Insights from CompanyCrafters #4

How Innovative Business Models Can Create Sustainable Competitive Advantages (Part 2)

This article is part of a series that explores how established organizations – corporations, research institutions, even nonprofits – can apply entrepreneurial thinking to become more innovative and successful.

In the last issue of Insights from CompanyCrafters, we discussed Bright Horizons, a company that did a great job of innovating around its business model to craft and grow a big, successful enterprise with sustainable competitive advantage.  It operated in the quintessential low-tech industry of pre-school childcare, one that was unattractive to most other savvy business people for very compelling reasons. 

Yet the Bright Horizons entrepreneurs were able to take virtually all the reasons that made daycare an unattractive industry and turn those factors to their advantage through a single, powerful business model innovation: instead of marketing their daycare services directly to parents like everyone else, they built strategic alliances with large employers to locate daycare centers onsite and let the employer-partners market the service to their employees. 

After scrutinizing the Bright Horizons story, we posed the question, "Where else has business model innovation served as the strategic key to startup business success?  And can this kind of thinking be successfully applied by existing, mature organizations to launch successful new lines of business or to enter new markets?

So let's look at some startup examples where business model innovation – as opposed to technological or scientific innovation – served as the strategic keystone to the company's business success.

A couple decades ago, the barber shop and beauty parlor business was, if anything, even less appealing than the daycare business when Bright Horizons launched.  Low margins, labor-intensive with high staff turnover, poor marketing efficiencies, and really tough to scale beyond a single location (resulting in virtually no role for branding).  Along came Supercuts with a seemingly obvious business model innovation: Form a nationally-branded chain of unisex hair-cutting shops, located in strip malls, with a limited "product line" of standard cuts, strong compensation and benefit packages (thereby attracting good professionals and lowering staff turnover), rigorous training (ensuring consistent quality), standard shop layouts, no appointments required, and consistent, competitive prices.  The result?  Marketing efficiencies, loyalty to brand (vs. the traditional loyalty to an individual stylist or barber), and high capacity utilization (due to high-foot-traffic locations and having stylists able to serve both sexes), and higher and more consistent margins.  

When Michael Dell started his direct-to-consumer computer company, the vast majority of PCs were delivered and serviced through retail channels including innumerable mom-and-pop stores and small chains; "corporate accounts" were sold through expensive direct-sales forces.  Austin-based Dell's primary business model innovation was simply to "cut out the middleman" (retail channels) and sell directly consumers and business accounts.  (Remember, this was before the Internet, so we're talking 1-800 numbers and catalogs.)  Capturing that extra couple dozen points of margin in the value chain enabled Dell to offer competitive prices while still being able to deliver excellent service.  And their direct-to-consumer model held a hidden gem of a strategic advantage: while its competitors were mass-manufacturing a finite range of models and suffering eye-watering inventory carrying costs to fill their retail channels with product, Dell was able to build to order.  This not only won legions of loyal customers (who else could do that?), but allowed them to slash inventory carrying costs by enabling just-in-time purchasing and assembly.  The rest is history: we all know that Dell rocketed to become the largest PC manufacturer, and that many of its original competitors have fallen by the wayside.

In the pizza biz, think about Ann Arbor, Michigan-based Domino's (NYSE: DPZ).  When Tom Monaghan launched it in the sixties, pizza was already fairly pervasive in the U.S., but, whoa, talk about a fragmented, mom-and-pop industry.  Pizza was popular, but "pizza chains" didn't really exist, and where they did, they were local, regional at best.  Folks ran pizza – or, more broadly, Italian – restaurants that might, oh, by the way, offer pickup service and might even deliver in a crunch.  So get this – Tom's big business model innovation was (something that today sounds, obvious today): We'll deliver pizza to you, and we'll deliver it guaranteed a) hot, b) fast, and c) at no extra charge.  So… the Domino's "whole product" (thank you Geoff Moore) was very different from the then-current model: Wherever you are, whenever it is, we'll get you hot pizza fast.

A more recent example is Netflix (Nasdaq: NFLX).  When they launched in Los Gatos, California in 1999, the entrenched video rental giants (think Blockbuster, Hollywood Video, etc.) were burdened by huge costs for facilities, payroll and inventory for their retail store networks, while struggling to support it all on the backs of the hated late fee.  Along came Netflix, whose business model innovation was to do away with the bricks-and-mortar rental stores and instead rent DVDs strictly online.  The movies were mailed out with postage-prepaid return envelopes, you could keep the movies as long as you liked, and when you mailed them back they sent you the next movies on your personal request list.  The result?  Internet-based sales obviated the need for expensive local store facilities and huge retail payroll and inventory costs.  Subscriptions resulted in low overall sales costs due to predictable recurring revenue.  And the keep-'em-as-long-as-you-like approach alone (the first-ever "no late fees" policy) generated tremendous customer goodwill and positive word-of-mouth.  Brilliant in its simplicity, Netflix's innovative business model enabled them to grow to over 5 million subscribers, grab significant market share from the established players, generate much higher profits, and build sustainable customer loyalty, all while using remarkably little investment capital.

We've now looked at five widely varied business: a couple of technology companies – Dell and Netflix – along with a three "no-tech" businesses – Supercuts, Domino's and Bright Horizons.  The common theme with all five is that their ultimate road to success was paved by business model innovation rather than technological or scientific innovation. 

Interesting.  Does this mean that technological innovation doesn't matter?  Absolutely not.  What we're pointing out is that, by itself, tech innovation simply doesn't suffice.  To launch a successful new business – whether as a standalone startup, or spun-up or spun-out from an existing enterprise – the business model is often of equal or greater importance to the new venture's success. 

In our next Insights from CompanyCrafters, we'll explore the opportunities presented by business model innovation.