Establishing a Continuing Business Model Innovation Process
by Donald Mitchell and Carol Coles

Introduction

Most business process development is focused on improving or replacing existing processes, activities that are long-standing and usually well understood. Yet, if we look backward in time to earlier days, experience teaches that it is often the processes that we don't have for activities we need to be doing, but aren't, that offer the greatest potential.

Consider just-in-time manufacturing processes. Prior to establishing these processes, most organizations operated far less effectively in every dimension of customer, competitive and financial performance. Products had more faults, shipments took longer, costs were higher, and much more money was tied up in inventory and work-in-process.

As an another example of where lacking a process can hurt, look at organizations that have not made major acquisitions before and have no process for the activity. In the absence of a sound process, such organizations often pick inappropriate large businesses to acquire, pay too much for them, and have great difficulty managing the new operations. By contrast, every experienced organization with a track record of acquisition success behind it that we have investigated has established a well-oiled process that is constantly being improved. Even with a smooth-running process for acquisitions, many errors will occur. A process helps to reduce the number and severity of these errors.

In recent years, most organizations find that they have more competitors than ever before, especially from companies based in other countries. In addition, competitors are launching new products and services more often. Pricing is made more complicated by more frequent and larger currency shifts. Tastes and needs of customers seem to change all the time. These trends towards having a tougher business environment are expected to continue. In response, many organizations have established elaborate processes for tracking and forecasting their environment and developing new plans to respond quickly to unexpected shifts. Other organizations are doing elaborate scenario development to create plans that will better weather the unexpected. With neither process approach, however, can an organization hope to leap frog frequently ahead of the competition by taking timely actions that regularly create new sustainable advantages that translate into ever larger revenue and profit margin gains versus competitors. What process might? Our research suggests that continuing business model innovation, a process currently employed in relatively few firms, offers this potential.

Methodology

What matters most now in making a company a perennial top performer in its industry, regardless of its current size? Many people have proposed potential answers based on evidence drawn from company activities pursued prior to 1996. Yet the evidence of measuring performance of companies versus their competitors suggests that companies now rarely create large, sustained advantages over competitors that translate into faster sales, profit and stock price growth that last for longer than a few quarters.

Our research with top-performing CEOs from 1992-2003 has pointed to a new answer, the paramount power of frequent business model innovation. This innovation activity has become more important in the last ten years, yet repeated business model innovation remains a source of continuing competitive advantage that few companies are considering or pursuing.(1)

From 1992-2002, we annually examined the 100 companies above a minimum size whose stock prices had grown the fastest in the U.S. stock markets over the prior three years under the same CEO. (2) We looked intently at the CEOs and companies that repeated on our lists most often. Think of these companies and CEOs as the equivalent of perennial all-stars (or future hall of famers) in sports. CEOs were asked which management practices they felt contributed the most to their success. We continued to track performance among these companies to see what performance they achieved and which practices seemed to contribute the most to their success. By 1995, we found that the management practice the most frequent high-growth repeaters had in common that the others lacked was continually replacing their business models with better ones, as often as every 2-4 years throughout the period we studied. Interestingly, many of the best performers began as start-ups or quite small companies under their current CEO in the prior three decades. Few, however, began making continual business model improvements until the late 1980s.

Why has other research failed to locate this process? Here are some possibilities. One possible reason is that we have been able to find and confirm the presence of less than a hundred practitioners of continuing business model innovation in the world. Also, most past best practice studies of overall company effectiveness have used criteria to select companies as top performers whose minimum results fall below what is needed to make the annual 100 company lists that we developed. Our research selection process is more selective in a further dimension. The companies we studied for this paper had to steadily outperform the most successful companies in and out of their industries over a period of 13 years (our study period included 1989-2002). Further, most study periods for characteristics of top performers date back to times before continuing business model innovation was being practiced by most of our examples. In addition, we found that research on continuing business model innovating companies is seldom reported in books and scholarly articles, and the material we found on these companies usually omits any reference to continuing business model innovation.

By a business model, we mean the combination of the seven elements of "who," "what," "when," "why," "where," "how" and "how much" an organization employed to serve its customers, end users and other stakeholders (including but not limited to employees, partners, suppliers, distributors, lenders, shareholders and the communities affected by the organization's activities).

As a result of repeated business model innovations, the firms we identified rapidly improved their competitive position. They saw their profit margins and revenues expand faster than competitors, while their access to low-cost capital gave them additional ways to outstrip the competition through acquiring businesses and paying employees less expensively. As a result of employing all these new advantages through more effective business models, it was not unusual for a firm with a modest market share to expand into worldwide leadership within a decade.

Here are two examples of business model innovating companies that started small, but didn't stay that way. Mr. B. Thomas Golisano founded Paychex with three employees employing an initially advantaged business model for providing a lower cost payroll service for small companies in Rochester, New York. Costs were lowered by doing more of the coding work for the employer at Paychex, and using the telephone and mail to transmit information. Competitors at the time (such as Automatic Data Processing) usually required employers to fill out computer forms which required special training, and transmitted all information by company courier. Paychex has since expanded into a national firm that provides a broad variety of services that enhance relations between small company employers and their employees (including employee benefits, retirement accounts and human resources services) to make small employers more competitive with larger ones. Each of these services is made more accurate and lower cost by relying on an existing, low-cost Paychex payroll database. In the process of making its business model innovations to add non-payroll services, the Paychex after-tax profit margin grew from 9 percent of sales in 1989 to 28 percent in 2002 while revenues grew nine-fold with the aid of few acquisitions. By comparison, industry-standard Automatic Data Processing had an after-tax profit margin on sales of 14 percent in 2002. The Paychex stock price grew by over 4,000 percent during the 13 year study period.

