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A Field Guide for Growth Leaders

consultants educators d t researchers

The Six Secrets of Business Model Exploration

April 2008

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Purpose of this document

Peer Insight has been practicing business model exploration in services environments for almost 5 years During that period we have years. completed dozens of projects and collaborated with over 1,000 senior practitioners, in 10 countries, from 50 different firms. When we combine this hands on field experience with our global hands-on research program, it provides a clear picture of how different innovation methods correlate to project outcomes. This document represents our best advice to business leaders who are considering this i hi important avenue f growth. for h Please direct your questions and comments about this document to: Tim Ogilvie CEO Peer Insight (703) 314-3123 tim@peerinsight.com Gordon Hui VP, Consulting Peer Insight (703) 778-5543 ghui@peerinsight.com

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Four Fundamentals and Six Secrets

Introduction The emergence of the services economy and the modern IT systems upon which it runs has opened up powerful new opportunities for corporate growth. At Peer Insight, we see that there are Four Fundamentals for profitable growth in the Services Era: 1. 2. 2 3. 4. Ability to detect unmet customer needs and design unique customer experiences; Open innovation to engage the best capabilities in the ecosystem; Business model exploration to retain a fair share of the value the firm creates; and Judicious use of technology to make these new offerings scale profitably. Can such a complex topic be reduced to a set of protocols, a cookbook, so to speak? Our experience in consulting projects in a wide range of environments proves that it can. g p The Six Secrets Any experienced business reader can tell you that the topic of innovation suffers no shortage of hyperbole. For that reason l initially l h secrets i in alone, we were i i i ll reluctant to use the term association with this guide. However, our research program has proved that, while business model innovation attempts are frequent, the methods used are crude and highly variable even among different teams within variable, the same firm. For the six methods below, we found that only 12 of the 100 projects in our recent study used more than half of them. Yet, when these so-called secrets were employed, the results were remarkable. Here are the six methods, in headline form: Secret #1 Secret #2 Secret #3 Secret #4 5 Secret #5 Secret #6 Everyone must speak business model Use customer priorities as the starting point Contradict the dominant logic Find a hungry partner to complete you The on-ramp is part of the business model p p ROL (return on learning) always precedes ROI

This document explores the third of these fundamental capabilities, business model exploration. Business models are often addressed at a conceptual level, to raise awareness and promote discussion. Alternatively, we often see business models addressed after-the-fact at an analytical l l t explain d l dd d ft th f t t l ti l level, to l i why a certain firms business model works (or doesnt). In this document, we wish to address the subject of business models at the design protocols level, proposing a series of practical methods that really work when it comes to unlocking what John Seeley Brown calls the architecture of the revenues.

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Examples of Services Era business models

Services Era business models are manifestations of the Four Fundamentals (customer experience, open innovation, business model exploration, and technology). Those fundamentals can take many different configurations. Below are ten examples of services models. One pattern you will see in these innovative models is how frequently they tend to shift the boundaries of which party does which tasks in a marketplace. This boundary shifting is usually based on new possibilities created by modern IT systems.

Nature of the innovation 1. Mass customization . . . . . . . .. . . a a 2. Marketing of excess capacity . . . 3. Marketplace / social media . . . 4. Info based 4 Info-based targeted offers . . . . 5. Narrowcasting ad model . . . . . . . 6. Lock-on through learning . . . . . 7. 7 Outsourcing . . . . . . . . . . . . . . . . 8. De-featured versions . . . . . . . . . 9. Pay-per-use plans . . . . . . . . . . . . 10. F ti Fractional ownership . . . . . . . . . l hi

Description (+ examples) y p ,y Use IT systems to enable mass produced, yet customized services Ex: Dell direct build-to-order PCs Business models, often leveraging ICT, that identify and sell unused capacity Ex: Priceline.com, NextJet Create a meeting place for buyers and sellers, enabling their transactions Ex: eBay, Facebook Use data mining to develop highly targeted offers based on unique insights Ex: Progressive Insurance, CapitalOne, Harrahs Use data mining to provide advertisers with access to precisely-defined customers Ex: Google Enhanced targeted marketing based on accumulating data through IT systems Ex: Amazon collaborative filtering, NetFlix recommendations Company assumes complexity or specific task(s) on behalf of client Ex: IBM IT Outsourcing Offer services that are more basic versions of an existing service, at lower cost Ex: Southwest Airlines On-demand or per-pay-use services Ex: Sun Grid Computing, Progressive Insurance TripSense Provide P id partial ownership of a capital asset ti l shi f it l ss t Ex: NetJets

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About the authors and contributors

Tim Ogilvie
Tim is the CEO of Peer Insight and has twenty years of experience in business strategy research and analysis. During the early 1990s, he founded Price Waterhouse's global benchmarking practice and conducted over 80 best practice site visits in 13 countries. Prior to forming Peer Insight he was the CEO of a software firm and a partner in a global strategy consultancy. Tim holds a Masters degree in Computer Integrated Manufacturing Systems from Georgia Tech, and a BA from the University of Virginia. Tim and his wife a Brazilian born artist are raising two young boys but he still wife, Brazilian-born artist, boys, makes time for running and rock climbing.

Field Testing with Clients

Our consulting practice lets us take new discoveries and put them into practice. We have been privileged to know quite a few courageous clients eager to apply leading-edge innovation methods to their new growth opportunities. We should acknowledge the collaborative efforts of several firms, including AARP, Bank of America, Celestica, GE, Hewlett-Packard, Procter & Gamble, Starwood Hotels, Siemens, and UPS, to mention a few.

