New IT Business Models and Value Creation stimulated new ideas for innovative business models, e.g....

John Favaro 9 June 2010

New IT Business Models and Value Creation 1

slide 1IEEE Software Experts Summit

© 2010 J. Favaro

New IT Business Models

and Value Creation

John Favaro

[email protected]


© 2010 J. Favaro

The Cambrian Explosion

“ … the moment when complex life burst forth in dazzling profusion …” – Bill Bryson, A Short History of Nearly Everything




© 2010 J. Favaro

A Modern Day Cambrian Explosion

Between 2008 and 2010, there has been a veritable explosion of innovative IT business models


© 2010 J. Favaro

The IT Cambrian Period 2008 – 2010

New IT infrastructures are emerging, e.g.

o The Cloud

o Universal connectivity through mobile platforms, social networking and location-awareness technology

These are stimulating new ideas for innovative business models, e.g.

o Service Oriented Architectures and Software As A Service

o Mobile platform based consumer markets for “apps” (high-volume, low-cost products on mobile platforms, often considered as potential competitors to open source)

o New “ecosystems”, e.g. e-publishing with content producers, distribution channels, end user platforms

How much value will be created by and for the participants in this modern day Cambrian Explosion?




© 2010 J. Favaro

The IT Pre-Cambrian Period

Lessons from a dark and remote past


© 2010 J. Favaro

The IT Pre-Cambrian Period 1998 – 2000

Dot-Com

Between 1998 and 2000, there was a veritable explosion of innovative IT business models




© 2010 J. Favaro

A Pre-Cambrian Explosion

In the late 1990s new IT infrastructures were emergingo Broadband technology

o Universal connectivity through the Internet and the World Wide Web

These stimulated new ideas for innovative business models, e.g.o Business-to-business e-

marketplaces

o DSL services

o Web-based consumer markets for everything from groceries to fashion

When I took office, only high energy physicists had ever heard of what is called the Worldwide Web.... Now even my cat has its own page. - Bill Clinton


© 2010 J. Favaro

Lessons from the 90% Club

Between March 2000 and March 2001, more than 500 companies listed on NASDAQ experienced declines of greater than 90% in market value

They became known as the “90% Club”

How did it happen?

The parallels to today’s IT landscape are clear

If we don’t want today’s IT Cambrian Explosion to go the way of yesterday’s IT Pre-Cambrian explosion we must learn the lessons of the 90% Club




© 2010 J. Favaro

Creating IT Business Value is Difficult

Let’s start with some basic observations

Spending on IT is about 2.5 trillion dollars today, half of all corporate spending

Investments are huge and failure rates are high*o Gartner Research: on average, 20% of the corporate IT

budget is spent on initiatives that don’t achieve their objectives

Clearly, creating business value with IT is very difficult – but why?

* Source: “Getting IT Right”, Harvard Business Review


© 2010 J. Favaro

A CEO’s Point of View

Two major reasons why IT too often does

not create business value:

One is related to finance:

Lack of financial discipline in evaluating

technology related investments

The other is related to strategy:

Difficult to sustain technology-based

competitive advantage




© 2010 J. Favaro

Finance: Lack of Discipline

Management often lacks the financial discipline and processes for evaluating technology investmentso “64% of the CIOs interviewed did not have to defend their IT

spending against budget and did not undertake any follow-up to determine whether IT projects failed or succeeded” *

o No idea of whether they are making efficient use of capital and producing Economic Profit rather than merely accounting profit – recall the enormous “burn rates” of the IT pre-Cambrian era

A CEO’s opinion:o “If business goals are clear, a way to determine the value

technology creates should exist. The inability to determine at the outset the impact an investment has on the business is an early warning sign of failure.”

o “Imagine trying to make your investment decision if you can’t calculate its Net Present Value”

* Source: “How IT spending is changing”, McKinsey Quarterly


© 2010 J. Favaro

A Pop Quiz on Finance

What is Net Present Value?

What is the difference between accounting profit

and Economic Profit?

What is the dividend discount model?

What is the Capital Asset Pricing Model?

What is the Weighted Average Cost of Capital, and

what effect does leverage have on WACC, beta,

and default risk?




© 2010 J. Favaro

Competitive Strategy: Replicable IT

Information technology is easily replicatedo It is easily accessible and evolving at a rapid

rate

o Any advantage gained quickly erodes as competitors catch up

As much as 85% of technology investments goes into infrastructure (think Clouds, mobile platforms, …), which is an easily replicable commodity, with only 15% funding front-end innovation

Even front-end innovation is often easily and quickly replicatedo How long did it take to replicate the first Intel

chip technology?

Even front-end innovative software products and services are often easily replicated (SaaS, “apps”, iPads, …)


© 2010 J. Favaro

Business Value Comes from Great

Management

“… it is good management – not technology – that

creates value in business.”

Competitive advantage is created by managerial

innovation

“Technology is too easy to replicate. Fundamental

business changes are much more difficult to

replicate.”

“But when technology innovation is fused with

fundamental change in business processes and

capabilities, real competitive advantage is created.”




© 2010 J. Favaro

Management Impact versus IT Impact

+8% +20%

+2%0

Man

agem

en

t-p

ract

ices

sco

re

75th percentile and above

25th percentile and below

Comparative influence of Management and IT on Total Factor Productivity

Source: London School of Economics – McKinsey


© 2010 J. Favaro

The Pre-Cambrian Lessons

The mantra in the New Economy

was “growth above all” for

“network effects”

The market’s fixation on growth in

the late 1990s encouraged most IT

companies to prioritize growth

above all else

Too often, growth came at the

expense of profitability

This was the fate of the members

of the 90% Club




© 2010 J. Favaro

Growth and Profitability

Analysis of growth and profitability from a managerial perspective

There is a constant tension between growth and profitabilityo What are the key factors affecting growth?

o What are the key factors affecting profitability?

The key to managing growth and profitability together is to understand their relationship to each other

Growth Profitability


© 2010 J. Favaro

Achieving Growth and Profitability ?

There are many ways to enhance revenue growth

o Reduce prices to increase market share

o Adding services to products; or new services

o Creating new product variants

o Entering new market segments

o Creating entirely new markets by inventing something (iPad?)

There are many ways to enhance profitabilityo Increase efficiency of current activities

o Increase prices

o Outsourcing to lower cost suppliers

o Exit unprofitable products

But can both be achieved at the same time?

o What determines the ability to achieve both growth and profitability is not doing these things simultaneously, but rather their effect on the common bond that unites them




© 2010 J. Favaro

The Common Bond: Customer Benefit

The common bond that unites profitability and growth is

customer benefit

o The customer benefit of a product or service is not what the

product or service can do

o It is the reward that customers receive through their experience

of choosing and using that product or service

Customer benefit is not that hard to measure (indirectly)

o The measure of customer benefit is willingness to pay

o Thus an increase in customer benefit manifests itself in a higher

price, or a higher market share, or both

o If that doesn’t happen, then there is probably no customer

benefit

Sounds obvious and easy, doesn’t it?


© 2010 J. Favaro

Customer Focus = Customer Benefit?

Management innovation in the last five decades was all

about sales and marketing – customer focus

o Differentiation, unique selling propositions, brand positioning,

customer satisfaction and loyalty, CRM, etc.

o In software development, agile processes focus on delivering

business value to the customer

Incredible though it may seem, customer focus can also

result in unprofitable growth

o Companies confuse “customer focus” for “a focus on customer

benefit”

o They fall into a number of customer focus traps




© 2010 J. Favaro

Customer Focus Trap Number 1

Confusing features with benefits

The first strategy for increasing customer focus is to improve what you offer customers to distinguish it from competing offerso But it is easy to add features without adding

benefits

o Study: 80% of companies thought they were delivering a superior customer experience – only 8% of their customers agreed

o New technologies can bring new benefits, but it is not always a new function that brings the most benefit from a new technology – Nokia, then Apple delivered customer benefit through fashion

Expanding product lines with variants can be a way to reflect differences across customerso But unless it materially adds to customer benefit, it

will likely lead to a proliferation of low-volume lines


© 2010 J. Favaro

90% Club Lesson Number 1

The 90% Club proliferated products without real competitive advantage

If growth is all that matters, then you must introduce more products – at least, it seems that wayo But introducing profitable products is extremely difficult,

requiring genuine competitive advantage

o Adding unprofitable products is relatively easy!

In 1996 Amazon carried nothing but bookso By the end of 1999, Amazon had expanded into 25 online

businesses, from DVDs to household tools

o Only after investors pressured for earnings did they slow down

Without real competitive advantage in terms of customer benefit, product proliferation will not support profitable growth




© 2010 J. Favaro

Customer Benefit Trap Number 2

“Me, too!” market entry

Entering new markets because they look good to you – rather than because you look good to themo Companies who search for revenue

based on the size and growth of new customer markets usually find that a weak position in a fast-growing market is less rewarding than a strong position in a slower-growing one

o See Microsoft’s move into the web portals market, growing at more than 30 percent per year – MSN, a weak entry, actually lost share year over year

New mobile platforms are creating new publishing ecosystems (markets) – who are the “Me, too!” entries?


© 2010 J. Favaro


The 90% Club confused “high-growth” markets with

“high-profitability” markets

Entering new markets is a popular way to fuel growth

Geoffrey Moore (Crossing the Chasm) promoted the

search for explosive growth markets

But like new products and new customers, it is hard to

do profitably

In the late 1990s, revenues were growing at 35% in the

DSL market

o At least 50 firms entered the market in the 12 months

between March 1999 and March 2000

o Not one single firm became profitable

High growth does not necessarily mean high profitability




© 2010 J. Favaro


The 90% Club constantly added new customers at the expense of profitably expanding relationships with existing customers

o Too many companies find it easier to add new customers than to expand relationships with existing, profitable customers

Telecom equipment makers in the late 1990s provided an exampleo In the late 1990s, the market for telecom was growing at

more than 20% per year.

o Many traditional equipment makers did anything possible to attract new ISP customers (free accounts, etc.)

o When the crash came, not only did they have many new, unprofitable customers, but: the old, profitable customers were complaining of bad service and went away


© 2010 J. Favaro


Confusing “value for money” with customer benefit

If customer focus naturally leads to improving features and adding product lines, it also leads to thinking about “value for money”o But this connection may lead to using a discount

in price (typical on the Net, mobile platforms) rather than a premium in customer benefit to push up market share

o The discounting itself isn’t the trap – it is discounting when the benefit of your offering isn’t any higher than any others!

o The gains from such approaches are usually transitory at best




© 2010 J. Favaro


Confusing Time to Market with customer benefito Time to market is one of the biggest red herrings in

IT

o First of all, there are countless counterexamples. Microsoft was a successful second mover for decades. Then after ten years of promoting tablet PCs … Apple took over in weeks

o Second, arriving to market fast with no superior customer benefit will bring only short-lived advantages

Time to market can be useful, but not for the reasons usually giveno It’s not because you “get a jump” or “earn more

revenues”

o It’s because you get a chance to find out what the customer really wants


© 2010 J. Favaro

Some Final Pre-Cambrian Lessons

Lesson 1: IT is myopico Yes, even agile methods are myopic, despite our

acknowledgements of the importance of business value

o That is why we have so much trouble understanding whether business value is created with IT

Lesson 2: Great management is difficult and sophisticatedo “Money attracts brains” – Burton Malkiel

o We are generally hopelessly unprepared

o Perhaps managers chase the latest IT fad (“it’s easier”)

o But we chase the latest management fad (“it’s easier”)




© 2010 J. Favaro

Conclusions

The Pre-Cambrian Explosion of the late 1990s and

its subsequent crash resulted in countless millions

in value destruction – but it changed the world

Today’s Cambrian Explosion will change the world,

too – but will it involve the same level of value

destruction?

Make Customer Benefit your mantra

o Make your business model secondary, and be agile – be

ready to change it based upon your customer benefit – not

the other way around

o As they say about the weather in Munich: If you think you

have your business model figured out ... wait five minutes

New IT Business Models and Value Creation stimulated new ideas for innovative business models, e.g....

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