Chapter 11

Malleable: Business Model Innovation

“DOA (Dead on Arrival)!” exclaimed Jonny Evans in Computerworld about tablet competition as Apple announced version two of its iPad.¹ Jason Perlow ran a blog on ZDNet a few weeks later with a picture of the HP TouchPad with the same acronym “DOA” in bold and red.

Perlow said, “The only way the iOS tablet ecosystem can be disrupted by a competitor is to come in substantially cheaper. I've said this as well about Android tablets—without a comparable ecosystem, you have to come in as more value-priced.”²

He was prophetic. Just a few weeks later HP announced it was killing the product and announced a fire sale with some versions going at $99. Later in 2011, Amazon announced its tablet, Fire, at $199. Definitely value-priced!

Samsung and other tablet vendors may disagree—indeed, they should be offended with the DOA designation, but as we have described in other chapters, Apple's efficiency in manufacturing and logistics allows it to compete ruthlessly on price while continuing to be extremely profitable.

It was fascinating to watch, in contrast, when the iPad was introduced, Apple actually managed to convince book publishers to increase e-book pricing beyond the market standard being set by Amazon.

In technology circles, we look for competitive advantage via form/factor and feature/function. Mark Johnson of the consulting firm Innosight (which he co-founded with Clayton Christensen, well known for his work on disruptive technologies) says, “It's far harder for an incumbent to fight back against a business model innovation than it is for them to match and raise the stakes on a technology innovation.”³

Repeatedly, Apple has shown a willingness and ability to compete on “business model innovation.” Amazon does the same—it lost money on many e-books at $9.99 as it tried to build customer loyalty around a new way of reading books on Kindles. It has long subsidized shipping of physical books and other items and it offers customers Prime membership, which for $79 a year (in the United States; prices vary in other countries) includes two-day shipping. This is a great deal for frequent customers.

Competing on Business Models

The strategy consultants at Boston Consulting Group define business model as having two essential elements, the value proposition and the operating model.⁴

The value proposition “reflects explicit choices along the following three dimensions:

• Target Segments. Which customers do we choose to serve? Which of their needs do we seek to address?
• Product or Service Offering. What are we offering the customers to satisfy their needs?
• Revenue Model. How are we compensated for our offering?”

The operating model “captures the business's choices in the following three critical areas:

• Value Chain. How are we configured to deliver on customer demand? What do we do in-house? What do we outsource?
• Cost Model. How do we configure our assets and costs to deliver on our value proposition profitably?
• Organization. How do we deploy and develop our people to sustain and enhance our competitive advantage?”

Technology is allowing industry after industry to look at new business models. GM used its OnStar navigation and emergency services as a car selling feature. As we described in Chapter 1, it is now unbundling the functionality and packaging it into a rearview mirror that allows anyone—even with a Ford or a Toyota—to sign up at $18.95 per month. We mentioned in Chapter 6 how Virgin America allows you to upgrade for a fee while you are on the plane. Try doing that on other airlines, with their policies that cut off upgrades hours or days prior to a flight.

In consumer markets, mobile payments are increasingly allowing for micro-payments and attracting new consumers “at the bottom of the pyramid.” Of course, they also allow targeting more affluent consumers. Soon you should be able to activate ski insurance for just the day you ski, via your cell phone. Evernote, with apps that help users document and remember trivial and important things, epitomizes the “freemium” business model. Many of its 40,000 new users a day happily upgrade to its paid service after trying out its free products. “Virtual Currency” is growing in popularity, as Zynga shows with its ZCoins and Facebook with its credits.

Don Tapscott, the leading management thinker, puts it succinctly: “There are two kinds of business models: those that have been disrupted by technology, and those that have yet to be.”⁵

Let's look next at some markets that have seen seismic, technology-driven shifts in business models, and others poised to be similarly affected.

