Uber Versus Traditional Taxis: An Illustration
A critical difference between Uber and most traditional taxi companies is that they operate with very different resources. Taxi companies own vehicles and employ people as dispatchers (the people you call to request a taxi). They also own government-granted licenses to operate in specific locales. Uber does not own cars, nor does it employ dispatchers. Instead, it uses a web-based app (a resource) in lieu of a human dispatch system. Its other critical resource is the network of independent drivers it can attract to be part of the Uber system. As discussed below, this network becomes fundamental to Uber’s value proposition. Uber also invests heavily in its brand. Most of us have no idea which taxi company we might have used last Thursday in New York City or London. We just went out to the corner and stuck our hand up, went to a taxi stand, or found the number of a local taxi company to call.
Both Uber and traditional taxis ostensibly create value the same way. They offer the convenience of ride at a time (approximately) and place of your choosing. Because they leverage an expensive fixed asset (a car) across many users, they can offer this convenience at a relatively low cost. But Uber and taxis differ in the specifics of how they create this value. Traditional taxi companies have relied on licensing requirements, regulations, and government oversight to position themselves as a safer alternative to private rides (or worse, hitchhiking). Uber creates value by building a network of private individuals who are willing (for a fee, of course) to give you rides in their car. In essence, Uber is high-tech hitchhiking: instead of sticking out your thumb, you use it to open the Uber app. Because it does not own its own cars, Uber’s economics are different than those of a traditional taxi company. Uber cultivates the biggest network possible because the more drivers in its network, the faster it can respond to your requests for rides (which is usually valuable for customers). Uber is less worried about having underutilized cars because its drivers own the cars. Uber cars do not look like taxis so, in most cases, Uber drivers are using their vehicles for both Uber work and personal use. Uber offers some extras that many find valuable, such as convenient payment (no cash, credit card on file, automatic e-mail receipt), information about the whereabouts of your driver and the ability to contact them easily, and driver ratings.
Uber and traditional taxi companies also capture value in very different ways. Traditional taxi companies have several revenue streams. First, they usually keep about 30 percent of the fare generated by drivers (the other 70 percent is for the drivers).2 Second, they can also charge taxis in their network a dispatch fee for the privilege of being connected to their dispatchers. Third, they lease vehicles to drivers who do not have the capital to own a taxi. And, finally, in places where taxi licenses are tradable, they capture value by selling licenses to anyone who wants to operate a taxi. Uber largely makes money by collecting a 20 percent share of the fares generated by its drivers (although Uber will also lease vehicles to drivers who want to drive for Uber). Note, the value capture dimension of business models makes us differentiate between a company’s business and how it makes money. From a customer’s perspective, Uber and a traditional taxi company are essentially in the same business: they offer ways to get rides from one place to another. They are close substitutes. But each makes money (captures value) in very different ways.
Finally, because of the different choices they have made around resources, Uber and traditional taxi companies have different value distribution approaches. Uber has attracted considerable venture funding with the prospect of generating considerable capital appreciation (Uber is valued at approximately $70 billion at the time of this writing).3 Taxi operators tend to be local. Even if owned by a larger group, they operate independently because they are regulated locally (usually by city or county jurisdiction). This means they cannot offer the massive potential capital appreciation of Uber. Instead, they seek to generate positive cash flow that can be distributed to owners (usually private entities) in the form of dividends or profit sharing.
What’s the Relationship Between a Business Strategy and a Business Model?
We can illustrate the difference between the distinct concepts of business strategy and business model with groceries. Whole Foods clearly follows a different strategy than traditional grocery chains like Stop & Shop. Whole Foods focuses on organic and natural foods, appealing to health- and socially conscious consumers through its strict food standards, its strong emphasis on sustainability, its requirement that meat suppliers conform to stringent animal welfare standards, and its emphasis on “fair trade” and local farm sourcing. In addition, Whole Foods offer a broad selection of non-GMO, vegan, gluten-free, dairy-free, and other specialty foods. The company also tries to offer superior service through a human resource model that emphasizes teamwork and gainsharing. Whole Foods, though, also appeals to consumers with enough disposable income to afford its higher prices. It is a classic upscale provider—offering a differentiated product (and service) that customers are willing to pay a premium for. Traditional supermarkets like Stop & Shop position themselves differently in the market. While they recently have started to offer organic and natural foods, the bulk of their sales comes from mass-market (nonorganic, nonnatural) grocery products and brands. They do not utilize sourcing policies as restrictive as Whole Foods’. Traditional supermarkets appeal to more budget-conscious consumers who place less value on organic, natural, and sustainable foods.
Whole Foods and traditional supermarkets may follow divergent strategies, but their business models are similar (although not identical). Both utilize broadly analogous types of resources—they own or lease large retail establishments and have heavy investments in inventory. They both create and capture value by selling products (although despite differences in their specific value propositions). Their economics both depend on generating high revenue per square foot (although Whole Foods’ higher cost base means it must generate greater revenue per square foot). Inventory turns are critical for both. And both Whole Foods and most traditional grocery retailers are publicly traded companies (or subsidiaries of public traded companies) that must ultimately distribute a portion of value captured to their shareholders through dividends or stock appreciation.
It is also entirely possible for companies to follow a similar strategy with different business models. Consider a new entrant into the grocery business that decides it will carry a product offering similar to Whole Foods’ (with similarly restrictive sourcing practices). It too targets health- and environmentally conscious customers with high disposable income. But, instead of having retail stores, it sells its products strictly through the Internet with home delivery. In appealing to the same customers with the same type of product offerings, these two strategies are similar. Yet, the business models are completely different. One has stores as a key resource; the other does not: its critical resources are warehousing and distribution systems, and most likely data about all your past purchases. One creates value by having product available on the shelf; the other creates value by having products available for home delivery. The value distribution components of their business models could also be different if they had different ownership structures. Of course, the example of Whole Foods (which is now owned by Amazon) illustrates that a company can simultaneously pursue multiple business models (in this case, a physical retail store model and an online model).
We can find many real-life examples of similar strategy-different business models. For instance, in the quick service food industry (better known as fast food), chains often follow a similar strategy—consistent food served quickly and conveniently. Particular offerings may vary (pizza vs. hamburgers vs. chicken, e.g.), and they may also differ in some other aspects of their strategy (e.g., breadth of choice). Their broad strategies are similar, yet we see a variety of business models. Some chains like Pal’s or Chick-fil-A have restaurants that are wholly owned by the company; others like McDonald’s use a mix of franchising and company stores; still others like Penn
Station rely almost exclusively on franchised operations. Franchising is a fundamentally different business model than a company-owned store. It completely changes the capital structure of the enterprise (resources) and generally changes the way value is captured: company-store models generate profits for the enterprise directly, whereas in the franchise model, value is captured largely through the sale of the franchise rights and ongoing licensing fees.
Obviously, some degree of coherence is required between a strategy and a business model. A company trying to differentiate itself, for instance, through extraordinarily high levels of personalized “high-touch” service might find it difficult to execute this strategy through a business model that did not utilize physical touch points between service providers and customers (such as stores or offices). Innovation in your business model should be consistent with your organization’s long-term strategy.
Business Model Innovation as a Competitive Weapon: The Case of Netflix Versus Blockbuster
Many of us remember a time, not that long ago, when renting a home video required a trip to a local rental store.4 You had to physically search for a video on the shelf, check it out, bring it home, and then bring it back to the store (hopefully in time, to avoid a late fee). You may also remember that, by a certain point in time, the “local” video store was very likely an outlet of a big chain like Blockbuster. All this began to change in 1997, when Reed Hastings came up with the idea of online video rental and founded Netflix. Instead of going to a store, you picked out a movie (or television show) online, and the DVDs were mailed to your home. You could keep the video as a long as you wanted. When you were done, you just mailed it back to Netflix. Today, of course, many of us are not even getting physical DVDs in the mail but instead are streaming or downloading content directly to our televisions, computers, and phones.
The history of this market provides an illuminating window into how rapid business model innovation—from the video rental store to the Netflix DVD-by-mail to video on demand—can shape competitive dynamics. Using the RV3 framework, we can pinpoint how different choices impacted the fortunes of different companies.
Blockbuster: A (Once-) Successful Retail Business Model
The ultimate failure of Blockbuster (it filed Chapter 11 in September 2010) makes us forget that Blockbuster once had a very successful business model. Blockbuster’s critical resources were its huge network of stores (at one point, approximately 90 percent of the US population lived within a ten-minute drive of a Blockbuster store) and its library of new releases. We also tend to forget that, when Blockbuster started, it was a pioneer in using data to pinpoint neighborhood-level differences in movie tastes. So, for instance, if people in Charlestown, Massachusetts, tended to like films about bank robberies, the local Blockbuster stores there would carry a greater inventory of films like The Town (set in Charlestown), Heat, or Inside Man, whereas if people in Cambridge, Massachusetts, liked films featuring crusty professors, that local Blockbuster might stock up on films like The Paper Chase. These data were an important resource for the company. As the name of the company implied, Blockbuster focused on carrying movies that had a strong box office performance in the theaters. It created value by providing customers convenience and availability of new releases. With just a short drive, you could find a selection of movies for rental that perhaps just weeks before could be viewed only in theaters. At an average price of four dollars per one-day rental, this was a much less expensive way to enjoy a movie than seeing it in the theater (with average per-person ticket prices at twelve to eighteen dollars). It captured value through per-movie (fixed time period) rental fees and through late fees imposed if the video was returned after the due date. Late fees accounted for approximately 10 percent of Blockbuster revenues. The company also captured value on the sale of ancillary “movie night” items such as popcorn, ice cream, and candy. Finally, Blockbuster captured considerable value by selling previously rented videos. This not only generated additional value from its film library but was necessary to free up shelf space for each wave of newly available, more in-demand videos for rent.
The coherence between Blockbuster’s choices of resource, value creation, and value capture methods helps to explain how the company rose to be the dominant rental video chain. The value distribution component of Blockbuster’s business model is more complicated because the company went through a number of ownership structure changes. Blockbuster was initially a privately owned company but was acquired by Viacom in 1994 for $8.4 billion. Viacom then spun off Blockbuster in 2004. Prior to the spin-off, Blockbuster paid out a special dividend of $905 million (going largely to the shareholders of Viacom, which owned 81 percent of the company). This special dividend required Blockbuster to issue more than $1 billion in debt, which it ultimately had difficulty repaying as its business declined in the face of competition from Netflix.5
Netflix: A Business Model Innovator
Netflix entered the video rental market with a different mix of resources than Blockbuster. Most obviously, it eliminated stores. But its film library was also different. Rather than focusing on the latest films, Netflix initially carried older, less known films (sometimes referred to as “art house” or “independent” films). A big advantage of such films is that they tend to be cheaper to acquire from the studios because there appears to be less pent-up demand for rental. When Warner Brothers experienced record box office returns from the movie Titanic, it was pretty obvious to them that they had a hot commodity on their hands. Copies of Titanic to rent out would not come cheap. On the contrary, a film like Hotel Rwanda did relatively poorly at the box office despite winning many awards. For a studio, Hotel Rwanda was a commodity that offered seemingly poor prospects for rental. It was likely to gather dust in the studio’s library. Which film would you rather negotiate for?
The good news is that if you are Netflix, you can likely acquire films like Hotel Rwanda relatively inexpensively. The bad news is that many people may not have heard of it, and thus might be unlikely to rent it. So Netflix created another resource that helped movie watchers find films they may not have heard of before. The Netflix software algorithm translated a viewer’s ratings of films into recommendations of other films that seemed to match the viewer’s tastes. The more films you watch and rate (and the more films other Netflix users watch and rate), the better the recommendation system becomes at understanding your tastes and matching them with potential films.
Netflix created and captured value in a completely different way than Blockbuster. Netflix was creating value by offering renters the convenience of renting from home. No need to drive to a store and browse a shelf. No need to return the video. You selected films on the computer, and delivery and return were provided through the US Postal Service. It was also convenient in the sense that you could keep a designated number of videos (depending on your plan) at the same time, which offered flexibility about which film to watch when. The recommendation engine also created value as it enabled viewers to discover films they liked that they might not have known about. Value was captured through a flat-fee monthly subscription (e.g., $9.99 per month for four films). There was no per-film rental and no late fees.
Netflix is a publicly traded company. The value distribution component of its business model appears oriented around capital appreciation rather than dividend payouts. This is not uncommon for companies that operate in businesses with strong “increasing returns” to scale economics.
What made Netflix’s business model ultimately superior to Blockbuster’s in the traditional video (DVD) market? In some industries, different business models can coexist to serve different segments of the market. In the beer industry, both craft brewers and big mass brewers carve out different niches of the beer market. Both have done pretty well. But that did not happen here as the Netflix subscriber base grew at the expense of Blockbuster. Clearly, Blockbuster failed to anticipate this. Shortly after Netflix went public, a spokesperson for Blockbuster was quoted as saying that onlin
e video rentals would never be more than a small niche.6 The RV3 framework helps us understand why this turned out not to be the case.
Let’s begin with value creation. Blockbuster created value by offering availability of the latest popular movies to rent and convenience of having a store close by. This value creation formula required a heavy investment in two expensive resources: an extensive store network and an ever-changing library of the newest available films. Investment in expensive resources is fine, as long as the they create enough value for customers in terms of willingness to pay and as long as Blockbuster can charge a high enough price to capture this value. Before Netflix existed, both of these were likely true. Having a Blockbuster within ten minutes of your house offered the best available convenience for video rental. Blockbuster’s scale gave it enough bargaining power with studios to get reasonable prices on content. In addition, because it was a dominant player in the traditional market, Blockbuster had some degree of pricing power (and it likely had lower costs, given its scale) relative to smaller chains or independents. However, once Netflix entered the market with its business model, the dynamic changed. The relative convenience advantage of the store model began to erode—in fact, once Netflix could deliver DVDs to most locations within one to two business days, it may have gained an overall convenience advantage. Furthermore, because Netflix did not have to invest in an expensive store network, its cost structure was lower, and it could therefore charge a relatively low subscription rate (at $4 per movie rental, the breakeven for a $20 Netflix subscription was just five movies per month). This made it harder for Blockbuster to capture value through higher pricing. In essence, Blockbuster was saddled with an expensive resource (stores) that could no longer be supported by the value created or captured.
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