Mr. Lowry Mays started Clear Channel Communications accidentally after having to foreclose on a loan to a single, small radio station in the 1970s. He soon developed an advantaged business model similar to that of other successful radio entrepreneurs, acquiring and inexpensively remodeling local radio station broadcasting formats and operations to attract more listeners and advertisers. From that base, the company made several unique business model innovations to shift into a custom global provider of more effective, lower cost advertising packages involving radio, television, billboards and live concerts. These innovations were made possible by creating complementary audiences in different media that fit advertiser needs in unusually low cost ways. Relying heavily on acquisitions to expand nationwide and internationally in radio, television, billboards and live concerts, Clear Channel's sales grew from $52 million in 1989 to $8 billion in 2002 while profits soared to over $700 million before the effect of a change in accounting principles. Stock price grew by over 8,000 percent during these 13 years.

Despite their remarkable sustained successes, these two firms have been written about very little in the best-known business books. When the firms have been written about, their continuing business model innovation is seldom mentioned.

Many of the companies we initially found which have been adept at improving their performance by changing their business models competed in technology industries such as Dell in custom-making personal computers, servers and other computing gear, EMC in mass data storage hardware and software, and Tellabs in telecommunications equipment. We next decided to cast about further to see if we could locate examples in more mundane and slower growth industries to see if such continuing business model innovation was going on elsewhere. In the process of expanding and diversifying our study group, we hoped that the key elements of continuing business model innovation success could be better identified and understood.

To expand the study group, we read 22 years of quarterly reports (covering 1978-2000) in the Value Line Investment Survey. We started reading before 1989 to be sure that we understood what business models had been in place before 1989 in the companies we studied. We sent e-mails in early 2001 to all the companies that seemed to have made at least two successful business model changes since 1989 and had had markedly improved their revenue and profit margin performance versus competitors. We asked these companies to confirm or deny that they had been business model innovators more than once during those years. If they confirmed our impression, we asked for permission to conduct top management interviews to learn about their practices. Our study group includes all those who allowed us to interview at least the CEO. We further limited our investigations to business model innovations that the interviewee had participated in as part of his or her current position. In the course of the research, we found many intriguing examples of continuing business model innovators in mundane, low-growth industries such as automobile parking services, cabinet making, children's bicycles, cleaning materials, dental supplies, mining, power generation, storing paper records and road-building materials.

Encouraged by finding these additional examples, we next expanded our search to look for continuing business model innovators among small and medium-sized private and public companies, and non-profit organizations deliberately missed by our earlier screens. We relied on literature and on-line searches, contacts with experts and our own observations of outstanding organizational performance to locate other organizations that were rapidly outstripping their competitors and counterparts in growth and economic effectiveness (such as by having lower costs and prices than the alternatives). We investigated these effective organizations to verify their use of continuing business model innovation in the same way as with the other cases.

We next used statistical tests to locate the common elements that these successful continuing business model innovators have used.

Definitions

A business model improvement is any successful pioneering change in any business model element ("who," "what," "when," "why," "where," "how" and "how much") that delivers substantially enhanced ongoing sales, earnings and cash flow advantages versus competitors and what customers can supply for themselves. Matching what competitors and customers are already doing is merely business model catch-up . . . not business model improvement. Improvements affecting four or more business model elements constitute a business model replacement. Such replacements that offer products and services previously unavailable to customers are also business model innovations. The ongoing management process of developing and introducing improvements and replacements is what we mean by continuing business model innovation.

Preparation

Before launching business model innovation processes, many companies and nonprofit organizations found it valuable to check on their values and to understand what parts of their history might apply to business model innovation.

The investigation by new CEO, Walt Boomer, at Rogers Corporation, a materials company with expertise in polymers, was a model of how this can be done. Mr. Boomer looked at:

  1. Whether the company had a solid base in values;

  2. Where taking lots of affordable risks could reduce or eliminate bigger, unaffordable risks;

  3. How the company's past performance could serve as a surrogate for experiments in adding benefits, adjusting prices and reducing costs for all stakeholders;

  4. Where the company could make fast progress on several fronts at once in adding value for customers and other stakeholders;

  5. What kind of organizational structure would work best for creating and implementing his future experiments in business model innovation;

  6. How he could instill a better spirit of teamwork and cooperation for mutual advantage.

In the case of Rogers, the company found that it had the necessary values. Mr. Boomer used the values he was most familiar with as a former assistant commandant and head of Operation Desert Storm in Kuwait and Iraq for the U.S. Marine Corps in making this evaluation. On the risk side, the company was trying to perfect new products too early in the development cycle and experiencing production problems that delayed introduction of these new products for too long. Rogers needed to take more risk with early market experiments with prototypes to see whether fine-tuning the products was worthwhile. The company had worked in isolated organizational silos so that product development and manufacturing managers had little to do with one another. That made introducing new products slow and ineffective. The organizational structures and development processes were changed to integrate these functions. Also, the company had a distinguished history of co-developing new products with offshore joint venture partners who had both product and manufacturing skills. In part, this past success was probably due to development managers being used to working independently of manufacturing. Much more of this type of co-development could be done with reduced costs and risks over Rogers carrying the whole load.