Gordon Hui
Gordon is the Partner in charge of Peer Insights g g consulting practice and directs engagements on a variety of emerging innovation topics, including service innovation, growth platform development and customer experience design. Gordon has implemented innovation and growth strategies at a number of Americas most well-known companies, including Hewlett-Packard, Standard Poors, St d d & P and P t & G bl H h ld an d Procter Gamble. He holds MBA from The Wharton School at the University of Pennsylvania and B.S. degrees in Finance and International Business from the University of Maryland at College Park. In his spare time, Gordon is a budding acoustic guitar player and climbs the occasional mountain in Tanzania.

business model exploration

secret #1 . . .

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Everyone must speak business model

Despite the importance of emerging economies to most modern supply chains, the language to learn in the Services Era is not Hindi or Mandarin. . .its business models! As many leading business thinkers are quick to point out, the y g q p , business model mediates the linkage between the technical and social domain. Every day, the innovation-oriented product engineer at Hewlett-Packard not only must understand the language of ink technologies and product roadmaps, he must also be conversant in Adrian Slywotzkys perspectives about value capture and value creation. i b l d l i Similarly, the growth-driven brand director at Procter & Gamble cannot simply focus on brand equity pyramids and stage-gate models, she must also think about Henry Chesbroughs theories on open innovation. Most of the firms that we admire today are not only multinational corporations, they are also multi-business model corporations. Apple, Amazon, IBM, GE. Brave and relentless explorers of new product and service business models, these firms have their own shared vocabulary and y shared set of cultural experiences, both successes and failures. They avoid the paradigm of just sticking to their knitting; in fact, they recognize that ripping the knitting apart is the only way to continually foster game-changing innovation over time.

Secret #1: Everyone must speak business model

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The focus of innovation efforts change over time

The transition from product technology to business models as the primary basis for innovation is a recurring theme across many industries. Consider the automotive sector. Product Innovation Business Model Innovation
onStar (1995) Japanese cars go premium (1986, 1989)

Rate
Speedometer Model T, (1901) headlamps (1908) 4 Stroke Auto Engine Electric (1890) Transmission Ignition (1904) (1910)

Toyota Scion (2003)

Most basic features of the modern automobile internal combustion engine, speedometer, automatic transmission, headlampswere created between 1890 and 1910. This period of rampant product innovation coincided with the p p emergence of many car brands that still exist today, including Daimler, Cadillac, and Peugeot. By 1913, the focus of innovation efforts shifted greatly towards process innovation. The application of large scale assembly line scale, techniques to auto manufacturing by Ransom Olds and Henry Ford ushered in a new era of lower cost production, resulting in more affordable cars for the masses. The focus on process innovation and driving out costs continued into the 80s, when g , Japanese management methods focused on lean production and quality were widely adopted. Over the past 20 years, the focus of innovation efforts in the automobile industry has transitioned f t iti d from operational excellence, which i ti l ll hi h is now table stakes, to new business models.

Assembly Line (1914)

Lean Production (1980s)

Process Innovation
No Haggle Pricing (1985, 1993) Hybrids (1990s)

Adapted from Abernathy and Utterback (1978), Grant (2002), Wikipedia 2008

Time

Secret #1: Everyone must speak business model

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Business models have a self-supporting structure, part external and part internal

Customer Experience
Creating Value (External)

Customer Needs

Customer Offering

Most senior executives recognize that the goal of any successful business model is to make money and grow profitably. However, the idea of getting paid is only an internal view of business model. Savvy strategy thinkers recognize that innovative business models change the competitive dynamics of a market and must specifically account for creating value, which is an external-facing activity. We balance this external perspective of creating value with the internal perspective of getting paid through the Business Model Innovation Diamond, a sequential approach to fostering new business model development.

Getting Paid (Internal)

Value Capture

Control Points

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First focus on creating valuethe external part of your business model development
The external perspective of business models begins with an understanding of your target customers and their Customer Needs. In every business, there are functional needs related to cost, quality, and delivery, plus emotional needs driven by perception or customer behavior. Strong business models avoid the Swiss Army knife approach to customer needs, choosing instead to focus on a narrow set of customer-desired outcomes. A precise understanding of customer needs provides the building blocks for the creation of a targeted Customer g g Experience. This is at the heart of your business model innovating effort. Can you create a more premium experience to drive a new business model in a commoditized industry? Howard Schulz of Starbucks says yes. Can you take out some of the unnecessary components of your experience t d i i to drive a l low-end b i d business model? Cl t d l? Clayton Christensen in his three books about disruptive innovation says yes, yesand yes! With a customer experience vision established, the next step p g is to enable that experience with a Customer Offering that combines products and services. For some product-centric firms, building a complete offering that explicitly includes services can be a substantial paradigm shift. The development process is different (its not product development after all), and corporate performance goals often dictate selling more widgets. For other firms, the question is not Should we sell more services? but, Are we creating the right ones?

Customer Experience
Creating Value (External)

Customer Needs

Customer Offering

Value Capture

Control Points

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Then shift to the internal: getting paid for the value you have created
Once the Creating Value piece of the business model is established, then you can transition to the Getting Paid part of the Business Model Diamond. This domain has been thoughtfully considered by a number of people, and we are indebted to strategists like Adrian Slywotzky and the survivors of the Dot Com Era (i e not Pets com) for their (i.e. Pets.com) pioneering efforts. Any innovative business model has to create barriers to entry through strategic Control Points. Simply put, why bother g p g y creating a new business model and spending the money to induce trial if the customers are going to leave right after your competitors copy your hard work? There are a number of ways to lock-in customers. Network effects, loyalty programs, channel, brand. Equally important are control points that lock out your competitor, such as standards or partner networks. Only when all four of the other facets of the Business Model Diamond have been accounted for, should senior executives truly deep dive on Value Capture. The ways to capture value are numerous. Proven models, including mass customization and razors to blades are still valid in the Services Era blades, Era. However, the emergence of Web 2.0 suggests that click through and marketplace models deserve consideration as well. Just remember, youre not going to capture any value if the y g g p y value doesnt already exist. Focus on the external part of designing a business model first.

