There is no guarantee that new technologies and new business models offer you, or others in the market, attractive profit opportunities. Profit potential in a market is determined by a set of structural factors, like barriers to entry, intellectual property, opportunities for differentiation, supplier and buyer bargaining power, and the availability of substitutes.27 In some contexts, technological and business model innovation might alter these forces in a way that leads to higher overall profit potential for some players. Strong increasing returns to scale has enabled Google to sustain a highly profitable position in Internet search/advertising. Facebook exploits inherent positive network economies in social media to sustain a dominant position in its market.
But, as in the case of digital photography, innovation can also level the playing field, which can make profitability very hard to achieve. The personal computer market is an example, as I discussed earlier. Personal computers were a transformative technology that created lots of value for society and lots of profits for Microsoft and Intel but not much for companies who sold them (with the exception of Dell for a short period of time and Apple, which used a proprietary operating system). Newspapers are another example. Over the past two decades, newspapers have jumped headfirst into digital channels. This is a classic “eat your own lunch” strategy. The presumption is that print is dying and that the only way for newspapers to survive is to embrace digital. As noted above, print may be declining, but there is still a large print market in the United States. And, according to new research on the topic, digital channels have not been very profitable for traditional newspapers.28
In determining how aggressively you should embrace a new technology or business model, you need to focus not just on revenue but on profitability. Revenue opportunities might be enormous, but this does not necessarily translate into profit (again, think about the case of PCs or digital photography). Let’s consider Walmart. The long-successful retail giant is certainly under threat from online retail, and Amazon in particular. Walmart’s profit growth in recent years has stagnated after decades of predictable growth, and today Amazon’s market capitalization is almost twice as large as Walmart’s. Yet let’s put Walmart’s situation in perspective. In 2016, Walmart generated operating income of $19.5 billion on $482 billion in revenue, for a return on sales of 4 percent.29 In comparison, in the same year, Amazon’s retail business generated approximately $1 billion in operating income on $123 billion in revenue, for a return of 0.8 percent.30 For all its dominance in retail, Amazon has not been particularly profitable in that segment. This creates a serious dilemma for a traditional (and still-profitable) retailer like Walmart. It cannot ignore online channels. Those channels seriously threaten its existing business. And yet those channels are not all that profitable—and may never be. Or consider the situation faced by auto companies today, which hear they will be disrupted by ride-sharing platforms that will make owning a vehicle an obsolete concept. Some are taking this threat seriously, as they should. Audi and GM, for instance, are experimenting with offering their own ride-sharing services. But will ride sharing ever be profitable for them? To date, ride sharing has not been profitable despite its hype. Industry leader Uber, even with strong revenue growth, reportedly lost more than $5 billion over the years 2015 and 2016.31 Uber’s leading competitor, Lyft, has promised its investors that it will not lose more than $600 million per year.32 This does not mean these companies will not be profitable in the future. Investors seem to be betting they will. But there are no guarantees for either of these companies or auto companies who enter the space.
We can see the dilemma some companies confront in dealing with fundamental transformations: if they stick with their current technology or business model, they run a potential risk of extinction. If Kodak had just stayed with film, eventually that market would have dried up. But if they move aggressively, they might be exchanging dollars for dimes. Neither of these are particularly palatable options. How you might navigate this dilemma is the subject to which we turn below.
Strategies for Navigating Threats to Your Business
I’ve highlighted two main forces you need to take into account when deciding how to respond to a potential threat of technology or business model disruption. The first is the nature of the threat: How certain are you that the threat will destroy your current business, and over what time horizon might this happen? The second is the impact on your profitability: If you do adopt the new technology or business model, can you still achieve reasonable profits? Each of these requires its own in-depth analysis. And, in reality, each requires a mix of cold analytics and artful judgment.
That technology predictions are often difficult does not mean you cannot engage in deep exploration and evaluation of trends to develop insights about what might happen. Uncertainty is time dependent. By this I mean that the level of uncertainty depends on the time horizon over which you are evaluating the potential threat. Will there be fully autonomous vehicles capable of transporting people over highways while they sleep in the next year? Not very likely. Will there be such vehicles in the next fifty years? Much more likely. Start by picking a time horizon for your analysis that matches your window of response. That is, figure out how long it will take you to respond to the threat, and then use that as your window to analyze what might happen. If you have long product development cycles (like, say, Boeing or a pharmaceutical company), you need to be looking far out on the time horizon to assess technologies because you have to act now to be capable of responding to a threat in ten years. If you are an app developer, whose product development cycles might be only a few months, then your threat window is shorter. You do not have to assess threats to your business or core technology in ten years.
