Connected Strategy

by Nicolaj Siggelkow

  In sum, platforms and platform strategies are related to connected strategies and also can be an element of a connected strategy. Yet connectivity allows for many other forms of value creation than the formation of two-sided markets, and it is the aim of a connected strategy to take advantage of them.

  When implementing a connected strategy, you need to decide how much of the customer experience your firm will generate internally and how much you will delegate to other partners in the ecosystem. Moreover, you may have to create new connections between players in your ecosystem. Chapter 7 provides guidance on these decisions. As we will see, there are five common connection architectures that are used across industries:

  Connected producer

  Connected retailer

  Connected market maker

  Crowd orchestrator

  Peer-to-peer network creator

  In chapter 7, we will describe each of these connection architectures in detail. By recognizing these, you can make the right choices for your business.

  We finish the chapter by introducing the connected strategy matrix. We have found this matrix to be a very valuable framework for systematically cataloging the various activities of your competitors in your industry, as well as an innovation tool to create new ideas for your own connected strategy.

  Chapter 8, “Revenue Models for Connected Strategies,” adds the second design consideration for your connected delivery model: the revenue model. Some connected strategies can rely on traditional revenue models. Disney, in its theme park division, is still making most of its money from admission tickets, food, merchandise, and fees for special experiences inside the park. Contrast this with Niantic and Nintendo, two companies that also produce amazing experiences centered on fictitious characters. With Pokémon Go, the partners have leveraged augmented reality to create a technology platform that turns any place into a virtual theme park. You can play it anywhere, anytime, and you can play it for free, together with its other sixty-five million active users. Niantic creates revenues through in-app purchases that enhance the game and through sponsorships by firms that create desirable locations for the game (e.g., Starbucks and McDonald’s).

  Technological advances are often what make connected strategies economically feasible. Of course, everyone would like to have personalized, on-demand services that fulfill the most fundamental needs. But how can firms offer such customized services at affordable prices? Vast improvements along many dimensions, from data gathering, data transmission, and data storage to data analysis, logistics, and manufacturing, have made connected strategies a possibility. In chapter 9, “Technology Infrastructure for Connected Strategies,” we will help you sift through these advances. By coming back to the connected relationships that you have designed in part II, we can identify key technologies and systematically ask which of these technologies will enable you to further advance your connected strategy.

  Finally, chapter 10, “Workshop 3: Building Your Connected Delivery Model,” presents a series of exercises and tools that will allow you not only to build your own connected strategy but also to get a better understanding of what is happening around you in your industry.

  The concepts just introduced allow us now to formally define a connected strategy:

  A firm’s connected strategy is a set of operational and technological choices that fundamentally changes

  how the firm connects to its customers by implementing the recognize-request-respond-repeat loop, which transforms episodic interactions into continuous relationships with low friction and high degree of customization, and

  what connections the firm creates among the various players in its ecosystem through the type of connection architecture it chooses and the subsequent economic value captured through a revenue model.

  BUSINESS-TO-BUSINESS CONNECTED STRATEGIES

  Connected strategies are arising in both business-to-consumer and business-to-business settings. Consider Rolls-Royce’s transition from a simple seller of aircraft engines to a much broader service provider enabled by deeper connectivity. Today’s aircraft engines are packed with sensors that generate gigabytes of data. This data allows Rolls-Royce to have a precise understanding at the level of individual parts within an engine. While previously parts such as a fuel pump would be replaced on a fixed schedule, now Rolls-Royce can replace pumps earlier or later depending on the state of the pump. This creates significant cost savings either by avoiding engine problems and subsequent flight delays (if a pump was previously replaced too late) or by being able to use a pump longer than normally. The ability to deliver preventative maintenance has allowed Rolls-Royce to change its revenue model from selling engines to selling flying hours, aligning incentives between itself and its customers. Moreover, when engines are decommissioned and returned, Rolls-Royce knows the exact performance profile of each part and is able to recover 50 percent of the materials to remanufacture them for use as new components, reducing manufacturing costs. Being able to aggregate data across a customer’s fleet allows Rolls-Royce to gain further insights. For instance, a clean engine burns less fuel, but washing engines is costly. Using fleet-level data, Rolls-Royce is able to determine the optimum time for each engine in a fleet to get washed. Finally, by adding additional data sources such as technical logs, flight plans, forecasts, and actual weather data, Rolls-Royce is able to provide insights to its customers for how to increase fuel efficiency—for instance, through improved flight schedules. Through its connected strategy, Rolls-Royce has increased the value it delivers to its customers while at the same time increasing its own efficiency.

  How to Use This Book

  Probably you are reading this book not just for your entertainment but rather with the intent of reflecting on how your organization creates connections to your customers and suppliers. We get it. That’s why we wrote this book neither as an academic textbook nor as a scholarly treatise. The main purpose of our writing is to help you design your own connected strategy so that you can create a competitive advantage for your firm.

