other firms in its industry. I was invited to be part of a leveraged buyout. The strategy for the firm appropriately established a potential competitive advantage in the industry, but the business model (including organizational structure and resources) was not consistent with the strategy. There was a disconnect between the strategy and the business model required to operationalize the strategy. I declined the offer, and the firm folded shortly afterward.
Let's look at the book publishing industry as another example. Firms in traditional trade book publishing are manufacturers that make products from a variety of materials, including paper. Another major raw material consists of words coming from suppliers (authors). The publishers convert the raw material into printed or digitized books and sell the books through their channels, such as online aggregators such as Amazon and traditional resellers such as Barnes & Noble. The editing, design, manufacturing, and distribution are the "value-add" of the publisher, for which the author is paid a royalty. That is the traditional business model. As long as new product strategy changes are incremental, they can survive with this model. But what if new product strategy is more drastic? Will the existing business model still work?
For example, if the strategy is to create enhanced multiplatform books, perhaps modifications in the business model are warranted. Let's say the authors now provide not just words but also embedded video and presentations; the editing and design functions of the publisher now change from standard copyediting to audiovisual and technology support. New competencies must be built into the business model. Also, the fact that the raw material being purchased incorporates intellectual property that goes beyond words may cause a rethinking of the contractual relationship between the author and the publisher. If the book morphs from a printed product to a multiplat-form product, the value-add of the publisher may shift either to broader electronic editing and design functions or to the role of web-based intermediary. In any event, a change in strategy may or may not require a reexamination of business models to ensure alignment between those functions.
Sometimes fluctuations in the external environment will require a change in strategy or a change in strategy will require a rethinking of the business model. That is why it's important to use best practices and success stories as sources of inspiration rather than as prescriptive how-to manuals.
CONSIDER THE ECOSYSTEM OF SUCCESS
What are world-class companies? Do they have larger revenues as evidenced by their presence on the Fortune 500 or a comparable list? Do they have better stock performance? Is their brand image stronger? Are they growing more quickly? Have they received recognition by their peers (or third parties) for being world class? Do they have stronger relationships with customers and employees? Do they use a balanced scorecard or espouse sustainability? What is the role of corporate culture and current external factors? Can any company become world class simply by following a prescribed set of best practices? Or does it require being an innovative disruptor?
These are not easily answered questions. However, I have worked with many professionals who doggedly seek out world-class best practices and occasionally force-fit them into their organizations. They may believe there is a single right approach and often minimize the due diligence necessary to learn the preferred approach for them at a particular point in time.
Let's explore some potential criteria that might be used to identify world-class companies, beginning with presence on the Fortune 500. Fortune magazine lists the largest corporations in terms of revenue. To be included, a company must be incorporated in the United States and file financial statements with a government agency. Between 1955 (when Fortune first began the 500 list) and 2011, there have been over 2,100 companies on the list. Only around 3 percent of them have been on the list from the beginning. Others were on the list for a few or several years before going private, being acquired by another company, or going out of business. Still others have more recently attained the size to become part of the list.
If we look only at the top 25 on the list (Table 1-1), we see subtle changes over the years. In 1955 the top companies were heavily dominated by automotive, oil, steel, and other industrial firms. Although some of those companies were still present in 2011, it's not surprising that technology, financial services, and retail/wholesale have grown in significance. Although I've listed only the top 25, similar observations can be made about the rest of the Fortune 500 and corporate America in general. Best practices arguably have changed as these shifts have occurred, and that doesn't take into account what might be the requirements for emerging technology and bioscience companies.
Obviously, size alone does not define world class since many large firms grow to be among the largest corporations in the world and then lose their footing. Perhaps public opinion and corporate reputation play a role in being perceived as world class.
In teaching executive education workshops for two decades, I have asked the class participants (managers, executives, and professionals) to categorize a list of 10 to 12 companies as winning and losing. Two things commonly happen. First, most groups don't articulate the factors they use to define winning and losing, although there is almost always a tacit expectation of current revenue and stock performance. Second, some companies (such as Apple, Dell, and Starbucks) have floated between the two columns, depending on the year. The executives' gut instinct is to define winning or losing in the short term even though in further discussion they define a true winner, a successful world-class company, as managing itself for the long term. Winning companies should be healthy companies. Competitive advantages are fleeting, and companies must continue to find new ones. IBM, for example, celebrated its centennial in 2011—and it's a very different company than it was when it started. Its centennial video demonstrates its ongoing business renewal.
Let's use a different lens: admiration rankings. Fortune's surveys of the most admired companies have yielded dramatically different results between 1984 and 2011. To gather the results, Fortune commissioned the Hay Group to survey executives, directors, and securities analysts to select top companies on the basis of innovation, people management, financial soundness, quality of management, use of corporate assets, social responsibility, long-term investments, and quality of products and services. Each of these criteria might spawn what are perceived to be best practices. Here again we see different companies moving on and off the list over time (Table 1-2).
