Using Business Model Innovation to Reinvent the Core

Using Business Model Innovation to Reinvent the Core

Title image

Using Business Model Innovation to Reinvent the Core

  • Add To Interests
  • PDF

  • Don’t Just Add a Blade—Redefine the Value Proposition

    When product innovation is leading to diminishing returns—when new blades no longer offer the profit lift they used to—customer needs are not necessarily completely satisfied. What is more likely is that unmet needs cannot be addressed simply by improving products. Think about compact discs. The fact that creating a thinner, lighter CD added little value did not mean that customer music needs were completely satisfied; it meant that needs had to be satisfied with entirely new offerings: digital music and accompanying devices.

    If customer value goes beyond the reach of traditional products and services, it may be time to redefine the value proposition in order to recognize that the product is not the main source of customer value. Start by considering the following questions:

    • What pain points result when a customer uses the product?
    • What else besides the product has an impact on customer experience?
    • What objective is the customer trying to achieve by using the product?

    Answers to the questions above often reveal a new value proposition, frequently one that shifts from a product to a service, an experience, or an outcome.

    Shift from Product to Service. Sometimes customers don’t value the product as much as they value getting the job done. For example, competition in the construction tools industry has typically been based on product features and innovation. Contractors purchase tools out of necessity but care more about completing jobs and moving on to the next project. These customers have several pain points that have not been addressed by traditional product-based value propositions. Tools are expensive and require significant up-front capital. Tool inventories have to be managed regularly to ensure that the tools are not stolen and that they remain in proper working order. There is no efficient way to share tools because employees often move from one job to another. And finally, contractors are forced to buy several particularly expensive tools that are necessary but used only in rare situations.

    Hilti, whose core business is tool manufacturing, picked up on these unaddressed pain points. In response, it shifted from selling tools to selling a tool management service aimed at alleviating the burden on contractors so they could focus on getting the job done. Hilti now leases tools to contractors, guarantees availability of the right tool at the right time, and automatically upgrades customer fleets with the latest equipment. It also provides theft insurance. Its service is accompanied by a new revenue and operating model. Many contractors, who in the past had purchased a small share of their tools from each competitor, dramatically increased their share of business with Hilti in order to obtain the full benefits of the company’s tool-management service.

    Hilti’s success depended on possessing a deep understanding of how the customer uses tools and what causes them frustration. Based on this understanding, the company expanded its view of the role it could play in delivering value to customers. This was a shift from a purely product-based mind-set to one that also included supporting services and solutions.

    Shift from Product to Experience. Sometimes customers are looking for an emotional connection and not just a product. Whole Foods Market, for example, has found an innovative way to differentiate itself in the highly competitive grocery-store sector, providing customers not just with groceries but with a unique shopping experience. Whole Foods Market has leveraged high-quality natural and organic products, strong customer service, and attention to corporate social responsibility to give shoppers the experience of a healthier lifestyle.

    First, the company’s decentralized structure gives store managers significant autonomy to discover local sources for products, ensuring that high-quality goods meet unique needs of customers in each store location. Second, Whole Foods Market has made an effort to inspire its employees through a common set of values, leading to effective customer service in an industry traditionally known for employee indifference. Within each store, employees are trained to be knowledgeable and friendly, helping customers select the best items to meet their needs. Third and finally, staying true to the third tenet of its mission statement, “Whole Foods—Whole People—Whole Planet,” the chain engages in “green initiatives,” such as reducing its own environmental footprint and giving 5 percent of profits to community and nonprofit organizations each year. Customers can gain the experience of living a healthy, responsible lifestyle when shopping at Whole Foods Market—both by buying healthy products and supporting a company that contributes to sustainable practices. In this way, the company delivers customers the whole package, allowing it to charge premium prices.

    The Whole Foods Market business model has driven breakthrough growth and high margins in a traditionally low-margin industry. From 2007 to 2012, Whole Foods Market achieved a 12 percent compound annual growth rate (CAGR) in revenue growth, a 17 percent CAGR in EBITDA, and it averaged around 8 percent EBITDA margins. Its strong performance has put it on a level above traditional industry leaders such as Kroger, for which revenue and EBITDA grew at 7 percent and 4 percent, respectively, with an average EBITDA margin of 5 percent.

    There are many opportunities for companies to shift from products to integrated customer experiences through BMI. Nike+ lets athletes and users track their performance statistics and improvement over time and track their individual goals along the way. As Nike CEO Mark Parker has said, “[Nike+ is] about much more than a shoe. It represents a shift for Nike from product to product plus experiences.” Similarly, Apple, with its iTunes and iPhone offerings, combined innovative products with a wide range of music, videos, and games and other apps. The key is to recognize what enhances a customer’s experience when using the product and then directly incorporate these services into the offering.

    Shift from Product to Outcome. Sometimes addressing an unmet need is not enough. Consider the example of ServiceSource. The company, involved in cloud-based software, recognized a potentially huge, frequently neglected source of revenue for many companies: recurring revenue streams from contracts and subscription renewals. In the technology sector alone, ServiceSource estimates that around $30 billion in renewal revenue is not captured annually; around 50 percent of customers do not renew simply because of a lack of contact from a sales team. ServiceSource saw an opportunity to help clients capture this revenue but realized that companies might be wary of the offering because they would be putting significant revenues at risk by outsourcing a portion of their sales process. To overcome this, ServiceSource had to develop an innovative business model to effectively launch its unique offering and capitalize on this unmet customer need.

    When ServiceSource started, it offered an outsourced managed-services solution, using its clients’ customer data to identify renewal opportunities. ServiceSource differentiated itself when it entered this market by not just selling a service but instead selling an outcome. The company charges customers on the basis of renewal revenues generated, not the hours of sales service provided. By using this pay-for-performance revenue model, ServiceSource shares the risk with its clients by putting its own revenues at risk.

    ServiceSource’s business model goes beyond just an innovative pricing model. As Christine Eckert, executive vice president of marketing, strategy, people, and systems for ServiceSource, said recently, “We offer clients a set of managed services, where we can solve the problem for them. We can give them everything they need to outsource this problem to us. We take it on and deliver them back a result.” Renewal sales are time sensitive and heavily data driven, requiring different infrastructure and processes than new sales. ServiceSource has developed a disciplined sales approach geared toward renewals in order to guarantee strong results for clients. The company drives an average 15 percent increase in renewal revenues for customers and currently manages around $9 billion in client revenues. Today, ­ServiceSource offers both stand-alone software products as well as managed services, but its initial focus on selling outcomes was a crucial part of the company’s early and sustained success. The strategy engendered client trust and bolstered breakout growth for the company. ServiceSource achieved a nearly 30 percent CAGR from 2007 to 2012 by targeting technology, health care and life sciences, and industrials companies.

    Many companies intuitively understand the outcomes their customers are trying to achieve, but changing the value proposition to selling this outcome directly—instead of simply selling products and services—requires an innovative business model. To transition away from a more traditional model, companies need to make the following changes to their revenue models:

    • A shift from product sales to outcome-based payments
    • An expansion of offerings that includes complementary products and services
    • An operating model adapted to support the new approach to selling, including new sales tactics, incentives, and value-chain configurations
    Oppenheimer Technology, Internet, and Communications Conference, August 13, 2013.