Book Publishing

Amazon accounted for an estimated 80 percent of all electronic-book sales, and $9.99 seemed to be established as the price of an e-book. Publishers were panicked. David Young, the chairman and CEO of Hachette Book Group USA, said, “The big concern—and it's a massive concern—is the $9.99 pricing point. If it's allowed to take hold in the consumer's mind that a book is worth 10 bucks, to my mind it's game over for this business.”⁶

Apple agreed to an agency business model as it launched its iPad in early 2010.

“Under those agreements, the publishers will set consumer prices for each book, and Apple will serve as an agent and take a 30 percent commission. E-book editions of most newly released adult general fiction and nonfiction will cost $12.99 to $14.99.”⁷

A few days after the iPad was introduced, a public spat ensued between Amazon and several of the major publishers like Macmillan. John Sargent, CEO of Macmillan, described the disagreement in an open letter:

By Sunday, Amazon announced on its website: “We will have to capitulate and accept Macmillan's terms because Macmillan has a monopoly over their own titles, and we will want to offer them to you even at prices we believe are needlessly high for e-books.”

Needlessly high? Apple can be credited—or blamed—for changing the business model.

The Mobile Phone Industry

“The more things change, the more they remain the same.” That expression could certainly apply to the mobile services marketplace. Prior to Apple introducing the iPhone, carriers paid device manufacturers just enough for “planned obsolescence,” and subsidized those devices to consumers. This allowed them to lock customers into another long-term contract with the new phone. There was little device loyalty. In fact, carriers like Verizon had the marketing slogan “new phone every two years.”

The iPhone is a platform with frequent software updates and an application ecosystem. So it has a much longer brand commitment. The device used to be the commodity in the equation. Now as Apple expands its carrier choices—AT&T, Verizon, and Sprint in the United States—the mobile service becomes the commodity in this changing business model.

“According to Paul Roth, AT&T's president of marketing, the carrier is exploring new products and services—like mobile banking—that take advantage of the iPhone's capabilities. “We're thinking about the market differently,” Roth says. In other words, the very development that wireless carriers feared for so long may prove to be exactly what they need. It took Steve Jobs to show them that.”⁹

The telecom industry has been a fiendishly complex one for Apple to navigate. Working with 200 carriers around the world, each of which is quasi-regulated, is a considerable logistical challenge. Many, like AT&T in the United States, were just not prepared for the heavy data demands the iPhone put on their network, which previously had mostly been geared for voice traffic.

The bigger challenge was that most of the telecoms wanted to continue with older business models, even around the innovative new phone. Two problematic areas, in particular, were long-term contracts (and related early termination fees) and hefty international roaming charges.

• Exhibit A: “Ross had no AT&T service after the nearby cell-phone tower went down and the other towers weren't working. Even still, AT&T wouldn't let him leave service without paying an early termination fee, despite the fact that it could be four months before the towers were repaired. That means four months more without service while still getting a monthly bill.”¹⁰
• Exhibit B: Comment from a customer named Mike: “You can imagine, I was totally floored. I had traveled all over India and Europe for weeks at a time and only incurred a few hundred dollars. Here I am in Canada with an $800 data bill. Pretty shocking. Here is something to keep in mind when you are traveling to Canada planning to use your iPhone: International voice roaming in Canada is $0.59/minute. High, but pretty much to be expected. International data roaming is $.0195/KB. That is about $20/MB. 1 MB is about the size of a small digital photo downloaded in an email attachment. No wonder my data bill was that high.”¹¹

While Ross and Mike may seem like extreme examples, they are actually pretty mainstream. Consumer Reports called AT&T its “lowest-scoring cell-phone carrier in the U.S.,” according to a satisfaction survey of 58,000 and it “found that iPhone owners were much less satisfied with their carrier and rated data service (web and e-mail) lower than owners of smart phones on other carriers that, like the iPhone, have a host of apps to encourage heavy data use.”¹²

Apple has moved away from its exclusivity with AT&T in the U.S. market, but Verizon's service was announced by Wired magazine as “Any smartphone customer who uses an ‘extraordinary amount of data’ will see a slowdown in their data-transfer speeds for the remainder of the month and the next billing cycle. It's a bit of a bait-and-switch. One of Verizon's selling points for its version of the iPhone is that it would come with an unlimited data plan—a marked contrast to AT&T, which eliminated its unlimited data plans last year.”¹³

Sprint, introduced as a new iPhone carrier in late 2011, has been running commercials targeting the data limitations imposed by its competitors.