We were struck that many organizations accomplished a great deal of business model innovation solely through the inspiration of strongly held values. A good example is Habitat for Humanity International which helps provide affordable, decent housing for low-income families around the world. Business model innovations have sprung up from all directions and stakeholder sources, and with a frequency that we did not find in any other organization we studied. This organization has also grown fast for a longer period of time than any other we located. With that success in mind, it seems like for-profit companies could improve their business model innovation performance with a greater focus on finding the most inspiring, appropriate values for their organization before launching a new process.

Although no two companies or organizations will find that the same values will be right for them, we have found the common denominator among organizations that have achieved the most success and strongly ascribed that success to the importance of company values:

  1. Pay attention to each stakeholder as an individual.

  2. Respect each person's views and interests.

  3. Be honest.

  4. Keep promises.

  5. Seek to "do good while doing well."

  6. Create innovative solutions to important, unmet human needs.

  7. Look for validation of ideas in customer and end-user acceptance.

  8. Put the interests of all stakeholders on a par with each other.

  9. Take pride in your work.

  10. Serve others in continually improving ways.

  11. Be reliable in looking out for others.

Beginning Sequence

Here's the sequence most companies go through to become more adept than their competitors in using business model innovation to continually reinvent themselves:

  1. They learn how to make one business model improvement or replacement from their prior business model base.

  2. Encouraged by the size of the benefits from their first improvement, they decide to do a second one, and need to expand the scope of what they consider and which stakeholders they tap for help.

  3. Further encouraged by additional success, they decide to turn business model improvement into a repeating activity, which requires a shift in corporate priorities and attention. The activity begins to become an ongoing process.

  4. Their business model improvements and replacements eventually propel them beyond the boundaries of their original marketplaces. They need new targets of opportunity for their subsequent business model improvements and must begin searching for them before momentum slows from prior enhancements.

This evolution is typical of how most new processes are established in major organizations. Managers want to get experience in a small effort before committing more time and resources to the new activity. More recent practitioners of continuing business model innovation are often likely to start with a commitment to having an on-going process and regular, rapid improvements in business models.

As we investigated those who went through these steps, we noted that continuing business model innovation processes required at least the following four dimensions operating simultaneously:

  1. Understand and optimally apply the current business model: Employ the best way that goods and services can be supplied now, by accurately and completely informing all stakeholders (including customers, end users, employees, partners, distributors, suppliers, shareholders, lenders and the communities which the company or organization affects) about what needs to be done to deliver and receive the most benefits.

  2. Establish, understand and follow an appropriate business model innovation vision: Identify the ideal benefits to deliver to all stakeholders in your industry as a guide for developing future generations of business model improvements, replacements and innovations.

  3. Ongoing design and testing of potential business model improvements, replacements and innovations: Probe stakeholders for the potential of various possibilities, and test promising concepts for their alignment with the innovation vision and effectiveness through checking stakeholder reactions to new benefits and various ways of supplying them.

  4. Understand and begin installing the next business model improvement or replacement: Specify both the next set of enhancements to provide more stakeholder benefits through your goods and services, and how the transition to providing those enhancements will occur. This can only occur after the third dimension has begun to regularly provide usable enhancements.

A more valuable process for continuing business model innovation also simultaneously describes more than one future generation of innovations in terms of dimension four.

Already, you are probably thinking that most businesses are weak in all four dimensions. Businesses have usually obscured key points about the first dimension so that some employees, suppliers, partners, distributors, customers and end users do not understand what they are supposed to be doing. Even more businesses have left the second dimension undefined. Most companies are pursuing no business model improvement or innovation experiments or tests. That last fact alone makes it clear why few companies are able to specify and begin implementing the next business model improvement or replacement.

To see how was this process can be successfully implemented, let's look briefly at an individual company example.

Commercial art schools had been teaching students for decades when Education Management started out in 1969 by purchasing the Art Institute of Pittsburgh. While improving performance of the Art Institute's existing business model, company leaders also immediately asked: How could the company develop new competitive advantages?

In answering that question, Education Management first expanded its business model innovation vision from solely teaching commercial art well to also serving employers' needs in ways that benefit students. As a result, the company learned to help its students develop more relevant skills in order to obtain and hold commercial art jobs while making better career progress in them. In pursuing that new business model innovation vision, Education Management initially made seven business model improvements through new management processes that constituted a business model replacement and innovation for the Art Institute of Pittsburgh:

  1. Continually define, update and add to the curriculum around employers' current and future needs, by actively involving employers in the curricula development process.

  2. Employ faculty who are practicing professionals for career specific subjects.

  3. Build the curriculum to concentrate on what students need for job success.

  4. Create facilities and technology like the professional career environment.

  5. Help graduates get jobs.

  6. Make potential students aware of the advantages of these educational and career choices.

  7. Start up, or acquire small local schools and convert them to the new Education Management business model through substantial investments, and install detailed planning and information systems to manage those operations.

The resulting innovative business model meant that Education Management had the potential to be the first commercial school in a metropolitan area to offer students a diversity of art programs, along with the combination of a superior faculty, facilities, technology and job-market outreach. This business model could either shift an acquired school's direction (like the Art Institute of Pittsburgh) or direct a newly established school to effectively employ the company's continually improving acumen.

As the company expanded geographically, it became the industry leader. On that large base, Education Management regularly added business model innovation tests, new programs and new services that have since provided several more rounds of successful business model replacements and innovations. In 2002, Education Management had twenty-four art institutes located in twenty-one major metropolitan areas across the United States, with a student population of over 30,000. As you can see, putting such a new business model in place required establishing new business processes (such as applying the business model to acquired schools) as well as changes to old processes (such as curricula development). By comparison, a company looking to reengineer its existing processes would be focusing only on processes it has today, and might limit its focus to making processes less costly or operate more rapidly. As a result, those process-driven efforts would probably create fewer competitive benefits than having process activities be directed in the context of a business model innovation process.

Commercial art applies artistic talent and skill to commerce. By using its new business model, Education Management soon learned from employers that they needed commercial artists with broader backgrounds than commercial art schools normally provided. This led to other rounds of business model improvements. For instance, the company expanded the variety of educational disciplines at the associate of arts level. The firm later added bachelor degree programs that required an additional eighteen months of learning, but led to a much higher economic return for graduates on their educational investment by making them more effective employees.

These changes created a win-win-win situation for students, employers and Education Management. Soon, the expanded curriculum was being successfully taught throughout its nationwide system.

As another example of ongoing improvements, when computers became more important to commercial design work, Education Management added significant workplace technology to the classroom to prepare students for multimedia and Internet work.

To test the relevance of these changes, Education Management paid attention to the percentage of students who finish the bachelor's program compared to those who start. Currently, 55 percent get their degree. By comparison, the national average completion rate of all bachelor's degree programs in the United States is about 40 percent. Dropping out is simply less attractive than staying in school compared to many other educational institutions. Many factors contribute. Students with a vocational interest are more likely to complete their education when they see the education as relevant to that interest. Students enjoy their subjects and the way that Education Management enables them to learn leading-edge practices. The schools also make it easy for students to find part-time, summer and full-time employment with interesting companies. By learning the causes for students dropping out, Education Management continually redirect its attention to the most important opportunities for making further improvements.

The company now sees an innovation opportunity to provide Internet-based learning for those who either don't have the time to study full-time or don't live near its schools. It has three bachelor's degree programs online and has trained more than 200 faculty members as online facilitators. Student and industry reaction to online course work has been very positive. Ultimately, online courses are expected to operate at a higher profit margin than those that are site-based.

Reflecting its business model innovations, Education Management describes its art institutes as "America's leader in creative education."

Future company innovation opportunities include applying this business model to other educational disciplines. In December 2001, Education Management acquired Argosy Education Group, which has undergraduate and graduate academic programs in the behavioral sciences, education, business, law and health sciences with nearly 6,000 students as of the fall, 2001. Stay tuned for more business model improvements, replacements and innovations in the company's historical educational disciplines as well as these new ones.

Not everyone moves so rapidly to become a continuing business model innovator. Zebra Technologies was like many start-up businesses. It began with no fixed business model. Rather the company's two founders opportunistically worked part-time on whatever custom electromechanical engineering projects they could find, and sometimes manufactured what they developed for their customers. The company unintentionally stumbled onto its first sustaining success after several years when it began making paper tape punches and readers for directing machine tools. Zebra soon realized, however, that this market was small and declining. Having benefited from that first business model, however, Zebra then began a deliberate search for a similar business but in a better market. Within two years, the firm offered its first bar code printer. The timing was good, for soon thereafter the Universal Product Code was adopted and the market for portable bar code printers expanded rapidly. Its printers were first used for meat and produce counters. The company next learned how to expand that expertise into other end markets that could benefit from bar codes such as industrial markets for inventory control.

Yet, most companies are still using the same business models as they did decades earlier and have no process to locate improvements and install them. Where should they begin in order to establish that first successful business model innovation?

Starting the Process of Continuing Business Model Innovation

As we noted above, you need to understand and apply your current business model well. In improving your performance with the existing business model, you need to identify what its most effective form of that business model is through careful measurements. The results can be enlightening. Huffy, the leader in U.S. children's bicycles, made a large order for one of its products with an offshore supplier. This was a test to see how costs and quality would be affected by outsourcing. Huffy's executives were astonished to find that they could vastly reduce costs and improve quality in this way. Further, they could refocus their attention on developing attractive new products rather than carefully nursing manufacturing operations to keep costs down and avoid excess inventory. So they reduced employment from over 1,600 people to 120, and became a more effective competitor.

Then ask stakeholders what they believe they are supposed to be doing and what they are rewarded and punished for doing and not doing. At Huffy, this meant rewarding experimentation and rapid roll-out of products rather than emphasizing manufacturing and inventory management. Since many experiments will undoubtedly fail, organizational penalties needed to be removed for those who conduct such experiments as long as implementation of the experiment is done effectively.

