Gaining and Extending Industry
Leadership Through Continuing Business
"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," says B. Thomas Golisano, founder, president and chairman of Paychex, Inc. What are the implications of this view for you?
In 1992, we began looking annually for best practices at the 100 companies whose stock prices grew fastest under the same CEO in the prior three years.1 We used three joint criteria: (1) the companies had been publicly held for several years and were above a minimum stock market equity capitalization size; (2) their stock prices grew the fastest during the previous three years within the group that met the first criterion; and (3) the same CEO was in place throughout the three years.
Our study period begins in 1989 and continues through the present. From 1992 on, we looked at, spoke with, queried, and visited a new group each year that met our criteria, with the minimum size adjusted to reflect changes in overall company valuation levels. Most CEOs and their companies were on the list briefly, but a handful frequently repeated. We paid more attention to those perennial winners, and interviewed many of them every year.
Beginning in 1995, we began to notice that they had made large changes to improve their business models. Then we noticed that they did it again. This surprised us because our earlier studies of best practices showed that such advantaged changes in business models occur infrequently.
We began visiting these companies, such as Dell Computer, EMC, Paychex and Tellabs, for in-depth investigations and expanded our knowledge further. We interviewed others about how their efforts had contributed to their extraordinary success, and continually studied the actions and performance of all the most frequent repeaters. It became clear that continuing business model innovation was their most important process for gaining and expanding on competitive advantages and industry position.
Definitions: What Are Competitive Advantages, Business Models, and Business Model Innovations, Replacements and Improvements?
A competitive advantage means that your products and services can be provided in ways that deliver more sales, higher profitability and greater cash flow to you than would occur for a competitor if that competitor supplied the same customer instead.
Here's what we mean by business model improvement and replacement. A business model contains the combined elements of "who," "what," "when," "why," "where," "how," and "how much" involved in providing customers and end users with products and services.
For example, many companies expand their direct delivery of products and services into more countries, changing "where" they operate. If they do this before other effective competitors do, they may develop an advantage over local suppliers whose offerings are weaker in some of the other six business model dimensions.
Changing a single business model element in a way that substantially enhances a company's ongoing performance versus the competition in sales, profits and cash flow is an improvement. Merely matching the competitor's offerings is a business model catch-up.
A business model replacement to us means improving at least four of these business model elements versus the competition. For instance, Iron Mountain, the global leader in records storage and management, started as a small data and paper records storage service in portions of the New York and New England areas. Iron Mountain changed "who" it provided services for and "where" it provided services several times by expanding first regionally, then nationally, and later globally to become uniquely positioned to help the largest worldwide customers.
It changed "what" it offered several times by focusing on helping customers manage their records more effectively in new ways. These new services include consulting, shredding at secure facilities, and recapturing lost electronic data.
By adding a great many facilities, Iron Mountain could handle all of many geographically dispersed customers' storage and management needs, changing "how" these customers could manage their information through outsourcing. Building its understanding of customers' needs for and use of storage, Iron Mountain was able to design ever improving programs that greatly reduced the storage that customers needed while improving data access, cutting "how much" customers pay in total. The bulk of Iron Mountain's competitors continue to operate like Iron Mountain originally did on a local basis. That's pretty typical. Companies find any change to be difficult to make, and business model changes are usually among the most challenging. You'll find out more about Iron Mountain later in the article.
When a company makes business model replacements that provide product or service offerings to customers and end users that were not previously available, we refer to those replacements as business model innovations. Since its competitors did not offer Iron Mountain's business model replacement, Iron Mountain's replacement was also a business model innovation. We refer to the process of developing and making these novel replacements as business model innovation.
When a company pursues an ongoing process of developing and installing business model improvements, replacements and innovations, we refer to that process as continuing business model innovation. When a company merely apes the improved business model of a competitor, that's still business model catch-up, which seldom draws a company into a profitably advantaged competitive position.
How Examples Were Identified and Examined
To extend our research base, we read 20 years of the Value Line Investment Survey to locate other possible examples.
We contacted all companies which seemed to have repeated business model innovation successes, and asked them what they had done. Interviews followed with the CEOs and senior company executives.
We also tracked these business model innovators to see how their subsequent actions have worked out.
From these investigations, we began to notice patterns of how organizations were repeatedly creating the business model innovations.
For the purposes of this article, we have concentrated on examples that apply to small for-profit companies becoming industry leaders.
The results of this research are reported in more detail in The Ultimate Competitive Advantage: Secrets of Continually Developing a More Profitable Business Model (Berrett-Koehler 2003).