Apple has smartly been beefing up its iPod to give customers most of the iPhone functionality without a carrier contract. Karin Morton, a consultant from Brazil who travels extensively, says, “I make calls using an Apple iPod Touch with the iPhone Stereo Headset, which has a microphone in its cord and costs about $30. Most people do not realize the iTouch does most things the iPhone does and you do not need to sign up for mobile voice and data plans. If you can get on wi-fi, the free Skype application allows you to call and SMS anywhere.”

It is a miracle Apple has succeeded with its iPhone saddled with its carriers and their business models. It has, however, opened the door for Google in particular to allow other device manufacturers and carriers to rally around its Android platform. According to Gartner, Android's share of the smartphone market has almost quadrupled over the last year, and now stands at more than double that of Apple's iOS.¹⁴

Many of those Android-focused carriers are competing with different business models. MetroPCS, which touts its no-contract policies, announced in late 2010, “This holiday season, we're giving customers what they've wished for—an affordable Android smartphone with a full spectrum of applications and unlimited services to do more like never before.” Virgin Mobile introduced a similar offering: “With a $149 initial investment and then an ongoing cost of less than $1 per day, someone can have a basic, but useful, smartphone in the U.S., with the flexibility of upgrading to a better phone or different carrier at any point in time.”¹⁵

Dennis Howlett, a ZDNet blogger based in Spain notes, “As a regular traveler between Europe and the United States, telco roaming charges and particularly the egregious data roaming costs charged by the mainstream telcos represent a significant cost and cause of deep resentment. Or at least they did up until my last trip. Long-time colleague Zoli Erdos told me about Virgin Mobile USA, which offers a ‘no-contract’ deal that includes unlimited data, wi-fi connectivity, plus 300 minutes of talk time for $25 per month. No need for a U.S. address or credit card—just pay as you go—and top up each month or as travel schedules dictate. That's a bargain in anyone's language, which I grabbed with both hands, courtesy of Best Buy. I also took the opportunity to try an Android-powered LG Optimus device that is updated over the wire rather than relying on a SIM chip. Five minutes spent verifying that Virgin does indeed deliver what it says on the tin and another five minutes for the Best Buy representative to activate the service and I was good to go. In an age of instant gratification, that scores highly as the kind of service and provisioning I want. I can top up directly from the Virgin Mobile website. No need to find top up cards or call in. How good is that?

“The Virgin service runs off the Sprint network backbone. While some say Sprint's coverage is spotty, I had no such problems in either the Bay Area or Orlando. Looking at the Sprint coverage map, I should be fine for all the major cities I visit. The Optimus gives me a full day of juice, which I recharge via my laptop's USB connection. It isn't the most advanced smartphone in the world but is more than adequate for my needs. Heck—it even encouraged me to make a few calls, something I am normally fearful of doing when traveling. At $200 plus tax the Optimus was a luxury treat that will repay itself in weeks rather than years. This is how all telcos should operate: fast, simple, and an easy service to both understand and consume.”

Microsoft, which has acquired Skype, and is working with Nokia, has a huge opportunity to target the Mortons and Howletts of the world looking for reasonably priced roaming functionality.

Business Services

Sun Print Management based in Holiday, Florida, is one of a growing number of managed services providers. It provides a service that manages all the onsite maintenance and help-desk support for your laser printer fleet. Customers are charged not for the individual products that they order, but for the number of pages they print. Each printer keeps a running page count. Page counts are collected electronically and transmitted to Sun Print. Depending on volume, some customers pay as little as a penny a page. Again, it's the model—paying for outcomes and at small units of consumption—that is innovative.

Cognizant, the outsourcing firm, has been offering what it calls BPaaS (business processes as a service) for more complex areas than print services, but using a business model that's as easy to understand and consume.