Change your communications, visible measurements, reward and feedback processes to emphasize the proper business model focus. The Balanced Scorecard is one tool that business model innovators are using for this purpose. Even with these changes, Huffy found that many employees could not adapt to the ideal implementation of its outsourced manufacturing business model. While continuing to offer learning opportunities to understand the changes and rewarding the proper behavior, Huffy also had to bring in many new employees whose thinking and habits better matched the new business model.

In developing your business model innovation vision and each business model improvement, locate highly desirable new benefits for stakeholders and enhancements of old ones where being first will provide the most ongoing competitive advantages. The four strategic questions you should be continually asking are:

  1. In serving what needs can you be first with the new business model?

  2. Where does being first provide the most initial advantage?

  3. Where does being first provide the most potential long-term advantage?

  4. How large can you become by serving this first need?

Huffy found that it needed to provide bicycles that captured both fashion and more specialized needs of riders at the lowest price point consistent with good quality, while insulating its retail customers from discount competition. The company began to consciously model itself around Nike, the footwear, apparel and sporting goods supplier. The firm expanded from one brand (Huffy) to three (Huffy for value, Royce Union for a trade-up buyers, and X-Games for the sport of stunt bicycling).

With the new business model innovation vision, you need to stimulate new approaches, experiments and tests. Begin by sharing this vision and testing to see that it is understood. Encourage stakeholders to propose new benefits to provide and enhancements of old ones. Be prepared to invest time and money to pursue the most promising ideas. You will often find that those who should develop the new approaches will be different from those who first perceived the opportunity. Provide ways for both sets of people to be involved. Expand the universe of those who can assist in this process as widely as possible. The best test ideas usually come from outside of your own organization. Keep stimulating these activities until your pipeline of improvement developments is operating at the maximum level you can pursue and apply. Then find ways to expand your capacity to pursue and apply improvement developments. The best business model innovators are constantly looking for ways to conduct experiments and tests less expensively and more rapidly.

Take your first proven improvement from the successful tests of experiments and communicate how to install and apply it as carefully as you did the optimum way to use your current business model. Roll the first improvement out with careful measurements in place to be sure that it is understood by stakeholders and effective in delivering the new benefits. Many choose to do this in a geographical part of the business while they are first learning how to be continuing business model innovators. Huffy benefited from using an early success with an in-line scooter to help those in management understand how nimbly and effectively it could operate.

As you pursue these four dimensions, learn from your mistakes and carefully monitor the best practices of your competitors and those in other industries as they pursue continuing business model innovation processes. Huffy found, for example, that it needed to be quicker to cut its losses from tests and initiatives that weren't working.

Key Process Characteristics

We found that the most effective continuing business model innovators shared a number of common behaviors in their processes. When we examined companies that did not pursue continual business model innovation successfully, we found that these elements were missing.

One, the company has established on-going business model innovation as a primary task of the organization. Although few innovators started with this as a priority, a business model innovation did occur at some point in that company. The unexpected success from the innovation then encouraged company leaders to make this shift. Usually, this decision to shift focus was made by the CEO.

Here's how one company made the shift. Before he began searching for successful business model innovations, mining company executive Goldcorp CEO Robert R. McEwen asked himself and everyone he spoke with this question. "Do you think that a CEO would be better off working on improving the company's business model or the efficiency of the way that the company operates now?" After much thinking, he decided to assume that the answer was the former. From this assumption came an inexpensive on-line contest for geologists that led to the company finding more gold reserves in two years than it had in the previous fifty combined. Since 1993, the company's stock price has grown more than twenty-fold.

American Woodmark has made business model innovation a recurring activity on a six year cycle. Top management works for two years to establish the main outlines of what the next innovation must accomplish. Then the new strategic vision for that business model innovation is shared with the rest of the organization. At first, the organization's reaction was to ignore the vision. After enriching the employee's innovation capabilities with training and more selective hiring, employees began to see the potential for their own careers through creating the next, better business model. Today, employees across the organization eagerly ask for advance hints about what the next business model will be so that they can get started on making it a reality.

Two, the company accurately focuses on where valuable competitive advantages can be developed. We call this focus a core insight.

Until the 1970s, parking was viewed as being an expense to be minimized by commercial and retail property developers. After all, their income derived from selling and renting building space . . . not parking. Central Parking realized that such developers were missing lots of potential profitability. With more desirable and efficient parking, developer tenants would pay more for building space and space would be rented out sooner and more often. Central Parking went on to establish many successful services to support such developers. The company's competitors lacked the expertise and interest to pursue these opportunities. Central Parking rapidly grew through internal development and acquisitions to become the industry leader.

For Paychex, the core insight was bringing small employers closer to their employees. Small employers have a hard time competing with larger ones due to usually offering fewer benefits, seeming to be less stable and having fewer ways to help employees become effective. When Paychex was founded, many small employers could not even afford a payroll service, and often made mistakes in withholding and tax reporting. Having found inexpensive ways to meet that need, Paychex expanded into reducing the cost of offering employee benefits like pension plans so that these could more often be available. To help employees progress, smaller companies also need to pay attention to the administrative details of the human resources function. Paychex automated many aspects of that work as well, so that employees feel more professionally treated. As a result of creating these successful solutions, Paychex is the U.S. market leader in serving small employers in all of these areas.

Three, employees, partners, suppliers, distributors, customers, end users and potential stakeholders are encouraged to propose and deliver business model innovations.