  At the end of each part of this book, we want to pause and help you apply all the frameworks in the form of a workshop. Each workshop consists of worksheets and guiding questions that we have road-tested with a large number of our executive education participants. Use them on your own, or even better, use them to engage your team members and other stakeholders in a structured workshop.

  On the website for this book, connected-strategy.com, you can find more information on how to run your own workshop. The site has suggested timelines for the workshops, as well as downloadable templates of all exercises and group assignments. We also provide you with a number of filled-out examples for the worksheets that will be useful as you apply the tools we present in this book. Lastly, the website hosts dozens of podcasts featuring executives from a wide array of industries, from consulting to education and from banking to security services.

  To illustrate our ideas and frameworks in this book, we use many examples from firms around the world. Some of these examples will hopefully spark ideas for your own organization. At the same time, we want to be clear about one thing: we certainly do not expect all the firms we mention to emerge as winners in their industries. Frankly, we would be extremely surprised if they did. The world of connected strategy is developing, and many new winners and losers will be created. We believe in the power of the ideas we present in this book, but we are not offering investment tips for particular firms.

  Whether you are a startup trying to disrupt an existing industry, or an incumbent firm that wants to revitalize its strategy and defend its business, whether you deal directly with end customers, or are in a business-to-business setting, we believe connected strategies will play a pivotal role in helping you achieve competitive advantage. If you don’t think about connected strategies, someone else in your industry most likely will!

  PART ONE

  THE REWARDS OF CONNECTED STRATEGIES

  2

  Breaking the Trade-off between Super
ior Customer Experience and Lowering Costs

  Every business in every industry faces a trade-off between the quality of the customer experience and the costs of providing it. Adding a glass of champagne and extra legroom on an airplane makes for better travel, but it also increases costs. An electric car with a Tesla-style 85-kilowatt-hour battery can go faster and longer between recharging cycles, but it also costs more than the Nissan Leaf’s 30-kilowatt-hour battery. A hotel providing personal concierge service leads to a superior customer experience compared with a surly desk clerk handing out local maps. In short, superior customer experiences come at the price of higher fulfillment costs. How can that be changed?

  This chapter explores the fundamental promise of connected strategies: by creating deeper connections with customers and new connections between various players in an industry, firms can create new business models that redefine the existing trade-off between customer experience and cost. To illustrate our ideas, we look at case studies from grocery retail and ride hailing.

  The Efficiency Frontier

  To see how connected strategies completely upend the traditional cost-quality trade-off, consider supermarkets, a $600 billion industry in the United States, $500 billion in India, and more than $700 billion in China. Sam, a typical shopper, is thinking about his weekly grocery trip to buy dairy, meat, and vegetables. Traditionally, Sam considers three options: a local farmers’ market, a supermarket chain such as Safeway or Tesco, and a discount market such as Aldi. What factors drive Sam’s choices? Perhaps for Sam, his happiness will be most affected by the quality of the available products. For instance, at the farmers’ market, the produce is organic, the meat is fresh, and the dairy comes from happy cows. Beyond the product attributes (e.g., organic vs. nonorganic), additional factors affect a customer’s happiness. There are lots of ways to delight a customer, and there can be many pain points that detract from the customer experience. For instance, do customers have to drive for long to do their grocery shopping, or can they walk there? If they have to drive, how easy is it for them to find parking? How long will it take to find all the items that they want? How long will it take to pay? The list goes on.

  There are many dimensions that drive how much a customer likes a product or service, including performance, features, customization, ease of access, waiting time, ease of use, and so on. We lump all of these together into a single score (think of it as a grade point average) and label this score the willingness-to-pay of the customer. The more you like something, the higher the maximum price you would be willing to pay for it. Economists often refer to customer utility, which captures the same concept. It is important to distinguish between the willingness-to-pay that a customer has for a particular product and the actual price that a customer pays for this product. The price for a particular product will depend not only on the customer’s willingness-to-pay for this product but also on the willingness-to-pay that competitors create for their products and the prices they charge.

  FIGURE 2-1

  Efficiency frontier

  To become more attractive to customers, firms want to increase their customers’ willingness-to-pay. But there is a countervailing force: the cost of creating and fulfilling such a customer experience, which we refer to as fulfillment costs. The better the quality of the product, or the more conveniently located the location, the higher the overall cost of fulfilling this customer experience. We can visualize this trade-off by plotting firms on a graph that has the customer’s willingness-to-pay on the vertical axis and the fulfillment costs for the firm on the horizontal axis. In figure 2-1, we have plotted Sam’s three grocery options. The farmers’ market lives in the upper left of the graph. It creates high willingness-to-pay for customers, but its fulfillment costs are also very high, since small farms do not have scale economies in production or distribution. Costs drop as we move from left to right on the cost axis. As a result, the discount market is on the lower right. Costs are low, but willingness-to-pay for this option is also low. Supermarkets exist in between the extremes.