Francisco D’Souza, CEO of Cognizant, explains, “The global services industry is undergoing deep structural changes that are reshaping both the demand and supply sides of the equation. Through wage arbitrage, economies of scale, and productivity improvements, global services providers have, over the last two decades, delivered significant savings to companies across nearly every industry by reducing the unit cost of many operational business and technology processes.”

He continues,

Analytics-Driven Business Models

Later we will see in the Valence Health case study how new businesses are mining the mountains of data increasingly available. We already live in a world of “big data,” which will soon look tiny as billions of smart devices collect our location, health, energy usage, cooking, and laundry pattern data and with sensors in the field collecting additional commercial data.

These monstrous volumes of data are calling for a new generation of analytical tools. One of those tools is the open-source tool, Hadoop. Per its website:

Hadoop is based on concepts developed at Google and made increasingly robust by other web companies like Yahoo! There are several versions of Hadoop, but a start-up called Cloudera says it has the best Hadoop distribution and it makes money by providing customers services and support around it.

Charles Zedlewski, Cloudera's VP of Products, explains some of the use cases of Hadoop and other “big data” tools:

The Music Industry

It's tough enough to develop a dominant business model in your own industry as Apple has with its iPads. Try bringing along the music industry with a single song model as iTunes did starting in 2003.

The music industry had little incentive to change: “Between the demise of the 45-single and the rise of CDs, no format existed to sell single songs. That was the honeymoon era for the recording industry, which reveled in selling complete albums to consumers at a handsome price.”¹⁷

Actually, with peer-to-peer (P2P) networks such as Kazaa and Napster, you had been able to download music files for years prior to iTunes. Not that there was a business model in that for the music industry. Napster was sued and shut down and thousands of users were threatened with legal action ruining the brand of the music industry. Apple's big innovation was to have consumers pay for the music. With over 15 billion iTunes song downloads later, many in the music industry are now resentful at how powerful Apple has become.

Apple has continued to innovate both the technology and business models behind its iPods and iTunes. iPods have evolved to a point where they are almost like iPhones—without the hefty monthly payment to a telephone company. In the process they destroyed Microsoft Zune and many a competing MP3 player.

Apple, however, found audiophiles still preferred buying CDs and ripping music from them to downloading from the iTunes store. So, in 2007 it announced with EMI Music a 256 kbps AAC codec “resulting in audio quality indistinguishable from the original recording.”¹⁸ That came at a higher price—$1.29 per single compared to $.99, but in the process Apple convinced the studio to make it DRM-free—free of the restrictions music companies levied like a limit of number of devices you could play the music on. Over the next few years, Apple convinced other labels to offer similar higher-quality, DRM-free, iTunes Plus tunes.

In 2011, as Amazon and Google beat it to the punch in offering “music in the cloud,” Apple was able to pull its usual “one more thing” as it announced its iCloud. It unveiled the iTunes Match feature. “We have 18 million songs in the music store. Our software will scan what you have, the stuff you've ripped, and figure out if there's a match,” Jobs said. ¹⁹

The Apple website added, “And all the music iTunes matches plays back at 256-Kbps iTunes Plus quality—even if your original copy was of lower quality.”²⁰

While some said the feature was legalizing pirated tracks, in many ways it was a bonus for the music industry. “Apple will split the $25 service fee with record companies and music publishers, giving 70 percent to the music industry and keeping 30 percent for itself. If the service becomes popular (which it very well may, considering the convenience with which it allows music to be shared among Apple's many popular devices), it has the potential to significantly help a music industry that has been under serious financial hardship since music became easily available digitally. Jeff Price, chief executive of the music distributor TuneCore Inc., said that iTunes Match has the potential to ‘reset the odometer’ for the music industry.”²¹

Many Technology Vendors as Laggards

Even as technology companies like Apple and Cognizant, shown above, have been open-minded about business models, way too many technology vendors cling to their older models. Indeed, a UK government agency report blares as its title “Government and IT: A Recipe for Rip-Offs.”²² While you can argue about efficiency in the public sector, in general, larger technology vendors have been loath to change their business models. Here are a few examples:

• IBM announced “On-Demand” services in 2001 in response to growing customer clamor that IT had become too fixed an expense. It isn't IBM, however, but cloud-computing vendors like Amazon and Salesforce.com that are delivering small, bite-sized units of technology procurement and provisioning to make IT spend more variable.
• Major telcos such as Verizon, AT&T, and Sprint sued Vonage, claiming prior art involving VoIP dating back to the 1990s. In spite of claiming prior art, they were not very interested in, and then not very successful at, offering VoIP to their customers. In fact, many continue to fight providers like Skype from offering VoIP on their mobile networks.
• Accenture (in a predecessor entity, Arthur Andersen) pioneered a software development center in the Philippines in the mid-1980s. It did not scale that low-cost pool for years and did so years later only in response to the global delivery model that firms from India and younger U.S. companies, such as Cognizant, showcased to Western customers.
• Larger software vendors like SAP and Oracle are years late in offering their own version of Software-as-a-Service (SaaS). In fact, it could be said that Larry Ellison, CEO of Oracle, smartly invested in two SaaS start-ups—Salesforce.com and NetSuite—because he realized starting them as projects within Oracle would not generate much success.

Conclusion

Technology-elite companies like Apple and Amazon have shown that creativity in pricing and efficiency in costing are as important as good product design and logistics. Technology is allowing for new models of “freemium,” “from the bottom of the pyramid,” and other options. In the next section, we see how a young company, Valence Health, using sophisticated analytical technology and a new business model, is building a viable venture.

Case Study: Valence Health

The average of healthcare cost in the U.S. was $7,290 a person in 2007. This was nearly two and a half times the Organisation for Economic Co-operation and Development average of $2,984.²³ Even with that much spending, the U.S. life expectancy, child mortality, and other health metrics are significantly worse than those of other developed countries. And, to accentuate the problem, the number of medically uninsured in the United States grew from 39.8 million in 2001 to 46.3 million in 2008.²⁴ That's almost 15 percent of the country uncovered in spite of so much spending.

Lost in the politics and rhetoric about the healthcare reform plan the current administration managed to pass and has been fighting to preserve (and which critics deride as “Obamacare”) is a stark reality. The U.S. healthcare system is in need of some fresh thinking.

Valence Health is bringing in some of that thinking. It was founded in 1996 by two entrepreneurs, Philip Kamp and Todd Stockard, who both worked in the managed healthcare consulting practice of the accounting firm PriceWaterhouseCoopers.

Stockard points to three flaws in the current healthcare system:

1. Fee-for-service reimbursement—For the vast majority of care provided today, a fee is paid for a service. So, patients largely do not care how many services they require and the costs to provide such care. As a result, there are no incentives in place for healthcare providers to focus on improving the quality of care in order to bring costs down. Providers also have the incentive to do more services because of the fee-for-service compensation model.
2. Lack of population management—Historically, hospitals and physicians have provided care for the patients that present themselves with symptoms and/or an existing medical problem. No one party is responsible for the management of the health of the population with a focus on keeping people healthy.
3. Inability to measure quality of care—Lack of comprehensive data across healthcare providers and disagreement as to how to measure quality has created a void in measuring the quality of care and outcomes by individual providers. In many cases, there is lack of evidence as to the impact of different treatment patterns.

Started as a services firm, Valence has broadened its product portfolio, leveraging increasingly powerful analytical tools and opportunities opened up by the reform legislation. Stockard, who graduated from Princeton with a degree in economics, jokingly says he missed his calling. As a young man, he was deep into baseball statistics, and he has carried that analytical bent into this venture.

Nearly 15 years later, with a staff of 120, Valence Health is a turnkey HMO administering the financial, actuarial, data analysis, claims payments, customer service, and medical management of many provider-sponsored health plans across the United States.

Valence also has a clinical integration practice that works with non-risk-assuming groups of doctors and hospitals, giving them the tools to become an integrated system and allowing them to collectively negotiate enhanced reimbursements from healthcare plans.

