April 2010


I’ve just finished Seizing the White Space: Business Model Innovation for Growth and Renewal by Mark W. Johnson (Harvard Business Press).  Johnson is chairman of Innosight, a consulting and investment company he co-founded with Clayton Christensen, Harvard Business School professor and author of The Innovator’s Dilemma.

Johnson aims to present a systematic approach to business model innovation that has grown out of the original research and analysis that fueled The Innovator’s Dilemma. For me, the most important contribution of that earlier work was the way that Christensen revealed an underlying pattern that explained the successes and failures of different innovations.  Since that book was published, Christensen and Johnson (and other collaborators) have refined those ideas, and this book is a neat and concise summary of their current thinking and practice.  In a nutshell, successful innovation requires a solid customer value proposition, a profit formula that will deliver value to the firm, and the right resources and processes.

Johnson makes these ideas accessible without watering them down too much.  When he talks about the role of resource velocity, for example, even readers without an MBA or experience in finance or accounting will get the relationship between resource turnover and profitability.

While Johnson is targeting the challenges of innovating from inside an incumbent business, any one who is developing a business will benefit from his business model innovation framework.

The white space that Johnson wants readers to seize is an area that does not fit well with the current organization (or industry) and consists of either new customers or existing customers served in new ways.  The customers comprising the white space are often nonconsumers who lack access due to affordability or skill.  Many of the case studies Johnson uses to support his argument, such as the $2,200 Tata Nano, the world’s cheapest new car, include new business models that address this lack of access.

This book reinforces one of the themes you’ll find in my previous posts.  Successful innovation starts with finding one or more unmet or poorly met “jobs” that a customer needs to get done.  This outside-in approach to innovation often runs counter to the way most companies innovate, but Johnson will convince you that business model innovation has the potential to create far more value than does product innovation.

Copyright 2010 by David G. Bakken.  All rights reserved.

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You’ve probably heard about Spirit Airlines’ decision to charge customers for carry on baggage–$30 per bag if purchased in advance, or $45 “at the door.” You’ll still get your one free “personal item.”  This latest example of an airline unbundling one more feature of its service offering resulted in a promise to Sen. Charles Schumer (D, NY) from five other major airlines that they will not follow Spirit’s lead, at least for now.

Spirit claims on its website that this charge will lower overall costs to passengers and improve service.  Here’s how this is supposed to work:  fares will be lowered somewhat, as will fees for checked baggage.  Since carry on bags have a big impact on how long it takes to board and to deplane (according to Spirit, but many passengers will probably agree), reducing the number of carry on bags on a flight will reduce turnaround time and get passengers off the plane more quickly once it has arrived at its destination.  Security lines will also move more quickly (ignoring the effect of passengers traveling on other carriers who will still have their carry on bags).

One wonders whether Spirit gathered any consumer intelligence or conducted any experiments to arrive at this decision.  Airlines have had varying success at generating revenues by implementing fees for service features that were once bundled into the fare.  US Airways, for example, seems to have retreated from charging for non-alcoholic beverages (including bottled water).  JetBlue has started charging for headphones but recent experience suggests that on some flights they still may give them out for free once the plane has left the gate.  Fees for checked bags may stick–as long as you get that free carry-on–but any additional fee gives a competitor a potential point of differentiation.  Have you seen the Southwest commercial, “Battle Cry,” where the ramp crew, in the manner of sports fans, flash the passengers on a rival airline with “BAGS FLY FREE” spelled out across their chests?

People’s Express was one of the first post de-regulation airlines built around a low cost no-frills business model, and perhaps the first to charge for checked baggage ($3 per bag).  Many elements of PE resembled Southwest’s model–one type of aircraft, open seating, and really large overhead compartments for those carry-on bags.  Food and drink were available for purchase, and all the seats on a given flight were the same price.  In many ways, the experience was more like being on a train or bus than an airplane, and with one-way fares between Newark and cities like Boston as low as $19, a lot of passengers were likely switching from those modes.   There’s no question that PE helped democratize flying, overcoming the affordability barrier for many passengers.  Following it’s initial success, People’s Express went on a buying spree (taking on a lot of debt) and the legacy carriers discovered yield management, enabling them to match or come close to PE’s fares for at least some passengers.  With all that debt, PE abandoned its original customer value proposition and profit formula and began to look more like other airlines.  Ultimately, PE was acquired by Texas Air and ceased to exist as a brand.

Whenever an airline makes a move like charging for carry-on bags or for using the lavatory (Ryanair), I can’t help but wonder if they even have a customer value proposition.  One problem may be that flying on an airplane is only a means to an end (the job that the consumer wants to do at the other end of the flight) rather than an end in itself.  This makes it hard to find a price that both matches the value to the passenger (which is a function of the value of completing the job at the destination) and the cost of providing the service, plus some profit.  The carriers have long inferred that business travelers place more value on the job to be done at the destination, and they have implemented a variety of pricing strategies to segment their customers based on the assumption that leisure travelers are far more price sensitive.  However, most of the assumptions about pricing do not reflect any understanding of the ways customers evaluate pricing relative to the value of the jobs to be done.  In the absence of such understanding, carriers have resorted to “mechanical” solutions to pricing and revenue generation.

Actions like Spirit’s carry-on fee often provide new instances of the law of unintended consequences.  It will be interesting to see what happens in the next few months.  Will Spirit retreat, or will other carriers follow suit?

Copyright 2010 by David G. Bakken.  All rights reserved.

I’ll be presenting a new workshop, “Think Like a Respondent:  A Cognitive Approach to Designing and Testing Online Surveys” as part of the ESOMAR Online Research Conference, 17 October 2010, in Berlin.  Click here for more info.

DGB

Yahoo Finance published an article today from Investopedia by Mark Riddix titled “Business on the brink: Change or fail?”  Of the five companies profiled, the only one that evokes a twinge of sadness for me is Borders Books (the others are Blockbuster, Rite-Aid, Palm, and trucking company YRC). (more…)

Nassim Nicholas Taleb introduced a new term into the lexicon of business forecasting, the “black swan event.”  The metaphor comes from the apparent fact that, for some reason, black swans should not exist, but they sometimes do.  In THE BLACK SWAN:  The Impact of the Highly Improbably, Taleb expounds for  366 pages on what is, for the most part, a single idea:  the normal (bell-shaped) distribution is pretty much worthless for predicting the likelihood of any random occurrence.  Taleb augments this idea in various, occasionally entertaining ways, acquaints the reader with power law and “fat tail” distributions, and takes excursions through fractal geometry and chaos theory.

Taleb tells us he aspires to erudition, and he introduces the reader to plenty of “great thinkers” that history has failed to credit.  You can come away from this book feeling that it is mostly about showing us how erudite Taleb is.  For me, one of the key shortcomings is Taleb’s tendency, via style, to claim that we should accept his arguments on faith.  There are plenty of concepts, especially involving numbers, that would benefit from concrete examples.  There’s just a little too much “Take my word for it” in his writing.  Still, if you’ve got time to kill, this is not an unrewarding read.

David Orrell tackles the very same subject–our inability to predict the future–in The Future of Everything:  The Science of Prediction (which has a sub-sub title: “From Wealth and Weather to Chaos and Complexity”).  For a mathematician, Orrel has an entertaining style and writes with clarity.  This book is far more focused than THE BLACK SWAN, which is sort of meandering.  The book is divided into three main parts: past, present and future.  The past provides a history of forecasting, beginning with the Greeks and the Oracle at Delphi.  The present considers the challenges of prediction in three key areas: weather, health (via genetics), and finance.  Orrel did his dissertation research on weather forecasting, and after reading this book, I think you’ll agree that it’s a great case study for revealing everything we think we know about the “science of prediction.”

Orrel’s main point is that a key problem in prediction is model error (the basis of his dissertation), which far outweighs the influence of chaos and other random disturbances.  In a nutshell, the complexity of these systems exceeds our ability to specify and parameterize models (models are subject to specification error, parameter error, and stochastic error).  Weather is a great example.  While there are only a few components to the system (temperature, humidity, air pressure, and such), the interactions between these components are almost impossible to predict.  Another problem is the resolution of the model; conditions are extremely local, but it it very difficult to develop a model that resolves to a volume small enough to predict local conditions.

Orrell educates.  The reader comes away with an understanding of the logic and mechanics of forecasting, as well as the seemingly intractable challenges.  Orrell provides clear explanations of many important forecasting concepts and does a good job of making the math accessible to a general reader.  There are a couple of shortcomings.  Orrell gives only passing notice to agent-based simulation and similar computational approaches to complexity.  And, in the third part of the book (the “future”), after spending the preceding two parts on the near futility of prediction (but for different reasons than Taleb), Orrell offers his “best guesses” for the future in areas such as climate change.

While I embrace the basic premises of these books, some new developments are cause for optimism.  Economists using an agent-based model of credit markets were able to simulate the fall off the cliff that we’ve experienced in the real world, as just one example.  While not truly “predictive,” these models can help us understand the conditions that are likely to produce extreme outcomes.

THE BLACK SWAN has its rewards, but The Future of Everything has far more value for the forecasting professional.  As a chaser, you might try Why Most Things Fail:  Evolution, Extinction and Economics by Paul Ormerod.

Copyright 2010 by David G. Bakken.  All rights reservcd.