The Importance of Continuing Business Model Innovation
Continuing process improvement has been applied to many corporate activities, from new product development to quality enhancements to cost reductions. What can continuing process improvement do for business model innovation?
Leading in continuing business model innovation within an industry 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 a chess champion, 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 innovator goes back to chess . . . but with diminished skill and finances.
As a result, skill in and pursuit of continuing business model innovation can create the ultimate competitive advantage. Your knowledge, skill, strategic position and resources can advance in lasting ways relative to your competitors.
The opportunity for you is to be like the world champion chess player with an advantage in the number of playing pieces while chess masters and the best chess computers advise only you on every move. The threat to you is to be that player's opponent.
Paychex Delivers More Benefits and Profitability
To get a sense of the opportunity and what's involved, let's briefly look at a star business model innovator and his company, B. Thomas Golisano, founder, chairman and chief executive officer of Paychex. The company started with three employees in a small office in Rochester, New York, committed to providing payroll services for small employers in Rochester who could not afford to use an outside accountant or a computer-based payroll service like those provided by Automatic Data Processing. Through innovations for making payroll processing simpler and easier to do, Paychex expanded its sales, stock price and profit margin in a way that serves as a standard for the successful business model innovating company.
Mr. Golisano founded Paychex with an initial business model of providing a lower cost payroll service for small companies in Rochester. Costs were lowered for employers by doing more of the work for the employer at Paychex, and minimizing transmission costs. The employer used the telephone to provide the necessary information to Paychex and the company returned the finished checks and records by mail.
If the mail was delayed, a Paychex person could provide the necessary detail over the telephone so the employer could write the small number of payroll checks by hand. Other payroll services at the time required employers to fill out complicated computer forms, a process that involved lots of time and training. The forms and checks were then hand carried to and from the employer.
These initial business model innovations by Paychex provided continuing advantages over many payroll service competitors, and would have sustained substantial growth simply because there was little competitive innovation in payroll processing for small employers. Think of this as a classic strategy of offering lower costs to the customer for payroll processing.
Spurred by innovations of larger competitors, Paychex later began making tax deposits for customers, to help them avoid government penalties for late payments, which was a much bigger cost than payroll processing. Despite being late with that shift compared to large company payroll processors, Paychex was impressed by how much the new service helped its business.
The company began to look around for ways to lead with new business model innovations. Before long, Paychex realized that many employee benefits, such as pensions, were expensive for small companies to administer and required accurate payroll records. Who better to serve these needs than the lowest-cost payroll service?
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) by making small employers more competitive in providing benefits related to larger ones.
In the process of making its business model innovations, the Paychex after-tax profit margin grew from 9% of sales in 1989 to 29% in 2001, while revenue grew almost eight-fold with relatively little contribution by acquisitions. By comparison, industry-standard Automatic Data Processing had an after-tax margin on sales of 14% in 2001. Despite this high profitability, Paychex's services usually cost less than competitors and what it would cost a company to do the work for itself.
While Paychex has continued with its strategy of being a low-cost provider of payroll processing for small businesses, its many shifts in "what" services it provides and "how" it provides them added most of the increased value enjoyed by the company's stakeholders. If Paychex had remained focused solely on being a low-cost payroll processing service for small businesses, the company's profits would probably be much less than a fifth of what they are today.
Shifting its business model to provide innovative services never before available to a small business from a payroll processor made all the difference. Not surprisingly, the company's stock price went from a range of $0.68 to $1.07 in 1989 to a range of $28.30 to $51.00 in 2001.
The rest of this article follows the sequence most companies go through to become more adept than their competitors in using business model innovation to continually reinvent themselves. Here's what typically happens:
What's Required for a Continual Business Model Innovation Process?
Continual business model innovation processes require the following four dimensions:
A more valuable approach to continual business model innovation also describes more than one future generation of innovations in terms of dimension.
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 and customers do not understand what they are supposed to be doing. Even more businesses have left the second dimension undefined and ignored the third dimension altogether. Many companies are pursuing no business model innovation experiments or tests. That fact alone makes it clear why few companies are enjoying the benefits of continual business model innovation.
For each of the first three dimensions of continual business model innovation, you need to identify the seven key elements-the "who," "what," "when," "where," "why," "how," and "how much"-viewed from the perspective of all direct and indirect stakeholders. Their combination defines either a business model or a business model innovation vision.
Examples of Pioneering Innovators
Here are two examples of relatively small businesses that pioneered initially with new business models, and later added competitive advantages to their initial business model innovations that propelled them to become industry leaders. These examples also show key elements of how and why continuing business model innovation is such an effective competitive tool.