Customer Experience Customer Needs Customer Offering

Getting Paid (Internal)

Value Capture

Control Points

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Congruent facets make a stronger diamond. Consider Southwest: low cost, high value
The nations low fare, high customer satisfaction airline Low cost, short haul We fly for peanuts Focus on customer satisfaction

In developing an innovative business model, the goal is not to drive radical thinking across all five facets. Fostering congruence and mutually reinforcing activity across the diamond are far more important goals. Just look at Southwest Airlines. Like many other airlines, Southwest focuses on basic customer needs: get me there at a low cost, safely, and on time. However, the airline anchors these needs against a customer experience of being the nations low fare, high customer satisfaction airline.* Southwest does this by providing an offering that focuses on short haul, no frills flights. They fly for peanuts, but they dont sacrifice quality, often ranking 1st in unbiased government and 3rd party surveys of airlines. To establish control points Southwest locks in points, customers with its generous Rapid Rewards program, superior customer service, and brand reputation as THE low fare airline. They lock out the competition with low cost point-to-point airport channels and self-managed reservation systems. And they capture value through a tiered pricing model that results in yield predictability and high frequency, quick turnover flights to drive volume. Low cost, high value. Sounds easy? Ask United and Delta. Delta Do it soon though There may not be anybody though. answering the phone at those places tomorrow.

Low cost but good quality and on time

Customer Experience

Customer Needs

Customer Offering

Value Capture

Control Points
Rapid Rewards program Customer service Brand Point to point nodes Personal reservation system

Tiered pricing model based on purchase timing drives yield predictability and value for customers; frequent flights provide options and drive high asset utilization

* Southwest Airlines 2006 Annual Report

business model exploration

secret #2 . . .

Use customer priorities as the starting point

There has been a lot of buzz about the importance of customer experiences. Are we now to believe they are the starting point for business model innovation, too? Actually, no. The first order of business strategy is customer selection; choosing which customers you wish to serve. With that done, aspiring business model innovators must root themselves deeply in the priorities of those customers, searching for unmet needs upon which to build experiences. Business models built upon the same outsourced market growth. research other firms are using will not drive growth Even B2B firms are investing in customer insight. Pitney Bowes and Intel, to name just two, have full-time ethnography and social research skills on staff to design and execute observational research programs in support of innovation. Both firms go on-site with customers to observe their workflow and search for weak signals of unmet needs. Peer Insight teaches our clients to frame their field observations using the atomic structure of customer i s experiences:
journey

touch point

your direct interaction with the customer a moment of high emotional significance

moment of truth

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Journey mapping helps us isolate the emotional moments of truth

As innovators, we dont treat the atomic structure of experiences as theoretical constructs. We build a map of the customer journey and use it to find innovation opportunities. The mapping process begins with what we know best: our own internal business processes (level 0 on the example below) and the touch points we share with a key customer (level 1). Then we work upward from those shared touch points to map the customers work flow (level 2). From there, we generate hypotheses about the customers key business goals (level 3) and their emotional needs (level 4). This highest level of insight holds the key to discovering the moments of truth. We find these are often upstream in the process, where an informal, two-way contract is being made with the customer. Progressive Insurances online quote comparison utility (known inside Progressive as the ticker) is a good example. Right away, it establishes Progressive as a firm with nothing to hide, and which respects your time.

Customer ABC emotional concerns Customer ABC business goals Customer ABC internal process activities Shared interactions between Customer ABC and your firm Your firms internal process activities

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A good journey map will have 40 to 60 nodes and tells us where to look
Once we have mapped the customer journey, we analyze it for potential moments-of-truth and blind spots (where we cant see well enough into the customers workflow or emotional journey). In the B2B example at right, there were 2 moments of truth (one early, and one late) and 8 blind spots. These became the focus areas for four weeks of field research performed by the development t d l t team. A quick glance at the pattern of interactions tells you something about the challenge for this company. There is little interaction upstream in the customers work flow (the green nodes). Then customer s a big hand-off occurs, and the work is all on the vendors side (the lower set of pink nodes). Not surprisingly, the primary moment of truth occurs when control is handed back to the customer (the cluster of pink hearts). Lumpy interaction models such as this one have the potential to create anxiety for both parties. The business model solutions envisioned by this firm include creating greater transparency and establishing earlier smaller moments of truth earlier, truth.

Green clouds indicate blind spots

Pink hearts represent the moment-of-truth

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Field research lets us test our hypotheses and arrive at deeper insights
There was a time (the 1990s, to be exact) when business models were the exclusive domain of strategists and financial analysts. In the Services Era, the social sciences have emerged as a critical part of the business model innovation team. Customer interviews and observation is best done in the subjects natural environment. Peer Insight social researchers and clients often team up to go into the field and perform ride-along research to understand the user environment in full context. We have found the best approach is to have two researchers and a single subject subject, as the photo at right depicts (the second researcher took the photograph of Peer Insights Katie Waterson and a research subject). We cannot design a unique experience for each customer, so we need to organize the field insights into patterns and clusters. When we find a cluster that (a) captures a common unmet need and (b) fits the capabilities of the firm, that becomes the focus area for business model innovation activities. In the picture at right, Tamzyn Peterson of Peer Insight is organizing field research into clusters to be used for customer co creation co-creation. Sense-making from qualitative research is a unique skill, one that your firm may find unfamiliar at first. It requires an aptitude for pattern recognition that we predict you will grow into quickly. (In fact, humans are far more naturally skilled at pattern recognition than at making precise calculations.)