At Sybron Dental Specialties, management's priority task is to spend time with such stakeholders to find out about problems they have and how they see possible solutions being developed. The company's leaders each know thousands of dentists on a first-name basis. That's important because individual dentists develop most of the improvements in dental care. Sybron encourages its stakeholders to inform it first of these potential advances. Sybron often invests in or purchases inventions from dentists based on its many contacts.

Mandalay Resort Group learned that it could accomplish more business model innovation by relying more on the initiative of its stakeholders. Its latest major resort-casino is the Mandalay Bay in Las Vegas. Partners such as the Four Seasons Hotels (the premier premium hotel management group) and Aureole (one of New York's top-rated restaurants) run their own parts of the resort without any direction from Mandalay Resort Group. As a result, customers get highly preferred alternatives inside the resort that Mandalay Resort Group could not duplicate on its own. Employees are encouraged to find unique business model innovations too. For example, the gardening staff is encouraged to operate like an external vendor whose charge is to create the best appearance possible. They have developed their own landscaping and greenhouse methods to meet the unique needs of this resort, and save the company millions annually over costs at other resorts while providing visitors with new and more beautiful types of natural decor that have never seen before in Las Vegas.

Four, the company regularly produces large numbers of inexpensive, low risk experiments to test out the potential of possible business model innovations.

At Ecolab, employees learn how to carefully observe and measure best practices among their current and potential customers. They are also encouraged to work with customers to take lessons learned in one account and apply them to similar situations.

Similarly, Dell Computer lets its manufacturing people try any experiments they want with creating better ways to make just-in-time customized products and employ fewer resources in the process. These experiments can be initiated by assemblers as well as by engineers. In one surprising insight, the head of one personal computer factory realized that the building had been designed for traditional manufacturing, which requires lots of overhead space on one floor. Using his imagination, he realized that what was excess vertical space for Dell could be efficiently turned into two floors supplied by conveyers which would almost double manufacturing capacity with only small additional outlays for construction and work stations. As a result, fixed asset intensity for manufacturing was almost halved.

Five, the company's most talented leaders focus their attention on developing and implementing business model improvements and replacements.

At Paychex, the senior management meets together weekly to think about new business model innovations, how to encourage experiments, the progress of existing experiments, and the implementation of proven business model innovations.

At Acacia Research, CEO Paul Ryan and his team rethink whether they should be in their current businesses and with what business models every morning.

Six, the increased cash flow and profits from business model improvements and replacements are first allocated to expanding and strengthening business model innovation before any sharing occurs with stakeholders.

Continuing business model innovators like Dell, Linear Technology, QLogic, Xilinx and Zebra Technologies avoid debt and pile up cash. They want to be sure that business model innovation is unaffected by even the most prolonged slump in the economy and in their industries. They are also unrelenting in advancing investments that enable or facilitate business model innovation as rapidly as possible.

Xilinx knows that the effectiveness of its ability to provide for stakeholders depends on its people. During the recent recession and technology bust, the maker of programmable logic chips deliberately harmed near-term profits in a major way to keep up its employment and innovation spending so that future performance could be much higher than competitors. One payoff of this approach was to shift its best proprietary technology into the next generation of lower cost semiconductor manufacturing a year ahead of any competitor. Although this focus reduced shareholders' stakes in the near-term, shareholders' long-term gains should be more than correspondingly higher. Every other shareholders is clearly better off from the company's approach in both the near and in the long term. Xilinx is also regularly rated by its stakeholders as one of the world's finest companies to be associated with.

Dell has taken this one step further by working on how to make its business models generate increased net cash flow as the company grows faster. It accomplishes this by receiving payment for most of its products before they are shipped and by keeping inventories and fixed assets at a bare minimum.

Seven, the available cash flow and profits beyond what is needed for continuing business model innovation are shared fairly among all stakeholders.

Nucor takes this principle to heart. Everyone in the company receives variable compensation. Production bonuses are paid weekly to help focus on the desire to fairly compensate all employees for what they have just done. The employee payments are made in a way that expands the size of the rewards for all stakeholders. At the same time, the company freely pays for more education for its employees and their families so that future improvements will be forthcoming.

At Timberland, this principle is extended to the communities in which the company operates. Each employee is viewed as a "citizen" and a "paid volunteer" in this role. As part of this commitment, Timberland pays for 40 hours of volunteer time to the cause of the employee's choice so that the community will be enriched as well.

Cytyc also deals in sharing psychic satisfaction. Its excess funds are devoted to developing new tests and encouraging physicians to use them to improve women's health. Early products have included better ways to detect and prevent cervical and breast cancer. All stakeholders can share in the warmth that comes from having there be less disease and suffering among our grandmothers, mothers, aunts, sisters, nieces and daughters.

Opportunities

Business model replacements and innovations most often succeed when they focus in a few areas.

1. Provide new customer or end user offerings or benefits based on a company's existing competitively advantaged activities. Discount retailer Jordan's Furniture had prospered on Main Street in blue-collar Waltham, Massachusetts through three generations of the Tatelman family by offering low prices on quality furniture while employing about 15 people. Then, owners Barry and Eliot Tatelman decided to improve upon that successful business model by making shopping for furniture entertaining. They began by opening late on Saturday night while humorously advertising a spoof of the opening of the television show "Saturday Night Live" on the radio that said, "It's live. It's Saturday night! It's Saturday night at Jordan's Furniture where underprices begin." For busy couples, here was a chance to do a little shopping on the way to or from a movie, or before or after dining at the many interesting restaurants nearby while competing stores were closed.

Encouraged by the response and realizing that others could also open discount stores late, the Tatelmans began to seek additional competitive advantages through business model innovations. Continuing with the idea of making furniture shopping more fun, they began putting new and different types of entertainment right into new suburban stores. To encourage customers to get the most benefit from this innovation, each suburban store offers a different theme and type of entertainment. This permits Jordan's to appeal to more types of customers in more ways while encouraging customers to visit more than one of the stores. As the latest example of its evolution, in 1998 Jordan's opened a 110,000 square foot store in Natick, Massachusetts that offers a free Mardi Gras show in the center using techniques similar to the robotic entertainment at Disneyland. From there you can now stroll past lovely furniture displays to a 3-D IMAX theater in one corner. In another corner, one of the most popular sandwich shops in the area provides great eating.

Through developing this "shoppertainment" approach over 25 years, Jordan's grew to report the highest sales per square foot of any furniture retailer in the United States. Shoppertainment is such a valuable innovation that Jordan's spends less as a percentage of sales to offer and advertise these attributes than the most effective competing stores do for advertising alone.

2. Locate and share valuable new improvement lessons with customers. Ecolab provides cleaning chemicals for manufacturers, institutions, restaurants and other service providers. While initially serving restaurants, Ecolab learned that it was economically more important to restaurant owners to keep good relations with the health inspectors than it was to simply have effective cleaning supplies. Being closed by a health inspector or publicized as unclean could ruin a restaurant. To help its restaurant customers achieve the desired result, the company expanded its offerings to include the chemicals to sanitize everything in a restaurant. With its knowledge of the chemicals, Ecolab also added ways to improve and better maintain the storage, food preparation, water treatment, cooking, dishwashing, cleaning, restroom and disposal equipment by making better use of the chemicals.

The firm later expanded into the pest elimination, janitorial, floor care, water treatment and management advice businesses because these areas are important to restaurant owners due to their significance to diners and health inspectors. In each area, Ecolab carefully observes and measures its customers' experiences to locate the best practices. Using the experience gained from analyzing its observations of many similar customers, Ecolab can advise customers on how to save money, and get better results while paying normal prices for its chemicals and services. The cost reduction benefits alone are often a large multiple of what Ecolab's products and services cost.

No local provider of any one of these services can hope to provide a more effective combination of solutions than Ecolab does. No new entrant nationally can hope to gain the knowledge the Ecolab has to create valuable, custom solutions while selling its products and services at very competitive prices. As a result, Ecolab is often the first choice of restaurant chains for cleaning supplies and sanitation services.

Ecolab duplicated this knowledge-based benefit-development process used for restaurants with other types of customers. Hospitals were an early and natural extension of this concept. Exposure to similar activities in other end-use markets, such as food manufacturing and institutional feeding, created additional knowledge that Ecolab has turned into customer benefits in each market.

3. Adjust prices to profitably encourage more purchases. Cytyc, a start-up that developed an improved Pap smear test for early detection of cervical cancer, was able to persuade insurers in the United States to break with precedent and pay much more for their improved test. This experience was no fluke, for the company was able to do the same for its newer test for earlier detection of breast cancer. In the past, physicians have been reluctant to prescribe new tests, even when they provided patient health advantages, when insurers would not provide full reimbursement. Since insurer costs are ultimately lower by reducing the number of women with cancer, everyone saves money while fewer people suffer.

4. Lower company costs that hold back growth. Software maker Red Hat could afford compete with industry leader Microsoft in providing its server operating system software by relying on a base of the free operating system, Linux, which has been developed as a labor of love and shared on the Internet. As a result, Red Hat's software can be improved faster than Microsoft's can by involving more developers yet maintaining a cost advantage over anyone who develops totally proprietary software.

Goldcorp used its on-line contest for geologists to reduce its cost of finding and mining gold by replacing exploratory drilling with knowledge.

Leading an industry with continuing business model innovation is initially like being the world champion chess player. Although the champion will not win every game, the champion will win more than anyone else by drawing on this well-developed talent. The only way there will be a substantial set-back is if the champion bets too much on the results of a single game.

Like chess matches, continuing business model innovation calls for creating new competitive advantages as opportunities arise and circumstances change. Each competitive improvement during the game can help lock out competitors and create on-going advantages that push the champion further ahead.

When continuing business model innovation is done well, it's as though the chess player with a skill advantage also has an edge in the number of playing pieces before each game, based on past wins. In addition, innovation successes bring more stakeholder involvement and commitment to the company's improvements. This is like having a team of chess masters and the world's best chess computer counsel the chess champion before each move.

When continuing business model innovation is done poorly, it's as if the chess player chose to compete instead in horseshoes and had little skill or experience in that area. After losing lots of time and resources, the disappointed player goes back to chess . . . but with diminished skill and finances.

The business opportunity for you is to be like the world champion chess player with an advantage in the initial number of playing pieces while chess masters and the best chess computers exclusively advise you on every move. The business threat to you is to be like that player's opponent.

Lessons for CEOs

Continuing business model innovation has to be established by a CEO's leadership. Otherwise, the requisite focus and development will not occur.

In small enterprises, the CEO is often the initial source of business model innovation concepts to test. For example, Mr. Don Graber, CEO of Huffy, came up with idea of placing that first large order for outsourced bicycles. Where that is possible, initial progress will be rapid, but later innovations may lag while other await the leader's next brain storm. That was the case at Paychex for several years as founder, Mr. B. Thomas Golisano, was initially reluctant to introduce new services for fear that they could harm the organization's existing level of effectiveness in the simplest elements of payroll processing.

In most companies, however, the CEO will not be able to play a central role in identifying and developing new business models. Such CEOs will need to rely instead on establishing a constantly improving process to generate and use ideas from all stakeholders to establish better business models. As soon as Paychex opened up the role of proposing and developing business model innovations, progress was rapid. In the long run, these organizations may become more effective than those who rely too heavily for too long on an inventive CEO.

Regardless of a CEO's level of skill in developing business model innovation ideas to apply through this discipline, the CEO's interest and attention are critical to turning such efforts from one more new program into the primary source of the company's future success.

A good start for such CEOs will be to read about and visit CEOs who are succeeding in this area. (3) To these investigations, the CEO should bring a sense of openness about what is possible. Establishing and extending an industry-leading business model often means eliminating many elements of the existing ones in a company.

To make room for continuing business model innovation, leaders will need to eliminate some current programs aimed at improving performance. Most CEOs we spoke with told us that each new business model provided more economic advantages than making the old business model more efficient. Since many of such profit-improvement and cost-reduction programs are aimed at improving the operation of obsolete business models, eliminating such programs often eases the change process by freeing up productive people and resources to work on higher potential opportunities.

Your human resource development programs also need to be redirected to emphasize developing business model innovation and implementation skills among those who are the current and future leaders of the organization.

Lessons for Boards

Most board members today look for an outstanding track record of accomplishment in the person they tap as the next CEO. Most of these candidates will have done so through fine-tuning and exploiting a current business model. Based on that successful experience, most leaders who become CEOs will want to do more of the same. However, competitors who focus on continuing business model innovation can quickly make mincemeat of that approach.

In their searches for new CEOs and in the development of other key executives and managers in the company, the wise board will also screen for those who have experience in and an understanding of the processes involved in continually and rapidly replacing business models with better ones. This skill will be one of the few reasons to choose someone new to the company as CEO.

In addition, the wise board will insist that the company monitor best practices in continuing business model innovation and regularly report to the board how company practices compare and what is being done to improve. As a method for doing this, the board should consider establishing a board committee that includes those members will the most relevant experience in this area, possibly such as the CEOs of other business model innovating companies. In evaluating progress in this area, be sure to consider how well current and potential company leaders are developing their knowledge and expertise.

In establishing criteria for selecting and evaluating board members, boards would also do well to look for those with skill and experience in this discipline. In our research on continuing business model innovation, it did not surprise us to find that business model innovators sometimes have the CEOs of business model innovating firms on their boards. The highly innovative, global leader in business information storage services, Iron Mountain, has had the champion business model innovator, Tom Golisano, CEO of Paychex, on its board from the time it was a medium-sized business. In turn, Mr. Golisano recently added Joe Tucci, CEO of veteran storage business model innovator EMC, to the Paychex board.

Board members should consider Mr. Golisano's thoughts about continuing business model innovation:

"Every decade or so, businesses have to master an essential new task in order to prosper. Business model innovation is such a task now. You need to become good at this before your competitors do."

References

(1) For more of our findings, see Mitchell, Donald W. and Coles, Carol, (2003) The Ultimate Competitive Advantage: Secrets of Continually Developing a More Profitable Business Model, Berrett-Koehler, San Francisco. Each part of this book is introduced by an on-going example of what could be accomplished by employing continuing business model innovation with that simple small business, a child's lemonade stand. We have since found photographic evidence that each of these potential innovations has been practiced by a child's lemonade stand somewhere in the past.

(2) To read our annual research on this subject through 2001, as reported in Chief Executive Magazine, see the articles menu for the "leading" file folder on the home page of www.mitchellandco.com.

(3) The most extensive compilation of these companies can be found in The Ultimate Competitive Advantage, ibid.


Donald Mitchell is CEO and chairman and Carol Coles is COO and president of Mitchell and Company, a strategic consulting firm they co-founded in 1977. They have contributed to many business model innovations, including more profitable ways to gain market share, adjust prices, reduce costs, add new customer benefits, improve customer and product mix, lower costs of capital, increase stock price multiples, attract more supportive shareholders and anticipate stock-market reaction to corporate decisions. Mitchell and Coles are co-authors of The Ultimate Competitive Advantage (Berrett-Koehler Publishers), The 2000 Percent Solution (with Robert Metz, AMACON), and The Irresistible Growth Enterprise (Stylus). Background on the firm can be found at www.mitchellandco.com .

Many more articles in Competitive Strategy in the CEO Refresher Archives

   


Copyright 2003 by Donald Mitchell and Carol Coles. All rights reserved.

Current Issue - Archives - CEO Links - News - Conferences - Recommended Reading