Iron Mountain started as a data and paper records storage service for the New York and New England areas. Auditors usually insisted that companies employ off-site storage for their backup computer files. Iron Mountain's first facility was in a cave, which provided unrivaled security. Since its trucks were carrying data storage from and to customer locations and there was plenty of empty space in the cave, it was logical to bid for the customers' paper storage business as well.
Management next developed a vision to provide all of a customer's records and information storage and management. Served by many tiny companies, the industry was ripe for consolidation and an improved business model to serve all of these needs.
Bell & Howell had the same idea and started in this direction by purchasing the Bekins records storage business in California and small operators across the country. When Bell & Howell's management decided to take the company private, it sold the records storage business to Iron Mountain. Iron Mountain thus became the only national vendor of these services.
The company could now add value to local storage companies when it acquired them by bringing in national account volume and more professional management of outsourced customer accounts. Soon, business was growing rapidly.
Launching More Successful Careers
Commercial art schools had been teaching for decades when Education Management started out in 1969 by purchasing the Art Institute of Pittsburgh. How could the company develop a competitive advantage?
Education Management expanded its focus from teaching commercial art to also serving employers' needs. The company learned to help its students get and hold commercial art jobs and make better career progress in them. Education Management initially made seven business model changes:
This new business model meant that Education Management was often the first commercial school in a metropolitan area to offer a diversity of art, design and culinary programs, along with 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 new school to effectively employ the company's improving acumen. In 2002, Education Management had 24 art institutes located in 21 major metropolitan areas across the United States, with a student population of 32,000 as of the fall, 2001.
The Advantages of Starting First
Each of these companies developed close relations with important customers and non-customer stakeholders through its new business model. Iron Mountain showed customers the benefits of outsourcing data management while providing the biggest, national customers with safer, more reliable storage. Education Management looked to provide a more productive employee to the largest local, regional and national employers, while making it more economically attractive for students to learn.
Once you have such relationships, keep them inaccessible to competitors. To wall off competitors while maintaining the relationships, first learn about the newest and most difficult problems these key stakeholders have. You can also create dialogues with stakeholders to improve on your business model.
You start with a base volume that can make everything new you do more profitable, allows you to offer more stakeholder benefits, lets you provide more attractive pricing and lowers your costs. Iron Mountain filled its storage sites faster and collected more revenues per facility than those who did not have national accounts or data management services. Education Management saw its revenues rise in fully developed schools, with relatively little additional investment.
In the cases of Education Management and Iron Mountain, business model advantages also made it possible for the companies to expand geographically through acquisitions and local start-ups, while enjoying superior economic results compared to competitors. With this enhanced geographic scale came the opportunity to develop even more potential business model advantages.
In planning your improved business model, locate enhancements where being first will provide the most ongoing competitive advantages. The four strategic questions you should be continually asking are:
Stay Focused on the First Solutions Where You Have an Advantage and Expand on That Strength
Have you ever watched pent-up, flowing water break through an earthen dam? At first, the water simply washes against the dam's side. Gradually, the water's weight and current begin eroding the weakest sections of the dam's soil. Next, earth along the entire dam begins to fall into the water. But the sections that eroded first continue to succumb more rapidly than the rest. Suddenly, a small trickle of water escapes the dam. The trickle rapidly becomes a stream and then a torrent. Meanwhile, the water cuts an ever-wider channel through the weakest sections of the dam. Adjacent sections collapse from the wetness and water pressure. Soon, the water has escaped the dam.
This natural physical process also captures the way that business model innovations work. A business model innovation attracts open-minded customers with great potential to benefit. Other similar customers will be attracted next. In subsequent business model improvements, the innovator must first concentrate on the advantage that has breached the dam of customer indifference. In this way, the next innovation can gain more rapidly than the last one. When a company shifts attention to serving dissimilar customers or to unrelated benefits, stout indifference to the new offerings will probably hold back the innovation like an unbreached earthen dam holds back water.
Let's look again at the two innovating companies to see how they built on their initial business model advantages to accelerate growth and profitability.
From Orderly Records to Cutting Records Costs Everywhere
Iron Mountain realized that its national coverage needed to expand to meet all of a customer's storage needs. The company acquired other firms to fill the geographical gaps, often making 18 to 20 purchases a year. This domestic consolidation was capped in 2000 when Iron Mountain purchased Pierce Leahy, one of the company's largest competitors for paper storage.
Large companies do business globally. Recognizing that, Iron Mountain began acquiring a worldwide capability in 1999. Europe and Latin America were the initial focus. By 2001, the company was clearly the world's leader in records and information management services.