Thus, it's more than stock value and admiration scores. Perhaps we must look at the underlying health of a firm: its ability to improve and sustain performance in the future. What are the elements of a healthy company? Different metrics are appropriate for different industries and situations. Although we occasionally read about centenarians living a long life despite not taking care of themselves, that is the exception rather than the rule. Some activities that feel good in the short term may be hazardous in the long term. We can list at least a few factors related to longevity, such as exercise, a good diet, and efforts to maintain health. The same thing is true of companies. Successful short-term performance occasionally comes at the expense of underlying health. Thus, there are many definitions of winning and losing, as evidenced by the various rankings in Tables 1-3 and 1-4.
One of the potential problems of blindly following world-class principles is that companies begin to benchmark themselves against leaders in the existing industry (this is sometimes a risk with Porter's five forces analysis). Over time these companies may begin to perform at a higher level than the market leader and drift toward complacency. To challenge your own complacency, study the practices of niche players or others that may change the rules in the future. Don't allow benchmarking to cause complacency. Expecting simply to fill out templates and implement best practices abdicates the role of leadership.
ARE THERE BEST-PRACTICE BUSINESS MODELS?
A best practice, as defined by Wikipedia, is "a technique, method, process, activity, incentive, or reward that is believed to be more effective at delivering a particular outcome than any other technique, method, process, etc." That's a very broad statement, but many managers seem to believe that there is a magic bullet in the form of world-class processes and best practices that you can plug in to your firm and guarantee success. Unfortunately, it's not that easy. Business success requires hard work, resources, and often plain luck. I read on a blog somewhere that best practices come from practicing your best consistently. That's not a bad idea. Perhaps future best practices will be those which turn conventional wisdom upside down.
We can find several examples of what happens with the overuse of best practices. Long before Google became noted for allowing its engineers to pursue pet projects, 3M encouraged researchers to spend unscripted time exploring potential new products. Between 2001 and 2005, when former GE executive James McNerney was CEO of 3M, emphasis shifted to operational efficiency and the application of Six Sigma techniques. Although waste was curbed and margins improved in the short term, it took a toll on the 3M business model of innovation. Six Sigma is still important in 3M's factories, but not in its labs.
A growth agenda is typically part of a firm's strategy, which by definition is a long-term plan of action to achieve a particular goal. Several authors have attempted to define the management practices that are linked to successful performance (most commonly defined as long-term stock performance). Nitin Nohria in an article in Harvard Business Review titled "What Really Works" studied 160 companies over a 10-year period and identified four primary management practices: strategy, execution, culture, and structure. It's worth noting that the authors did not define best practices in these four areas but suggested that superior performance came from clarity and alignment of these variables.
A few years later Christian Stadler in "The 4 Principles of Enduring Success" in Harvard Business Review reported on a 50-year benchmarking study of European companies. The principles identified included the following: (1) exploit existing assets before exploring new ones, (2) diversify the business portfolio to gain economies of scope, (3) learn from mistakes, and (4) be conservative about change. These two articles define success from the perspective of stock performance. In light of possible changes in the stock market, this definition of success might morph. As of 2011, Facebook and Twitter were avoiding public markets by raising millions or billions of dollars privately, although by the end of 2011 Facebook was considering going public. Even Apple and Google, which have a market presence, are not paying dividends in the way prior generation companies did. Whether these examples change capitalistic business models is yet to be seen.
As was suggested above, rather than detailed best practices, success comes from thoughtful analysis and interpretation of information. In fact, sometimes taking the opposite approach can be the best thing to do. Rather than learning from best practices, can you learn more from worst practices and failures?
Sometimes disruptions are so obvious that we can't overlook them, and at other times they sneak up on us. That's why it is important to review your business model as often as you review your strategy. Sometimes a change in strategy is sufficient to make progress toward your goals, sometimes a major restructuring of your business model is necessary, and in some situations a strategy change morphs into a business model change.
Michael Malone in The Future Arrived Yesterday: The Rise of the Protean Corporation and What It Means for You argues that companies in the future will need to be "shape-shifters" that reinvent themselves on an ongoing basis. The causes for this are multiple. Ubiquitous technology, a global economy, and "networks of free agents" are all contributors to the need for ongoing reincarnations. The major challenge will be to determine how to couple permanence with perpetual change.
Alexander Osterwalder and Yves Pigneur in Business Model Generation recommend that organizational leaders analyze and discuss nine business model building blocks: customer segments, value propositions, channels, customer relationships, revenue streams, key resources, key activities, key partnerships, and cost structure. They recommend a simple approach of plotting the building blocks on a poster and using Post-it notes to describe how each one is related to a firm's business model and what might need to change. New business models may emerge from different combinations of variables.
Mark Johnson in Seizing the White Space has reduced this set of factors into four elements, which he calls "the four-box framework": customer value proposition, key resources, key processes, and profit formula. His approach is to encourage managers to define potentially new business models by exploring the complex interdependencies of these parts.
The authors of both books identified the following categories of business models (with examples of each in parentheses). Osterwalder and Pigneur describe five patterns: unbundling models (private banking), the long tail (LEGO), multisided platforms (Google), free (Skype), and open business models (Procter & Gamble). Johnson's archetypal examples included high-cost solution shop (system integrators), high-volume value-adding process businesses (MinuteClinic), and democratized facilitated networks (online auctions).
Excerpted from BUSINESS MODEL RENEWAL by LINDA GORCHELS. Copyright © 2012 by Linda Gorchels. Excerpted by permission of The McGraw-Hill Companies, Inc..
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