Stockard elaborates:

One of the new concepts introduced by the reform legislation is an Accountable Care Organization (ACO). Explains a report from the National Institute for Health Care Reform:

A key concept behind ACOs is clinical integration (CI). Since buyers of healthcare are willing to pay for better quality, provider networks that can define, measure, and demonstrate improved outcomes and add value should be rewarded. A vehicle to achieve these goals for a given group of independent physicians and a hospital system serving a specific population is a clinically integrated network.

Says Stockard, “CI is the process by which hospitals and physicians are able to develop, analyze, and manage patient-centric care, in an effort to produce improved quality, achieve better outcomes, and earn increased reimbursement from payors in exchange for lowering the overall cost of treatment. Valence helps over 10,000 independent physicians use economies of scale that come with clinical integration—even when they lack a common healthcare information platform.”

Stockard continues, “We can provide software technology that can pull meaningful data from the disparate information systems of various healthcare providers, and can do so without the personal involvement of physicians or their staff, or the need to source any such data from payors.”

Valence created a proprietary tool that accesses a medical community's billing system and uses tools from the analytical vendor, SAS, to scrub the data, apply appropriate clinical care guidelines, and then pass information back to physicians.

Essentially, Valence is providing the benefits of an electronic medical record (EMR), allowing independent practices to see what is happening with a patient across providers. Using a chronic sinusitis guideline as an example, Stockard says, “if somebody shows up in a primary care office three times with that diagnosis, and the guideline says they need an ear, nose, and throat (ENT) referral and a CT scan, we now have the data from everyone in town and can look for that patient at the ENT encounter or look at the radiologist data to see if the CT scan happened.”

Additionally, Stockard points out that Valence can now provide alerts about patients before they visit a practice, so doctors have the information they need to ensure compliance with care guidelines. For one client, Valence used SAS Analytics to mine patient data to let doctors know which children needed certain immunizations. They provided doctors with a registry that was integrated with an interactive voice response (IVR) system to make outbound calls to such patients. Stockard continues,

Valence's advanced patient management tools provide clinical personnel the necessary information to manage the patient through the care continuum.

Seven disease-state modules are utilized:

1. Congestive heart failure (CHF)
2. Chronic obstructive pulmonary disease (COPD)
3. Type 2 diabetes (DM-2)
4. Asthma (including a specific pediatric asthma program)
5. End-stage renal disease (ERSD)
6. Anti-coagulation therapy
7. Coronary artery disease (CAD) Secondary Prevention

In addition to the disease-state modules above, Valence also has effective programs for high-risk pregnancy and catastrophic case management.

The company's consultants utilize its Disease Manager Tool to track the continuum of patient care and assist clients in actively managing high-risk populations. Certified case managers and disease managers interact with patients to foster acceptance of and compliance with recommended treatment and facilitate best outcomes.

The approach is working and Stockard notes, “The ROI for doctors is enormous. As a result of being clinically integrated through our process, physicians have been able to negotiate rate increases of between 15 and 20 percent with health plans. Before, individual doctors had no leverage in negotiations. In one region, doctors were getting 110 percent of Medicare amounts prior to clinical integration. Once they cleared the FTC hurdle and negotiated together, they got 130 percent of Medicare. Clinical integration facilitates the assumption of financial risk, allows doctors to compete for more market share, and also provides patients with better access to more informed care.”

The Twists and Turns

Kaiser Health News cautions that “creating ACOs requires hospitals and doctors to work closely together and to share financial risk as well as potential profits.”

“There are political and cultural challenges,” said Elliot Fisher, the Dartmouth health expert who helped devise the concept. “Many doctors still hold autonomy as a high attribute and many don't want to be bossed around or be employees.”²⁶

Stockard says Valence actually provides an alternative.

Kaiser Health News also cautions: “In effect, ACOs are an attempt to build integrated health systems like the Mayo Clinic where none exist. But Mayo took several decades to become a global destination for health care. The studies of ACOs called for in the congressional proposals aim to see if one can be formed in a year or two.”

Stockard demurs: