Can you innovate your business model?

by MRINALINI REDDY

When Zipcar launched in 2000, the American car rental company tried something different: it replaced the traditional daily car rental model with hourly rentals as an alternative for short-distance travel. It would go on to earn a much higher hourly rate than its competitors and the company's annual revenues are today approaching $200 million.

Also consider service provider LiveOps, a company in the business of managing customer service agents. Instead of employing and training a large workforce in low-cost locations such as India, the company built up a pool of loosely affiliated freelancers, allowing them to work remotely, paying the agents only for the time they served on the calls.

What Zipcar and LiveOps share in their achievements is not some breakthrough in their services but innovation within their business and operating models, say INSEAD professors Karan Girotra and Serguei Netessine. Their findings are published in an article “How to build risk into your business model” in the May edition of Harvard Business Review.

These companies differentiated themselves from their competitors by innovating their business models rather than focusing purely on product or technology innovation. They offered existing services to existing customers using existing technologies, but using a different operating model.

“There’s creativity in coming up with new products and there’s creativity in coming up with new business models,” said Girotra, an assistant professor of technology and operations management, in an interview with INSEAD Knowledge. “You can invent new products but to really realise the value, it is important to organise and create the right business model around that.”

Two popular companies did exactly that. Spanish clothing retailer Zara designed a hyper-fast supply chain to deliver new lines of clothing between two and four weeks allowing the company to keep abreast of evolving and arguably fickle consumer preferences. Likewise, technology superstar Apple created an ecosystem that included not only technology and product innovations but also a whole range of complementary software services.

Checklist for innovating your business model

But the challenge with business model innovation is in identifying where and how to make changes. Companies all too often focus on improving three variables—revenues, costs and resource utilisation—the professors explain, but completely ignore the associated business risks. This could include risk related to demand, supply, technology, quality, asset utilisation and many others. Managing those risks and rethinking traditional models can revitalise companies, the professors contend.

“Business models come inherent with some risks in them,” says Girotra. “What we are advocating is changing how your business models deals with those risks.” Additionally, it can also reveal unsuspected opportunities for creating value by adding risk, he adds.

Companies can spark such a risk-focused approach by first assessing their entire value chain including their buyers and suppliers to identify and ultimately reduce the associated risks. In other words, where in the value chain are the risks associated with creating, supplying and consuming products and services? “In my experience, companies do this very rarely,” says Netessine, a professor of technology and operations management. “They focus more on reducing costs rather than thinking about what kind of risk comes with this cost reduction.”

The professors offer a couple of techniques for reducing the risk variables. Speeding up the production process is one way, the professors explain, but it may well entail shifting operations. Zara’s zippy production cycle challenged the supply chain orthodoxy and proved that managing demand risk clearly outweighed the relocation and higher labour costs. “What many traditional apparel retailers did not probably think about was an increase in their risk exposure in [outsourcing to countries with low labour costs],” says Netessine. “Suddenly they have to think very very far in advance about what to produce, how much to produce, where to produce and once a decision has been made, it’s very hard to reverse it because it takes time to deliver goods.”

Another approach lies in shifting risk exposure by altering contracts with other stakeholders: employees, suppliers and customers. With LiveOps, for instance, changing the terms of employment from permanent to freelance hires transformed the company’s risk profile where employees now bore the risk of their underutilisation amid call centre downtime. Employees were willing to assume this risk in return for being able to make their own hours and work from home.

When it’s impossible to radically shorten production cycles or alter contractual agreements in the value chain, the professors offer another technique that improves the quality of information used for basing commitments. MyFab—an Internet-based furniture retailer—uses a design catalogue to gather customer feedback on furniture designs and only the most popular ones are put into production and shipped to buyers directly thereby reducing its exposure to stock-outs and excess inventory.

New risk can create a new competitive edge

But the aforementioned strategies can backfire without consideration of new risks created, the professors caution. For LiveOps, a new risk of reliability arose from employing freelance agents and independent contractors. The company in turn mitigated this information risk by monitoring agents’ performance and routing calls first to the best-performing agents.

In such situations, the ability to manage new risk can become a competitive advantage for companies. “Risk is not always a bad thing,” says Netessine. “What you might want to do is then take more risk upon yourself and that’s something few managers think about.” In the car rental business, the key risk factor is the underutilisation of the fixed assets--the cars. Traditional companies rent in daily increments even if the customer needs the car for only a few hours. Zipcar challenged this industry standard with its hourly rental rates proving that its returns outweigh the costs of maintaining a large fleet and multiple pick-up and drop-off locations.

If there was simply one advantage to driving risk-focused innovation in business models it’s that it’s significantly more predictable and does not require huge R&D expenses, the professors point out. It can be approached in a systematic way and with little expenditure, the professors assert, and relatively clear and credible estimates of the potential benefits and costs can be generated. Further, there’s no requirement for extensive experimentation and prototyping to identify powerful innovations.

Netessine cites the example of his native Russia where the government has made efforts to reinvigorate the economy with huge amounts allocated to achieving breakthroughs in technological innovation and nanotechnology, in particular. “My concern is that most of the Russian economy has nothing to do with nanotech,” says Netessine, “it’s mostly oil and gas.” A burgeoning industry like nanotech would take 10, 15 or 20 years to commercialise, he adds. “Most business models [in Russia] are very inefficient or ineffective. With innovating business models you don’t need to spend money on innovation and at the same time you see the results much faster.”