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Prototype it fast, and customers will show you their priorities with their actions and expressions
Business models are not built upon our initial conclusions about customer priorities, but low-resolution prototypes are. Remember, the best business models base themselves on fresh insights into l i i h i latent customer needs. Deep i i h emerges d insight slowly, based upon trial and error. The photos at right show testing of early, low-resolution (2D) prototypes with customers, in a B2C setting (upper photo) and a B2B setting (lower). Facial expressions offer important clues and the B2C setup allows researchers to capture both their choices and their feelings feelings. Deep customer insights are the essential starting point for successful business models. For example, when Pfizer developed its smoking cessation program, ActiveStop (later acquired by J&J), it was based on a subtle but crucial customer q y ) insight:

Smokers do not believe they have a health issue. They believe they have made a lifestyle choice, and that one day they will make a different choice.
This view is held by many smokers, despite the fact that the average smoker makes seven attempts to quit before they are successful. Based on this new insight, Pfizer designed its customer experience and business model on the basis of providing a healthy person with an opportunity to make a new lifestyle choice. (You could think of it as a gym membership for your lungs.)

business model exploration

secret #3 . . .

Contradict the dominant logic

Every organization has a story it tells itself, a story that explains why it doesnt go out of business. Henry Chesbrough of UC-Berkeley refers to this as the dominant logic of the enterprise. What makes the gravitational pull of this story so strong is that it doesnt have to be told people just know it. And by knowing it without challenging its validity, the dominant logic can be very hard to defy. Business model innovation requires us to do just that, to defy the dominant beliefs our firm holds dear, even if only in small ways. Peer Insight uses a structured approach to the challenge of defining and then defying the dominant logic of the enterprise. Every business model comprises three flows: Physical flows Information flows Financial flows In the Services Era, these three flows of value are often multidirectional, and collectively they create a customer experience. The most successful business model explorations are adept at mapping these flows and changing just enough of them to create a compelling experience. j h f h ll

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Example: The live music market

Netflix competes successfully with Blockbuster by contradicting several key elements of the traditional media rental market. Specifically, Netflix wins a key moment of truth by having no late fees ever fees, ever. GE Aircraft Power has become number one in its market by selling to a different customer (the airline CFO instead of the COO) and making a completely new promise: well lease g p y p the engines to you and guarantee up-time. The change from selling engines to providing thrust with a guarantee more than doubled GEs market share and delivered industry leading profits for nearly a decade. The dominant logic of most markets can be defined by about a dozen key elements. We can illustrate the analytical approach we use by making an example of the live music market (see figure at right) right). We like to convene perhaps 5-6 people familiar with the industry to help develop the initial contradiction frame. Next, for each element, we give them three minutes and ask them to write 3-5 post-it notes, each with an alternative approach (continued on next page) How could we contradict these elements? There are usually several ways for each. Alternate physical flows p y

Dominant logic of live music market Physical flows ys cal lo s Occurs in established indoor venues Events scheduled in evenings Live band or DJ on stage New acts appear every few days Amplified music Alcoholic beverages are sold Information flows Advertised in the media Aimed at a specific audience Limited data available in advance Limited data captured or reused Financial flows Pay a fixed fee to get in Single-use fee model

Alternate information flows

Alternate financial flows

Resulting customer experience Predictable except for the band p

Resulting customer experience

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Example: The live music market, version 1

that contradicts the dominant logic. After three minutes, each person posts his/her notes on a board and reads them aloud to the group. Within 45 minutes you can easily produce 80100 contradictory elements. The key to business model exploration is to change the crucial few that address the customer priorities you believe in in. The table at right shows how you can change only three elements of the traditional live music experience and have a completely new experience and a new business model in this case, a rave. The resulting customer experience is exclusive, unpredictable, dangerous, and exciting just what a lot of young music fans are looking for. Dominant logic Physical flows Occurs in established indoor venues Events scheduled in evenings Live band or DJ on stage New acts appear every few days Amplified music Alcoholic beverages are sold Information flows Advertised in the media Aimed at a specific audience Limited data available in advance Limited data captured or reused Financial flows Pay a fixed fee to get in Single-use fee model How a RAVE! contradicts

Occurs in a rented space

Novelty from new event/space

Info travels person-to-person

Pay a suggested contribution

Resulting customer experience Predictable except for the band

Unpredictable on many levels

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Example: The live music market, version 2

Another innovation popped up in the live music scene in Europe several years ago, the silent disco. Instead of blasting music through amplified speakers, party-goers dance to the music playing in their wireless headphones. This permits loud parties to occur in otherwise quiet neighborhoods and during quiet times of the day It also permits party day. partygoers to remove their headphones and have a social conversation, something that would be next to impossible in most music club environments. Dominant logic Physical flows Occurs in established indoor venues Events scheduled in evenings Live band or DJ on stage New acts appear every few days Amplified music Alcoholic beverages are sold Information flows Advertised in the media Aimed at a specific audience Limited data available in advance Limited data captured or reused Financial flows Pay a fee to get in Single-use fee model How a Silent Disco contradicts

Occur in diverse venues Occur at many times of day

Wireless headphones

Resulting customer experience Predictable except for the band

Out-of-the-ordinary, more social (can talk with headphones off)

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Successful contradiction prepares you for the next phase: combinatorial play

We have found this framework to be extremely intuitive. Client teams can begin using this method successfully within minutes The resulting brainstorm generates minutes. dozens of intriguing ways to contradict the current model for a market. The magic, of course, is in picking and choosing the y crucial few contradictory elements that will create a compelling customer experience and a viable business model. This next phase of business model exploration, therefore, resembles combinatorial play. Your greatest allies i this effort are ( ) the strength of your lli in hi ff (1) h h f insight into customer priorities and (2) the agility of your firm and your downstream partner network to develop and market a compelling solution for more than it costs to deliver. The business model exploration secrets that follow will help you meet this challenge challenge.

business model exploration

secret #4 . . .

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Find a hungry partner to complete you

The best business models combine the capabilities of two or more large entities in new ways. Finding a large, hungry partner in your target ecosystem lowers cost, reduces risk, and paves the way for a more complete offer that scales. This process is often called open innovation, and it is one of h f ll d d f those popular concepts that is more easily said than done. At the heart of open innovation is the requirement for an organization to expose its closely-held intellectual property to outsiders. Open innovation, therefore, requires a shared leap of faith. It works best when (1) you choose the partners and (2) you make the leap of faith as short as possible by using clever protocols. R&D-centric companies are embracing open i R D i i b i innovation with i ih open arms. Procter & Gamble, Clorox, and IBMs successes are well-documented. And the significant demand for open innovation has spawned an entire industry of open innovation intermediaries, including Venture2 and Nine Sigma. Just keep in mind that technology scanning is not the only reason to do open innovation. Channel access, early market feedback, and customer co-creation are valid reasons too. If nothing else, Eric Von Hippels work on the role of lead users in democratizing innovation, as well as the success of Google mashups and Wikipedia, are clear evidence that the hungriest partner may be your actual customer.

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Finding hungry partners bridges creating value and getting paid

Services Era business model development path
Customer selection
Customer Offering

1. 2.

Which customers do I want to serve? How relevant is my brand to those customers? (Which brands are most relevant?)

Control Points

Value creation

3. 4. 5. 6. 7.

What unmet needs do those customers have (including their end user customers)? How can I create a compelling customer experience (cX) to meet those needs? What assembled capabilities are necessary to fulfill the cX? Who are the other actors in the ecosystem? What are the possible ways to create value with and for those actors?

Value capture
(the architecture of the revenues)

8. 9. 10.

Who are the available payers? What payment mechanisms exist? What business models are possible? What are the likely costs? Profits? How can we create control points to claim a share of the profits?

If you are thinking about open innovation, you have reached a key inflection point in the Business Model Diamond. Having already identified the target customer and their unmet needs, you are seeking to create the ideal customer experience through a specific set of customer offerings The decision is no longer offerings. about what will create value, but how to create value in a way that allows you to capture it and lock out competitors. From the perspective of our Services Era business model development path, you are on questions 6 and 7. A key question here is: h you can share value with your partners? Even Apple, h how h l h l notorious for creating proprietary standards, has gone back to kindergarten and learned how to share.

Yes, Apple is everyones poster child for innovation today, but the real lesson to take away from the iPod story is not make all of your products white but make of all of your products partner-friendly. We all know that Apple didnt create digital music, music but the record label partnerships that allow for 99 cent downloads has revolutionized the way music is bought and sold. Several years later, the company continues to pursue unique partnerships to innovate the business model. Imagine a world where your iPod records the pace of your jog through your Nike shoes, and you can instantly d h d l download the song thats playing l d h h l when you visit Starbucks after the workout. Youre in luck; both of those potential innovations are realities today.

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When do you partner and when do you not? Use an eco-system map
The decision to partner or not to partner can feel like an extremely complex make-versus-buy decision. We find that creating an eco-system map allows senior executives to better visualize the opportunities and trade offs of open innovation. To begin your map first determine what are the key offerings map, that fulfill the ideal customer experience and create value. For each of these offerings, assess if your capabilities are adequate to develop, produce, and bring to market that product or service. y p As you map out the offerings, decide if each offering is core, adjacent, or distant to what you will fundamentally provide to the target customer. Think twice about partnering (and potentially giving away IP) on anything that is core. Starbucks, for example, is highly willing to partner to create music or sell ice cream, but the coffee retailer never partners on anything related to ff t coffee or t th t i actually sold i a St b k store. tea that is t ll ld in Starbucks t The figure on the right is an eco-system map for Nike+iPod from Apples perspective. For the purposes of illustration, the map has been simplified, but the point is clear. Anything that g y p integrates directly to the iPod and iTunes platforms is core and should be protected by Apple. Any offerings that are related to the iPod lifestyle are adjacent. Shoes are clearly distant. For those aspects that cannot be effectively fulfilled by existing capabilities and that are not core to your business, determine who ma be reasonable partners to complete your offering In ho may our offering. addition, think about the implications of eliminating a partner. Dell had a good run with its direct model that disintermediated retailers. Ecosystem Map for Nike+iPod

iTunes

Nike+iPod iTunes Software

Nike+iPod Website

iPod

Core

iPod Receiver Attachment (R,D,M,C)

Nike+Shoe Transmitter (R,D,M,C)

Adjacent

Nike+ Shoe (R,D,M,S,Di,C)

Distant

Legend: Hungry Partner Needed R: Apple cannot do R&D for the product or service alone D: Apple cannot Design the product or service alone M: Apple cannot Manufacture the product or service alone S: Apple cannot do Sales and Marketing alone Di: Apple cannot Distribute the product or service alone C: Apple cannot provide Customer Service alone I: Apple cannot provide IT support alone

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Case example: Progressive TripSense

When it comes to introducing successful Services Era business models, one of the most impressive firms is Progressive Insurance. The story of how TripSense came to market illustrates the step-wise nature of business step wise model exploration. We will also use it to illustrate a robust approach to identifying potential partners in the ecosystem. In the late-1990s a team at Progressive identified an unmet need in the auto insurance market. Traditional risk-analysis methods left some drivers stuck paying higher rates than their individual driving habits would require. Take the case of Greg S a 24 year old software S., 24-year-old engineer from Racine, Wisconsin:
Im a safe driver never had an accident or a speeding ticket. But I end up paying an absurd i b d insurance premium just because Im single, under 25, and drive a nice car.