Once you have a reasonable time horizon, you can then conduct all the usual types of technological and economic analyses to assess various scenarios. These typically involve talking to experts, analyzing patent data, probing the scientific literature, conducting your own research and competitive intelligence, and getting detailed windows into a technology through partnerships. To assess your level of confidence in the likelihood of an impact, go back to the three factors that can make it hard to predict technology or business model trends.
1. Are there complementary technologies that need to be developed for the threat to be realized? What is the status of those? What are the critical technology bottlenecks that need to be overcome?
2. What can we really glean about customer behavior and tastes? What are the signs they are changing in ways that might make a particular threat economically viable?
3. How much improvement potential is left in existing technologies? How long is the runway for the “last gasp”?
The goal of these analyses is not to make precise predictions but to get a qualitative feel for the threat level from specific technologies. Is the threat imminent and highly likely? Or is it distant and, at this point, relatively unlikely to impact the business? The process of getting senior management teams to even discuss these issues can be quite valuable.
The second piece of analysis concerns assessing whether you can earn reasonable profits by adopting the disruption in question. So, for instance, if you are an auto company and thinking about ride sharing, you need to analyze your future profit potential in the ride-sharing business. To find this answer, you will need to examine how the technology or business model change will influence fundamental industry drivers of profit potential: What impact will it have on structural market factors like barriers to entry, intellectual property protection, ability to differentiate, supplier and buyer bargaining power, availability of substitutes, scale economies, network externalities, fundamental cost drivers, and the like? Importantly, how might a particular technological upheaval affect where in the value chain profits will be earned? How well positioned is your company to earn profits under a new technology scenario? You need to assess realistically your capabilities to compete effectively in the new technology. In some cases, the technological change in
question is so distant from the company’s base of expertise and experience that it is virtually infeasible to develop the requisite competences. A good example would be the situation faced by Smith Corona, once a dominant player in traditional typewriters. The PC, as we all know, completely replaced the market for traditional electromechanical typewriters, but becoming a PC maker was simply not a feasible option for Smith Corona.
Thinking through these questions will help you assess your alternatives. Figure 4.1 provides a simple framework combining the two dimensions we have discussed: the nature of the threat (how likely is the disruption in question to occur in the relevant time horizon?) and your profit potential should you switch. From it, we identify a set of potential responses to technological or business model threats. This is designed to help you figure out when you should, in fact, move aggressively (eat your own lunch) and when obstinate defense of your existing position may be a better, if less glamorous, response.
FIGURE 4.1
Mapping Responses to Potential Disruptions
A New Day Is Dawning: The Case for Eating Your Own Lunch. Let’s begin with the case for eating your own lunch. If the threat in question appears relatively likely to impact your business and the profits from it are at least as good as your current business, then aggressively moving into the new technology or business model makes sense. Here, your logic is, the change is coming, but we can still be profitable if we adapt.
Let’s look at an example of how IBM dealt with this dilemma when confronted with the threat of open-source Linux software in the early 2000s. When graduate student Linus Torvalds first created the open-source operating system, Linux, from his dorm room, no one paid much attention. Linux appeared to be a hobbyist operating system—certainly no match for a proprietary enterprise-grade operating system like Unix. Being open source, Linux was not only free, but its source code was available to anyone who wanted to modify, fix, or improve it. Pretty quickly, a community of independent developers began writing new code for Linux, and its capabilities improved quickly. When its scalability, reliability, and security hit a certain level, companies began to install Linux on their servers to run business applications. If you were IBM in the late 1990s, this was not necessarily good news; after all, IBM had its own proprietary Unix operating system that came with its servers and garnered handsome licensing fees. It could fight by trying to improve its proprietary Unix, cut prices, improve service, and so on. Or it could switch: it could embrace Linux. This would almost certainly accelerate the demise of its own Unix system—a classic case of eating your lunch before someone else does. In this case, the threat was real and imminent. By 2000, there was little doubt in the minds of IBM leadership that Linux would penetrate the market. But how about profitability? How could Linux—given away for free—ever be a profitable business model for IBM? IBM realized if it embraced Linux, it would also need to adapt its business model. Rather than making money off licensing fees for its Unix operating system, it would instead make profits by selling “middleware” (the software that runs on the operating system), applications, and other services. Because these are highly profitable, the switch to Linux was actually quite attractive economically for IBM. It did lose revenue from Unix licenses, but it more than made up for them by additional sales of servers, middleware and applications software, and services.
