Business Designs for Strategic Control of a Profit Zone
This is the second in a four part series on controlling the architecture. This post is a synopsis of Slywotzky and Morrison's discussion of how strategic business design leads to profits. They developed a general strategy for gaining strategic control, as one element of a business design, by distinguishing between 22 models with different profit zones and strategic control points. My occasional comments are enclosed in square brackets.
The third post will continue this review by summarizing Slywotzky and Morrison's case study of how Microsoft evolved its standards-based architectural control through its first twenty years. In a subsequent fourth post, I will compare and contrast ideas from these contributions, contending that it may be useful, even though both are based on a de facto standard business design, to distinguish between control of a technological architecture during a formative period of hypergrowth and the strategic control of an evolving platform as the gorilla expands into new opportunities.
In 1997, Adrian Slywotzky and David Morrison published The Profit Zone: How Strategic Business Design Will Lead You To Tomorrow's Profit. Slywotzky and Morrison examined how several business leaders had reinvented their business designsby shifting their focus from "products" and "market share" to "customers" and "profits."
Slywotzky and Morrison posited that a business design is composed of four strategic elements: (a) customer selection (Which customers do I want to serve?); (b) value capture (How do I make a profit?); (c) differentiation/strategic control (How do I protect my profit stream?); and (d) scope (What activities do I perform?). If a business is to succeed, not only must these key elements be coherent and aligned with the customer's most important priorities, but also the business must be designed for profitability.
According to Slywotzky and Morrison (p. 13,):
. . . great business design is a combination of superb knowledge about customers and profit . . . together with great strategic imagination. The reinventors' unique skill is strategic creativity: constantly reversing traditional assumptions, developing new options, and making more inspired choices.
To insure long-term viability, a company's business design must be reinvented as customers' needs and priorities change and as value migrates away from the industry's traditional business designs. Just as products become technologically obsolete, business designs become economically obsolete. Over time, because of the competitive nature of business, most business designs are no longer allowed to make a profit. Their profit zone has moved. If a company hopes to create value for shareholders and wants to continue operating in its profit zone, it must reinvent its business design every five years, or even sooner.
Slywotzky and Morrison (p. 32-33) stated that, "The skill of customer-centric business design begins with the single most important insight about the customer and works its way back from that insight to craft the right business design."
The most important insight about the customer was called Customer relevance. Customer relevance must guide business design by answering, "What does the customer want or need?" and "What is the customer willing to pay for?"
To apply customer-centric thinking, managers must reverse the traditional value chain that customarily begins with their own Assets/Core Competencies and ends with The Customer. Instead, the Modern Value Chain reverses that traditional chain by beginning with the needs of The Customer. Thus, Slywotzky and Morrison (p. 21) argued that managers should design their business using the following reversed and customer-centric Modern Value Chain:
(1) what their customer's needs and priorities are; (2) what channels can satisfy those needs and priorities; (3) the service and products best suited to flow through those channels; (4) the inputs and raw materials required to create the products and services; and (5) the assets and core competencies essential to the inputs and raw materials.
Next, this focus on your customer's priorities serves as a guiding star that must be integrated into a strategy for achieving profitability that keeps your eyes on that prize of profits when designing your business model. You must answer two key questions: "Where will I be allowed to make a profit in this industry?" And, "How should I design my business model so that it will be profitable?"
Slywotzky and Morrison described 22 models of profitability that specified how each type of business design achieves profitability, including a diagram to visually illustrate the profit zone within each business design.
[These taxonomic models alone were worth the price of this book, which I bought on Paul Philp's recommendation on the NPI thread, because they provide a framework for analyzing the class of strategies for achieving profitability. Some illustrative, and I hope suggestive, names of the models include: Customer-Solutions Profit, Switchboard Profit, Installed Base Profit, Transaction Scale Profit, Cycle Profit, Value Chain Position Profit, Experience Curve Profit, Low-Cost Business Design Profit, and De Facto Standard Profit (which is of specific interest here).]
In the model of De Facto Standards Profit, the most striking characteristic is the business design's increasing returns to scale. OEMs, developers, and users are pulled into the gravitational orbit of the standard holder, creating a network effect: the more players that enter the value chain [web], the more valuable the system becomes. The holder of the standard experiences Brian Arthur's increasing returns as the value of the system [whole product] and its network [as a value web] grows through a virtuous cycle.
Not only must a business be designed to include a profit zone, but it also must sustain its profits. To do so, a company must create a powerful strategic control point. A strategic control point protects the profit stream that the business design has created from the corrosive effects of competitive and customer power. Slywotzky and Morrison (p. 52) regarded it as critical today because "the rapid growth in customer power in the last decade and a half has forced strategic control to the top of the priority list."
[As the Internet grows, it extends its reach, creating more connection that increase its value. The Internet's low transaction costs reduce the asymmetry of information between sellers and customers by providing customers with rich information cheaply. Information is power. Customer connectivity via the Internet produces both a greater reach and richer information that increases their power relative to sellers. (This is part of the thesis in Evans and Wurster's (2000) Blown to Bits: How the New Economics of Information Transforms Strategy, which provides another rich set of conceptual and strategic tools.)]
Slywotzky and Morrison (p. 53) provided a 10-point Strategic Control Point Index to assess a rank-order of profit-protecting power, ranging from High to None.
High profit-protecting power included:
10-Own the standard
9-Manage the value chain;
8-String of superdominant positions [3 to 5 times competitors' market share]
7-Own the customer relationship.
Medium profit-protecting power included:
6-Brand, copyright
5-Two-year product development lead.
Low profit-protecting power included:
4-One-year product development lead
3-Commodity with 10 to 20 percent cost advantage.
None-no profit-protecting power included:
2-Commodity with cost parity
1-Commodity with cost disadvantage.
Every good business design has at least one strategic control point; the best business designs have two or more. For example, Slywotzky and Morrison (p. 54) noted, "Microsoft owns the standard, a string of superdominant positions (in multiple product categories, and a brand." [According to Business Week and Interbrand, in 2001, Microsoft had the second most valuable ($65.1 Billion) global brand.]
Identifying companies points of strategic control increase analysts' [presumed] ability to predict [relative] future stock prices. According to Slywotzky and Morrison (p. 54) "The greater the strategic control, the greater the predictability; and the greater the predictability, the higher the valuation."
Profit-centric business designs create shareholder value. The value of a business design can be assessed across industries because the drivers of value are the same: return on sales (EBIT/Sales, profit growth (projected growth via Value Line or analysts' estimates), asset efficiency (Assets - Cash& Equivalents - Accounts Payable/Sales), and strategic control (Rating on 10-point Index). [Also, the authors contended that these four metrics are excellent proxies for the everyday qualitative judgments of investors.]
How valuable is your business design? Slywotzky and Morrison (p. 55) argued that these four metrics that can be used to estimate a company's market value (Market Cap/ Sales) and, across time, to measure value migration. Value migration is their term for shifts in customer priorities through time that require a change in strategies and a reinvented business design for capturing value in this new profit zone. That is, as customer priorities shift for A to B, the profit zone moves from A to B with them. Slywotzky and Morrison provided many charts of theses metrics to illustrate both cross-company comparisons and temporal change within companies as they reinvent their business designs. As expected the value metrics were associated with the index of strategic control.
After introducing these concepts in Part I, Slywotzky and Morrison presented case studies of 12 reinventors in Part II. Each reinventor used his outstanding knowledge of customer's priorities and strategic creativity to invent a unique and innovative business design. Microsoft was the subject of their final case study.
In Part III, Slywotzky and Morrison introduced The Profit Zone Handbook, which consists of a useful set of questions designed to help managers move their companies into the profit zone by innovatively changing their business design.
Slywotzky and Morrison (pp. 279-280) concluded:
Reinvention is about the customer and profitability, but ultimately it is about creativity, about designing a business model that is unique.
Perhaps the most important benefit of studying any reinventors and how they discover or create their profit zone in their industries is grasping how the creative process works in business (how business designs change every five years), what discipline (in customer and profit thinking) it requires, and how extraordinary its outcomes can be.
I hope this helps.
Don |