The key question became one of enabling real-time proof of driving habits. Progressive tested a solution in Houston during 1997 that provided drivers with a GPS system and reported their (a) time and date of use, (b) average speed relative to the speed limit, and (c) aggressive braking and acceleration. Unfortunately, the potential customer savings of $300 per year was not enough to offset the $500 cost of a GPS system. But Progressive learned

about the key elements of a new customer experience, once an affordable delivery model could be developed. By 2003, the computing infrastructure in automobiles had changed y 3, p g g sufficiently for a new solution: a small device made for less than $20 could be plugged into the diagnostic port of the automobile (see photo above). Customers must manually sync-up their TripSense device with their laptop to send the driving data to Progressive. Their incentive to do so? A guaranteed 5% discount regardless of their actual driving habits, and greater savings if the data shows they drive safely. Auto insurance had entered the pay-per-use era, and many Progressive customers co-create their own insurance costs.

A team at Progressive set out to see if there was a way to let customers like Greg S. pay a variable premium based on their actual driving habits.

Secret #4: Find a hungry partner to complete you

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Case example: Progressive TripSense focuses on information-centric value

Lets analyze TripSense with a view toward how it might engage prospective partners. Remember steps 6 and 7 in the business model development path?
6. 7. Who are the other actors in the ecosystem? What are the possible ways to create value with and for those actors?
Progressive TripSense 16 17 18 19 20

Value Creation Opportunity Template

1. Product-centric value creation questions (omitted for brevity) 2. User-centric value creation questions (omitted for brevity) 3. Owner- or buyer-centric value creation questions Does the buyer need help deciding which offering to select? Does the buyer need help placing the order? Does the buyer need help financing the purchase of the offering? Is there risk associated with this purchase that the buyer might want to sell? Does this owner represent an asset that others might wish to reach? 4. Information-centric value creation questions
21

Peer Insight uses a list of 31 value creation questions to identify potential elements of a business model. The table at right shows questions 16 through 31, and indicates whether Progressive would elect to Keep the th opportunity f it lf or Sh it with a partner. t it for itself Share ith t You can see that Progressive is primarily interested in the information value created by TripSense. That is because Progressives business design is predicated upon its ability to price risk with greater accuracy than other insurers. TripSense provides a rich data stream from which to build competitive advantage. Question 22 suggests an interesting opportunity: perhaps fleet operators (such as UPS) would want to see the driving behavior of their drivers. UPS could be a channel partner or a customer for TripSense. Question 26 brings to mind another possibility: a police department might wish to use TripSense to rehabilitate dri ers with too man speeding tickets drivers ith many tickets. Finally, Progressive off-loaded the manufacturing of the plug-in device (question 29) to a partner.

K S K K K S K

22 23 24 25 26 27

Is the info useful to a downstream (or upstream) process? Is the info useful to a party in a remote location? Does the info have predictive value? Does the info provide historical value? Does the info accrue value over time? Is there a secondary audience that values the info? Can we work with the customer to define an information stream that adds value to them? 5. Value network- or partner-centric value creation questions

28 29 30 31

Is there an opportunity to consolidate upstream and/or downstream tasks into a simpler offering? Is there an opportunity to off-load unattractive portions of the offering to partners? Are there jobs associated with this system that the operator or owner may wish to pay others to do? Are there jobs you currently do that the operator or owner may be willing to take over?

K = keep, S = share

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There are effective ways to protect your IP without formal patent rights
Working with partners means exposing at least some of your intellectual property to another entity. In the Services Era, very little of the IP qualifies for formal patent protections For too many firms the fear of protections. firms, losing control of their IP limits their potential innovation partners to smaller firms they can dominate. There are effective ways to protect services IP without formal patent rights. There are two categories of IP protection that should support your partnership strategy: 1. 2. Contractual protections (formal agreements) Informal protections (see table at right)

Informal Protection Method

Documentation

Purpose
Prevent the disappearance of the latent knowledge, increase the effectiveness of the entrepreneur Prevent the spreading of confidential information to outsiders Prevent the spreading of confidential information to outsiders Stay ahead of imitators and accelerate the development of the business Prevent individual workers f P i di id l k from h i access to having the totality of the business model Reduce the dependence upon key workers by replicating capability elsewhere Preclude others from patenting or owning the owning same concept

Confidentiality

Concealment

Quick innovation pace

Dividing f Di idi of tasks k

The first category is well-understood. The practical issue many firms face is the frequent delays that occur under the heading of legal review. The lesser known category is Informal Protections The lesser-known Protections. table at right shows several of the methods Peer Insight uses to help clients protect their services IP.

Recycling of tasks

Defensive publication

* Source: IP Management for Services, Tekes, Finnish Agency for R&D (2007).

business model exploration

secret #5 . . .

The on-ramp is part of the business model

A few years back, the New York Lottery had a slogan: Youve gotta be in to win. It is even more true of business models: customers have to actually try the experience before anyone can win. After 5 years of focusing exclusively on service innovation, customer experience design, and business model innovation, one thing has become clear: not enough attention is paid to creating an on-ramp to tryout. Too many firms think Marketing will have to sort that out once we get this amazing experience b ilt built. i Products have a far easier path to tryout, and 90% of them fail to meet their ROI hurdle rates. In the case of services, you cant hold them in your hand or try your friends service before you buy one. The on-ramp is one of the most crucial on ramp elements to innovate. The approach taken by GM for its OnStar system provides an extreme case of on-ramp investment. GM needed a services growth platform so badly that it: Built the hardware into every GM car Licensed it to other auto manufacturers for their cars Gave away the service free for 1 year models, Most companies are hungry to explore new business models but not that hungry. For a more affordable on-ramp, consider Progressive Insurance, which offers to take $100 off your annual premiums if you sign up online to receive statements