  When we connect the dots representing the firms that are farthest out on this graph, we get the current efficiency frontier for this industry. This line represents the frontier because firms on this line have maximized the willingness-to-pay they have created for customers for a given cost level. Conversely, for a given level of willingness-to-pay, these firms have minimized the costs at which they can create this willingness-to-pay. Firms that are not on the frontier are at a severe disadvantage. They face competitors who can either create a higher willingness-to-pay while incurring the same cost or create the same willingness-to-pay at a lower cost. In either case, the competitor is able to provide the customer with a better deal: either a preferable product at the same price or the same product at a lower price. The efficiency frontier also illustrates that firms face a trade-off: once the firm has reached the existing frontier, higher willingness-to-pay will come at higher cost; or, conversely, cost reductions will lead to lower willingness-to-pay.

  Pushing Out the Efficiency Frontier

  Despite countless cooking shows on television, consumers in most developed nations have lost their appetite for spending a lot of time on meal preparation. This has led to the emergence of an entirely new product category, enabled by the internet and low transportation costs: kits that contain the ingredients for meals in customized portion sizes, delivered right to the doorsteps of subscribers. In the United States, Blue Apron initially dominated this market segment, leading to an almost $2 billion valuation in its IPO in 2017. Launched first in Germany, HelloFresh has since surpassed Blue Apron in this category. Most recently, supermarket chains such as Walmart and Albertsons have joined the party. And, you probably guessed it, wherever there is money to be made online, Amazon is not far behind—the company now sells meal kits through Amazon Fresh.

  As with any case study that you will see in this book, we are not endorsing particular companies, and you should certainly not use our work to pick the next stocks you buy. Blue Apron has struggled financially since its IPO, and Uber, to be discussed later in this chapter, has had its own share of legal and financial challenges. Whatever might happen to these companies, we believe that subscription-based meal-kit deliveries and ride hailing are here to stay. The fact that both Blue Apron and Uber are facing fierce competition is tough for them as individual companies, but it demonstrates the vibrancy of the newly created market segments and thus underlines the potency of their connected business models. We will speak more about connected strategy and competitive advantage toward the end of the chapter.

  How do companies such as Blue Apron operate? Customers who sign up for a Blue Apron subscription are asked to specify their preferences. From then on, every week, Blue Apron sends the customer a box containing ingredients and recipes. Blue Apron sources sustainable produce directly from smaller, often family-owned farms. All of the meats and seafood that Blue Apron provides are free of hormones and antibiotics. Quite often, Blue Apron will also include ingredients that are not very well known, such as fairy tale eggplants or pink lemons. Blue Apron’s agroecologists advise farmers on crop rotation, planting dates, plant spacing, and pest management in order to enable them to cultivate unusual varieties of produce, yielding richer harvests and sustainable farming.

  Why do so many customers sign up for this service? On the product side, its high-quality and sustainably sourced products put it on a relatively even level with products from a farmers’ market. In addition, Blue Apron raised customers’ willingness-to-pay by reducing a number of pain points along the customer journey. There is no need to spend time looking for recipes, to make a shopping list, to drive to several stores to find all the unique items, or to wait in line to pay. There are no leftover ingredients rotting in the fridge. On top of these advantages, customers learn how to cook unique meals with novel ingredients that they might not have used otherwise and might have had a hard time finding in stores. In sum, for many customers, the willingness-to-pay has in
creased.

  But how about fulfillment costs? Despite its convenience, Blue Apron has lower fulfillment costs than a traditional farmers’ market. Part of this cost advantage results from its massive scale, especially when compared with traditional farming co-ops. For instance, for some ingredients, such as the fairy tale eggplant, Blue Apron purchases nearly the entire commercially available supply.

  As far as retail operations are concerned, the subscription model of Blue Apron allows the company to forecast demand for ingredients with a high degree of accuracy. This reduces Blue Apron’s excess inventory. And Blue Apron does not have to worry about stock-outs, one of the major operational hassles for supermarkets. If avocados are scarce, the company can change the recipes of the week and customers will eat asparagus instead.

  The forecasts also let the company help farmers manage their own businesses efficiently. Blue Apron often buys the entire crop of a farmer, providing a more predictable income stream than would be possible if the farmer attempted to sell a product at farmers’ markets, where demand varies. Lastly, Blue Apron eliminates two links of the supply chain—transportation from warehouses to grocery stores, and the grocery store retail sites themselves—thereby removing real estate, utility, insurance, and other costs. By creating a curated offering, Blue Apron has pushed up the willingness-to-pay of its customers. At the same time, by creating new connections between farmers and customers—a connection architecture we will call a connected retailer in chapter 7—Blue Apron has also been able to reduce its fulfillment costs. In sum, Blue Apron has pushed out the efficiency frontier, as we illustrate in figure 2-2. The dotted line in this figure corresponds to the increased competitive advantage that Blue Apron has gained relative to farmers’ markets due to its connected strategy.