In this business, customers seldom change suppliers. The average account lasts for 50 years. As a result, Iron Mountain is building a long-term relationship with customers that enables the company to add new services. These new services build on its knowledge of how each customer uses storage and information, and increase the profitability of existing accounts and acquisitions.
All Iron Mountain employees are eligible for gain-sharing incentives based on both the performance of their unit and the entire company. This stake in the company's overall success may have encouraged service innovation in support of the company's business model.
Here are examples of new offerings. One service helps ensure that digital records can be read and used when they are retrieved from storage. Iron Mountain will also do confidential shredding and disposal of outdated paper records inside its secure sites. Its consulting services are always adding new ways for customers to reduce records cost while increasing the integrity of those records.
From Teaching Commercial Art to Creatively Improving Education
Commercial art applies artist talent and skill to commerce. Education Management soon learned from employers that they needed commercial artists with broader backgrounds. The company first expanded the variety of educational disciplines at the associate of arts level. The firm later added bachelor degree programs that required an additional 18 months of learning, but led to a much higher economic return for graduates on their educational investment.
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.
When computers became more important to 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% get their degree. By comparison, the national average completion rate of all bachelor's degree programs is 40%. Many factors contribute. Students with a vocational interest are more likely to complete their education when they see the education as relevant. 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.
The company now sees the opportunity to provide Internet-based learning for those who 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 development, Education Management describes its art institutes as "America's leader in creative education." Future company 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.
The Advantages of Staying Focused on Building from Initial Advantages
As you can see from these examples, focus adds to knowledge of what customers need and how to provide better solutions. Without that focus on continuing business model innovation, competitors can gradually catch up to an advantaged business model.
Adding superior new solutions over a long time increases customer stability. From such longer-term relationships, even more can be learned. At the same time, your reputation can be improved with these customers, making them more willing to try your new products and services.
Most interestingly, adding new benefits onto your business model innovations can expand your competitive advantage. Make your competitive advantage in customer performance good enough, and you can afford to acquire your most significant competitors through the profits earned by upgrading them to your business model. The price premium they demand is easily justified by the value your improved business model brings to their operations. Clearly, Education Management and Iron Mountain understand and apply this lesson.
Can this process of constantly improving business models ever stop? No.
In our research, we could find no company that was attempting to increase its rate of successful business model innovation to a maximum level. That suggests that innovations that are not disruptive of existing activities can potentially be added even more quickly than we observed. It's probably the lack of having any significant business model innovation competitors that causes companies to moderate their focus on continuing business model innovation.
The Paychex example seems to support this point. The payroll processing services that Paychex provided were little affected for employees or customers as non-payroll processing services were added. Think of this as modular business model innovation. Notice, too, that such innovations are limited primarily by the ability to provide superior solutions with the business model innovations. With increased development activities to create such solutions, progress can be accelerated.
Most industries do not yet have a continual business model innovator among its leaders. This suggests that existing companies will reap outsized rewards where they can successfully be the first to apply this process to their industries. At the same time, it appears that competitive pressures are likely to become much worse in these same industries when the additional effects of business model innovation are felt.
The implications of this process is particularly positive for companies that operate in countries with the least amount of business regulation, which enhances their ability to conceive of and execute flexible changes in business models. As a result, U.S. companies are especially likely to benefit from this approach. This observation is validated to date by the much smaller incidence of continuing business model innovators we found among non-U.S. companies.
Finally, many companies are finding it harder and harder to differentiate themselves successfully through technology and new products. In such an environment, continuing business model innovation can become much more important. Robert L. Bailey, president and CEO of PMC-Sierra, put it this way, "Technological innovation gives a company a 6-12 month advantage, at most. A business model advantage can last years potentially yielding a dominant franchise."
We were encouraged to see that many technology-based companies like Applera, Beckman Coulter, Business Objects, Cephalon, Cytyc, Dell Computer, EMC, Linear Technology, PMC-Sierra, Qlogic, Red Hat, Rogers, Sybron Dental Specialties, Tellabs, TriQuint Semiconductor, Xilinx and Zebra Technologies have made continuing business model innovation part of their corporate strategies.
It's clear that continuing business model innovation is in its infancy. We look forward to observing what it's full potential will yield in the future. Clearly, the opportunity is unique and vast . . . a sort of Oklahoma land rush for corporate strategists.
Footnote 1. If you would like to read this research, it is available for free at www.mitchellandco.com (click on the "leading" file folder at the far left on the home page to see the index of articles and companies).
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 .
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