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Were asking our customers to swim upstream

online. Their belief is that they will save more than $100 over the life of a customer if he/she will interact with Progressive over the Internet. The most common lament I hear about failed services business models is: Designing the On-ramp to Benefits
Most business models are d i dt ti i here designed to optimize h

REVENUES

net promoter repeat use habitual use

The customers that use it, love it.

p p That means too few people were able to make it onto and up the on-ramp to benefits: awareness,

use purchase tryout seeking

understanding, consideration, tryout, purchase, use, reuse, habitual use, and advocacy.
At Peer Insight, we refer to the table at right as the fish ladder. It h l dd I shows the set of h dl our customers must h f hurdles overcome, just as a salmon must swim upstream to spawn. For many business models, 99% of the focus is on the green area, where the system is up and running, data is accumulating, and everyone is happy. A successful Services Era offering must address the yellow area with experience elements that are comforting, exciting, or otherwise rich with meaning. This is not simply a role for marketing. It is a crucial element of the business model.

Innovative on-ramps are necessary to enable tryout

awareness

BENEFITS

A company that understands this issue clearly is Siemens Building Automation. One of their recent innovations is a program that encourages field technicians to voluntarily enroll in a program to sell time and materials (T&M) add-ons to the facilities managers they support. Most field technicians dont want to become sales people. Without their participation, however, these little T&M jobs were becoming an annoyance to their customers. (continued on next page)

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The on-ramp needs elements that are rich with meaning

Siemens designed a clever on-ramp for its field technicians. They created a Reward Store filled with nice gifts similar to American Express rewards. Field technicians would earn a big chunk of points for enrolling in the program, plus another chunk of points whenever they fulfilled a T&M job for a customer. Most importantly, Siemens sent the program announcement to the field technicians homes described on a postcard so their spouse would be able to read it, and displaying gifts that a spouse would find appealing. Within sixty days they reached over 60% voluntary enrollment in the program, and within six months nearly 25% of the 2500 field technicians had completed at least one T&M job for a customer! Ultimately, Siemens succeeded in fostering tryout because it recognized its field technicians as people and found a way to benefit the technicians and their families as well.

business model exploration

secret #6 . . .

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ROL (return on learning) always precedes ROI

Exploring new business models sounds risky, but in fact virtually all large enterprises today already have multiple business models. Unlike GM OnStar, the great majority of new business models emerged from small bets that built success slowly, not go-for-broke propositions. go for broke GE Aircraft Power didnt invent the sell guaranteed thrust, not engines business model after walking out of an off-site strategy retreat. In his book From the Gut, Jack Welch recalls how it began innocently enough from the acquisition of an engine repair firm. The newly acquired firm was accustomed to working on all types of aircraft engines (notably GE, Pratt & Whitney, and Rolls Royce) and saw no reason to limit their services to GE engines just because they had been acquired. This relationship began a series of modest marketplace experiments by GE Aircraft Power that today looks like a wholesale redefinition of the marketplace. The Batten Institute (part of the University of Virginias Darden School of Business) has conducted a study of growth ) y g leaders executives who have achieved outstanding growth relative to their industry and discovered their penchant for placing small bets fast. Growth leaders are impatient to learn, notes Jeanne Liedtka, Executive Director of the Batten Institute. They h f h h have a nose for unsolved customer problems, but contrary to popular myth they are not gamblers. They are just highly

Secret #6: ROL (return on learning) always precedes ROI

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The lesson is clear: Business model innovators must learn before they earn
adept at minimizing their risk by using a technique we call affordable loss. Affordable loss is the process of calculating How much can I afford to lose to find out if this works? According to Batten works? Batten, once the growth leader has set his pain threshold and it is often quite low he can focus his efforts on maximizing the learning from the experiment. We call these experiments learning a p a g launches, since they often are not on a linear path to commercialization, says Liedtka. In our research, Peer Insight found something similar: some of the most successful business model innovators make a practice of testing concepts they do not believe will work (in addition to testing concepts they do believe will work). When we heard the term learning launch, it immediately explained this fascinating practice practice. established? Can you imagine standing up to the VP of Sales and telling her you want to show her best prospective customer a lower price from Allstate? In fact Progressive first experimented with the ticker in a state fact, where they were not yet licensed to write insurance. Thats right, they risked nothing. You could call this approach timid, but we prefer to use Battens term: affordable loss. Today, Progressives ticker is one of the signature elements of y g g their brand, and an important part of the on-ramp to becoming a Progressive customer. Again and again, the lesson is clear: business model innovators must learn before they earn.

Jeanne Liedtka Executive Director Batten Institute

Progressive Insurance, for example, has a utility on its website that provides competitive quote comparisons (inside Progressive it is referred to as the ticker). They find that Progressive is the low-cost provider about 40% of the time low cost time. What kind of courage must it have taken to get the ticker

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A template for placing small bets fast

At Peer Insight, we are firm believers in the affordable loss concept. One simple protocol we use is called the 100-day pilot. In this approach, we posit that the project must create a working prototype experience for at least one live customer within 100 days. days For many large enterprises, this degree of speed and commitment to a live experience completely shatters the corporate norms. One client said, For us, a good 100-day goal
Affordable loss template
A. The senior leader establishes: A clear challenge statement . . . . . . . . . . . . . . . . . . . . . Diverse membership of 2-4 people . . . . . . . . . . . . . . . A limited number of hours . . . . . . . . . . . . . . . . . . . . . . A small expense budget . . . . . . . . . . . . . . . . . . . . . . . . A tight timeframe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Necessary design protocols . . . . . . . . . . . . . . . . . . . . . An expert coach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exit criteria A concrete learning objective . . . . . . . . . . . . Defined go/no-go criteria for 2nd phase . . . . Defined structure for the next phase . . . . . . The team executes the exploration Leader and team use the lessons to: Achieve the learning objective Determine whether future investment is warranted Enter 2nd phase if appropriate Build capability for future experiments

would be to create a 100-page powerpoint deck and commission a 100-page market research study. The template below shows a typical affordable loss construct for a business model exploration An initial phase might be as exploration. short as 45 days and require two people. Subsequent phases would merit larger teams, greater investment, and more rigorous exit criteria. The point is to place small bets fast.

Example project definition

Pilot a self-service solution for expense tracking 1 service marketer, 1 IT developer Half time Half-time for 45 calendar days; not to exceed 200 hours $10,000 expense budget 45 days [proven methods the team has experience with] Staff member from Corporate Concept Studio See if it can be done with less than 2 hours of hand-holding Customer is enthusiastic; team is enthusiastic 90-day development phase; 3FT people; $50,000 expense budget

B. C.

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A return on learning approach results in engaged, courageous teams

One crucial advantage of taking a Return on Learning approach to business model exploration is the effect it has on your teams. The cartoon scenarios: 1. 2. at right contrasts two Comparing Two Approaches to Risk Management
Risk management-based This better work, and if it doesnt, Ive got to find out quick and kill it.
How is this really going to work? How H much is it going to cost? hi i i ? Whats the 5-year ROI? Are you sure?

Affordable loss-based

senior leader

It wont cost that much, and I want to know the answer.

I know you can do it. Can I help you get access to customers to work with? Do you have what you need?

Traditional risk management approach Affordable loss approach

How many times have you seen the team at left, worn out by the obvious anxiety of their senior leader and agreeing tacitly to a a ag g a y just keep their heads low and let the experiment die? The difference between these two scenarios is the leader and how much he perceives is at risk. The growth leader, according to Batten, (1) makes better bets (i.e., hypotheses) and (2) knows how to hedge those bets. Such leaders learn faster (ROL) and end up with a bigger ROI.

Wow, Wow hes nervous Id nervous. better just play it safe.

Im going to go for it. This could really work.

innovation team

business model exploration

Bonus section . . .

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Insights from a recent Peer Insight study

Peer Insight recently completed an 18-month formal analysis of business model exploration methods in services environments. The findings on the pages that follow illuminate several of the business model secrets shared in this field guide. The research model we use captures practical insights from a diverse group of admired companies and places them in a broader context. Patterns that are not apparent to individual companies become strikingly clear when aggregated across industries. This approach has enabled our research team to create a steady stream of new-to-the-world insights and leading-edge methods.

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Peer Insight recently completed formal research into services business models
A recent Peer Insight global research program analyzed 100 innovation projects from 42 different firms. We looked at three possible areas to innovate the business model: Channel: Modify the way your services get to market Financial Model: Change the way you get paid Value Network: Collaborate with partners in a new way For services firms, we found it is fairly common to explore aspects of the business model. The table below shows how frequently the three methods were used on the 100 projects in the research sample. Figure 1
Used none of the methods Used at least one method 29% Least successful 71%
7

Fifteen of fifty-two (29%) modestly successful projects used at least two of the methods; and Seven of twenty (35%) least successful projects used at least two of the methods. Figure 2
Use of at least two types of business model innovation

Most successful Modestly successful

14 15

14

28 37 52

20 13 10 20 30 40 50

0%

20%

40%

60%

80%

100%

Most important the research found that business model important, exploration correlates positively with project success. Figure 2 compares the outcomes for the 100 projects. When we compared the projects based on which ones used at least two of the three business model innovation methods we found: Fourteen of the twenty-eight ( (50%) most successful ) projects used at least two of the methods;

Number of Projects

We compared the frequency of the three methods of innovating the business model (results are shown in Figure 3). As we expected, the method used least often was value network, an approach which relies on open innovation protocols. Open innovation (which we discussed in Secret #4) is a little

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Open innovation may help minimize the risk of poor outcomes

like raising children: simple at the conceptual level and mystifying at the practical level. One research subject said, Value network innovation brings an initial rush of euphoria, as you think about what could be accomplished with the right partner followed by deep anxiety anxiety.
most successful outcomes
Channel Financial Model Value Network
13 16 15
1

successful outcomes occurred in these latter two categories 18 out of 19 least successful projects that attempted to innovate the business model. It seems that engaging the value network can go a long way toward mitigating the risk of a failure even though it does not guarantee success failure, success.

Figure 3

least successful outcomes

8 10

Describing the Data Set The 100 projects analyzed in this study were all completed in the past 36 months. Forty-two different corporations are included, and five different countries served as the primary development site for at least one project. The corporations include: Apple Baxter Healthcare GE Hewlett-Packard Intel Medtronic ServiceMaster Siemens UPS York

37% 48%

32%
40% 50%

0%

10%

20%

30%

Firms that find constructive ways to deal with that anxiety may earn great rewards. Of the 32 projects that attempted to innovate the value network way, 15 (47%) were among the projects with most successful outcomes 16 (50%) were most successful outcomes, among the modestly successful and only 1 (3%) was among the least successful. By comparison, channel innovations led to most successful outco es outcomes in 13 out of 37 (35%) cases, and financial model 3 o a d a c al odel innovations led to most successful outcomes in 16 out of 48 (33%) cases. Furthermore, the greatest number of least

Two-thirds Two thirds of the innovations were pure services (example (example: AARP Voices of the Civil Rights initiative). The remaining one-third were hybrid services that included products or devices as part of the offering (example: Progressive TripSense pay-per-use insurance requires a plug-in device for your car).

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Peer Insight

Tim Ogilvie tim@peerinsight.com (703) 314-3123

Gordon Hui ghui@peerinsight.com (703) 535-8175