Eating your own lunch is almost a no-brainer when you are moving to an equally attractive profit position. Netflix’s move from traditional DVD rental to video on demand is another example where it seems to have paid off to eat your own lunch. VoD—the capacity to stream or download media content to your computer, television, or phone—was an emerging technology in 2005. Then, it took about an hour to download a film, and, in fact, you could only watch content on your computer (televisions were not Internet compatible). But, even then, it was apparent that these bottlenecks would be overcome. Apple was introducing a device to connect televisions to the Internet (Apple TV) and making a few films available online. Broadband speeds were accelerating. Storage was becoming cheaper and cheaper. Netflix realized that video on demand was inevitable and that it could displace its traditional DVD rental by mail business. But could VoD be profitable? After all, many companies entered the VoD space (Amazon, Apple, Google, Hulu, to name just a few). The key in VoD is proprietary content. Customers will pay for a subscription if they can get content not available elsewhere. Because there are high fixed costs of acquiring or creating proprietary content, Netflix’s scale and its large subscriber base are a huge competitive advantage in the world of VoD. Netflix may have eaten its own DVD by mail lunch, but it continues to enjoy tasty profits in the world of VoD.
The Party Is Ending. In the worst-case scenario, your core business or core technology not only looks likely to become obsolete, but you do not even have a viable path to profit under the new regime. This was the scenario facing Kodak. This kind of dire situation reminds me of the line from the movie Annie Hall about a commencement speaker’s admonition: “More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly.” What should you do if you are faced with such terrible alternatives?
There are two basic strategic plays. One is to pivot around your capabilities. Rather than trying to compete in a market where you have little chance of profiting, find new markets where you can deploy your existing capabilities. Kodak might have pivoted to markets where its existing and unique specialty chemical and materials capabilities could be deployed, a strategy successfully used by Fuji.33 Smith Corona repositioned itself as a producer of thermal ribbon used in thermal transfer printers.34 Such repositioning strategies are often more easily implemented in a diversified company that has organizational mechanisms to redeploy resources from one business to another or to start (or acquire) new business units.
The second possible strategy is defend and extend. In this strategy, you try to prolong the decline as much as possible by improving your technology, finding attractive sub-segments of the market where your technology still has an advantage, and reducing costs. Under this strategy, you are betting you can create a long and potentially profitable last gasp. This is by no means a cure. It may be purely a life extension. This strategy is not glamorous, nor is it a prescription for growth. But it may be the only possible alternative and can set the stage for an exit that is the least costly solution for shareholders.
Intriguing Possibilities and Clouds on the Horizon. How should you respond if you really do not know whether the threat in question will materialize (let alone whether it will create or destroy profit opportunities)? Almost all disruptions that do materialize once started out in this category—at one time, things that seemed inevitable were murmurs at conferences and wild speculations. Many companies do nothing at this stage, but that is probably a valuable opportunity lost. By the time something is inevitable, it may be too late to respond to either seize the profit opportunity in the new wave or to reposition the company for a transition.
This was a mistake made by Baldwin Locomotive, once the largest manufacturer of steam locomotives in the United States. The diesel engine was invented in the late nineteenth century and began to be used in locomotives as early as 1912, but they were not commercially successful because of poor power-to-weight ratio. Only a few prototype diesel locomotives were produced by the 1920s. At this stage, the diesel locomotive should have looked like the classic ambiguous threat to Baldwin. There was something there, but it did not appear anywhere close to commercially threatening. Could it advance enough to challenge the steam engine? Could it be made at attractive costs? Would rail operators adopt them? Could the steam engine be improved enough to maintain its superiority? This would have been an ideal time to begin exploring the technology as a means for Baldwin to hedge its bets and develop options to participate in the new technology should it advance rapidly. Baldwin chose not to do so. In fact, in 1930, the chairman o
f Baldwin, Samuel Vauclain, stated publicly that advances in steam technology would ensure the dominance of the steam locomotive until at least 1980.35 Baldwin bet on steam and on another emerging technology, all-electric locomotives.
If one recognizes the difficulty of predicting future advances in technology, then such “all-in” commitments are really quite dangerous. They make the precarious assumption that your technological forecast is correct (in this case, steam can improve and all-electric will beat diesel). A better strategy under such conditions of uncertainty is to hedge and create options (e.g., make smaller R&D investments in diesel). In fact, Baldwin’s largest competitors in steam locomotives, ALCO, did exactly that. It was investing in diesel technology as early as the 1920s. While GE eventually went on to dominate the diesel locomotive industry, ALCO survived until being acquired in 1964. Baldwin filed for bankruptcy in 1935.
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