Unit 3: Discussion 2 Week 3 MBA695

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Strategic Management

Jeff Dyer

Third Edition

Chapter 10

Innovative Strategies that Change the Nature of Competition

Professor’s Goals for this Lecture

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:

- the homework assignment involving calculating an experience curve in semiconductors

- Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)

- the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry

Definition of Innovation

However, before we get into The Innovator’s DNA framework, I’d first like to share with you what years of research on business innovators has found in terms of where creative ideas come from. This summary framework was compiled by Teresa Amabile, a professor of entrepreneurship at Harvard who also serves as their department chair in entrepreneurship. After reviewing all of the studies on creativity in business Amabile found three common themes. Creative ideas come from people who: 1) have deep expertise in a particular field or knowledge domain, 2) are intrinsically motivated to pursue new ideas, and 3) have “creativity skills” which was generally defined as being “right brained” or able to see things from a different angle and think intuitively.

An innovation is a new product or service that comes from a creative idea. An innovation needs to be: a) novel, b) useful, and c) successfully implemented in order to help companies win. While there are several types of innovation, this mini-lecture focuses on strategies based upon more radical innovations. These are innovations that draw on different knowledge bases to create value in truly unique ways. Strategies that draw on radical innovations often use new technologies or employ fundamentally different business models than rivals, that is, they deliver customer value through very different activities. Innovative strategies are often called “disruptive” innovations because incumbents find the innovation so disruptive that they can no longer do business as usual.

Types of Innovation

Incremental Innovations

Radical (Disruptive) Innovations

Incremental Innovations

Better offerings that generate better profits from current customers

New features

Important for success but they don’t create growth because they are replacements of existing products

LED TVs

3D TVs

Incremental Innovations

Example of an incremental innovation. You improve a feature

Categories of Innovative Strategies Based on Radical Innovations

Reconfigure the Value Chain to Eliminate Activities

Low End Disruptive Innovations

High End Disruptive Innovations

Reconfigure the Value Chain to Allow for Mass Customization

Blue Ocean Strategy—Creating New Markets by Targeting Non-Consumers

Free Business Models

It’s difficult to provide a full list of different kinds of strategies based on radical innovation because new innovative strategies are constantly emerging – change is a natural part of innovation. Indeed, a firm’s strategy must be dynamic due to changes in competitive offerings and in customer needs. However, strategists have identified several types of radical innovations, and these types may provide a useful guide for how to develop a strategy based on radical innovation.

Categories of Disruptive Innovation

Reconfigure the Value Chain to Eliminate Activities

Amazon vs. Barnes & Noble; Netflix vs. Blockbuster, 1800 Mattress, Charles Schwab (eliminate stores, labor, and inventory).

Southwest vs. Hub & Spoke carriers (eliminate meals, seat reservations, baggage transfer, etc.)

Categories of Innovative Strategies

Process innovations that typically create an efficient new business model; allow companies to create, deliver, sell, or service a product more efficiently.

Reconfigure Value Chain Activities

1. Eliminate Activities in the Value Chain

One type of innovative strategy eliminates or reconfigures activities in the value chain. The most typical pattern is to eliminate a step in the channel to the customer, such as a store, which also eliminates the need for salespeople and inventory. This allows the innovating company to offer similar products and services at much lower prices. This is how Netflix gained a cost advantage over Blockbuster. Similarly, Amazon offered lower prices than Barnes & Noble by eliminating the brick and mortar bookstore and shipping directly to customers. Rather than eliminating stores, Southwest airlines eliminated meals, seat reservations, and luggage transfers in order to lower total costs.

Reconfigure Value Chain Activities

Barnes & Noble

Amazon.com

Amazon’s business model is an efficiency innovation for selling a book. Dell direct model was an efficiency innovation for manufacturing and delivering a computer.

Different Value Chains

Barnes & Noble

Amazon.com

Authors

Publishers

Warehouse

Store

Customer

Authors

Publishers

Distributor

Store

Customer

Warehouse

Comparing Value Chains

To illustrate, Blockbuster dominated the home video rental market by building 5500 stores around the country where they offered more than 1000 different movie options. Blockbuster made a huge investment in stores and in DVDs. But Blockbuster didn’t make money from the videos sitting on the shelves, so it needed to get customers to rent the DVD and return it as quickly as possible. To encourage customers to return the DVDs quickly, Blockbuster charged late fees. These fees were unpopular, but Blockbuster couldn’t make money if it didn’t get DVDs back quickly. This strategy worked extremely well… until Netflix entered the movie rental business. Instead of building stores, Netflix shipped DVDs directly to customers’ homes. The downside of renting movies online was that you had to plan ahead—no impulse movie watching. But the upside was the ability to access over 90,000 movies in the Netflix library.

Film Studios

Film Distributors

Blockbuster’ Warehouses

Blockbuster

Stores

Customer

Film Studios

Film Distributors

Netflix

Customer

Categories of Disruptive Innovation

Low End Disruption: Low cost business model based on new technology that improves

Nucor vs. U.S. Steel

Skype vs. AT&T

Honda vs. Harley Davidson or Mercedes Benz

2. Low End Disruptive Innovations

Rather than eliminating activities in the value chain, some companies use different technologies than rivals to produce low cost products or services. Harvard professor Clayton Christensen observed a pattern in a number of industries where a firm leverages new technologies to launch a product at the “low end”—the most price-sensitive segment of the market—and then gradually moves upmarket as it improves its technology and processes. He called these “low end disruptive innovations.” For example, Nucor used this approach to disrupt integrated steel producers like U.S. Steel. Nucor pioneered a new way to create steel products using small electric arc furnaces to melt scrap metal in mini-mills. This process was much simpler and cheaper than the traditional method of melting iron ore in enormous blast furnaces. Initially, mini-mill product quality was poor, so they could only make rebar – material used to reinforce concrete. This was a low-margin market that the big steel makers were happy to abandon. But as Nucor’s mini-mills improved their quality, their cost advantage enabled them to trounce the integrated producers in higher margin products such as angle iron, structural beams, and sheet steel.

Similarly, Apple and IBM’s first micro-computers were inferior to the mini-computers sold by DEC and Data General. But over time their performance improved enough that companies dumped mini-computers for the micro-computers that became good enough to do the job. Skype’s cheap—and often free—phone service is gradually moving upmarket as the quality of calls improves and as the technology allows for video conferencing and other higher end business services. Interestingly, incumbents typically do not attempt to imitate the new low cost offering because they see little to gain by selling an inferior, cheap product to a niche market. By the time they realize the new product has improved its performance enough to attract their customers, incumbents find it is too late to respond .

Not sure we have room to include this. But maybe this is more important than offering the Skype example. Thoughts?

Low-End Disruptive Innovations

Target customers whose needs are over-served in the mainstream market

Price is far more important than features.

Product performance is “good enough” on basic features to attract low-end customers of the mainstream market

Entrant uses a new low cost business model; performs different activities which allows the firm to earn profits even at deeply discounted prices

“Disruptive technologies are a driver of leadership failure and the source of new growth opportunities”

Performance

Time

Performance that customers

can utilize or absorb

Pace of

Technological

Progress

Sustaining innovations

Disruptive technologies

Incumbents nearly always win

Entrants nearly always win

Example: Leaders Fail and New Growth

7% margins

Quality of minimill-produced steel

12% margins

18% margins

22%

% of tons

Steel Quality

1980

1975

1985

1990

Rebar

Angle iron; bars & rods

Structural Beams

Sheet steel

25–30% margins

55%

Example: Nucor Moves Up-Market to Beat Competitors

Example: Personal Computers Disrupt Mini-computers (entire product categories can be disrupted)

Performance

Time

Disruptive technology: personal computers

60% margins on

$500,000 computer

45% margins on $250,000 computer

20% margins

on $2,000 computer

Sustaining innovations

to minicomputers

Example: Mfg. Companies Can be Disrupted (e.g., in specific products like microwaves.)

Performance

Time

General Electric

Panasonic

Samsung LG

Galanz Group

Performance that customers

can utilize or absorb

Categories of Disruptive Innovation

High End Disruption: Leapfrog technology with premium price comes from top-down.

Apple iPod vs. Sony Discman

Flash drives vs. floppy disks

PCs vs. typewriters

Cell phones vs. landlines

3. High End Disruptive Innovations

A third category of disruptive innovation is “high end” or “top down” disruption. In stark contrast to the low end disruptions we just discussed, high end disruptive innovations actually outperform existing products when they’re introduced, and they sell for a premium price. History provides several examples: Apple iPod out-play’s Sony Walkman, Starbuck’s beans and atmosphere drowns coffee shops, and Flash Drives zip past floppy disks and zip drives. These products typically rely on “radical” or leapfrog technologies are quite expensive initially. However, the costs gradually decline as companies make improvements in production technology.

A high end disruptive innovation may serve a specialized, high-end niche of a market for years before it finally trickles down to mainstream markets. Such was the case with Electronic Fuel Injection (EFI), a technology that first replaced carburetors in high performance racing cars before finally making its way to Detroit. These innovations slowly penetrate from above until they become practical and affordable in mainstream markets. When they do, consumers flock to the new offering. Cell phones, which originally cost $3995, followed a similar pattern. As the price (and size) of the phones dropped, the phones became accessible to a much larger segment of the market. In 2012, almost 30 percent of homes were “wireless only” households.

Example: High End Disruption Examples

Industry	Problem	New Solution	Disruptor	Disrupted	Type of Innovation
Coffee/ Donut shops	How to get quality morning coffee conveniently?	Source premium coffee; ubiquitous availability; drive-up service	Starbucks	Dunkin’ Donuts Ma and Pa Coffee shops	Radical (Architectural)
Music distribution	How to make music portable?	High capacity, small-size storage device; MP3 file structure and software	Apple (iPod)	Sony Panasonic	Radical (Architectural)
Package shipping	How to get packages to their destination more quickly and at a reasonable cost?	Create transportation infrastructure; guarantee overnight delivery	Fedex	US Postal Service	Radical (Architectural)
Telephony	How to make phone calls from any location?	Use towers and satellites to send signals directly to mobile device using radio spectrum.	Phones:Apple,Samsung, etc. Service: AT&T, Sprint	AT&T landline; Baby Bells	Radical (Technological)

Time

Sustaining Innovations

Low-end Disruptive Innovations

High-end Disruptive Innovations

Discontinuity in demand market following emergence of high-end disruption

Performance

Range of performance that customers demand

Example: The High End Disruptive Innovation Model*

Why High End Disruptions Are Difficult For Incumbents To Imitate

Radical (Architectural) Innovation

A product’s architecture reflects the way in which a set of components are integrated into a “system” (product). Architectural innovations change the architecture of a product (the way they are linked together or adding new components) without fundamentally introducing changing the technology underlying its components (e.g., iPod, Starbucks, FedEx).

Radical (Technological) Innovation

Innovations based on a different set of engineering and scientific principles and technologies. Compared to established products, a radical technological innovation establishes a new dominant design for the product and a new set of core technologies and design concepts embodied in components that are linked together in a new product architecture (e.g., Mobile phones, PCs, Electronic Fuel Injection).

Categories Of Disruptive Innovation

Reconfigure the Value Chain to allow for “Mass Customization”—the mass production of customized goods.

Build-A-Bear (mass produce components of stuffed animals and customize them at stores)

Dell Direct (customized computers)

Timbuk2 (customize/design your own handbag)

Nike ID (customize/design your own shoe.

My Twinn (customize your own doll, etc.)

4. Design the Value Chain for Mass Customization

A fourth category is “mass customization.” Mass customization is a bit of an oxymoron in business because usually firms either mass produce OR customize, but not both. However, new technologies and processes have allowed for the mass production of individually customized goods or services. Take Build a Bear Workshop for example. Customers essentially build their own Teddy Bear by choosing from a large variety of body styles after which the animal is stuffed at the store to the customer’s liking. Some like it squishy—some puffy. The customer can also add a heart or music box. After the animal is stuffed, the customer dresses their furry friend in the shirt, pants, skirt, hat, or even shoes of their choosing. In short, the components of the teddy bear are mass produced but put together in a customized way.

Dell used a similar strategy when it successfully launched its PC business using the “Dell Direct model.” Dell sold directly to customers and allowed them to choose the components that mattered most to them; they then custom built and shipped the PC to the customer within 48 hours. Dell’s ability to mass produce customized PC’s required a very flexible and responsive assembly system and supply chain which other PC makers didn’t have.

Or would Timbuk2 be a better example than Dell?

Conflicts In Mass Customization

Conflicts in Name:

Mass – Aggregation

Customization – one-of-a-kind

Conflicts in Operability:

Customers’ demands are diverse and irregular which calls for leads to high component variety, large numbers of suppliers, and high administrative complexity

Mass

Production

Craft

Production

Mass

Customization

Economies of Scale

Hand-crafted

Small, on demand factories

Optimized set-up, manufacturing lines

Example: Application of Mass Customization

Nike ID

Dell

My Twinn

Categories Of Disruptive Innovation

Blue Ocean Strategy: create new demand in an uncontested market space.

Cirque de Soleil (combination of circus, acrobatic troupe, music, Broadway).

Federal express (met uncontested demand for secure overnight delivery).

ChotuKool ($49 refrigerator that runs on a battery and uses solid state thermoelectric cooling)

5. Create New Markets by Targeting Non-Consumption

INSEAD professors Chan Kim and Renee Mauborgne identify a fifth category, called “blue ocean strategy.” They argue that a company can best succeed by creating new demand in an uncontested market space. Sharks competing for the same scarce food create a “Red Ocean” of blood due to intense rivalry. Blue Ocean success relies on swimming to empty water; in other words offering value that is very different from anything on the market. When Cirque de Soleil opened its first show it was nothing like a Ringling Brothers circus. A Cirque de Soleil show combines elements of a traditional circus, acrobatic troupe, street performers, and Broadway show to offer an entertainment experience that is like no other. Cirque created an offering that was so unique that there was no direct competition. Moreover, it pulled in a whole new group of customers who were willing to pay several times the price of a conventional circus ticket for a unique entertainment experience.

80% of Indian households have no refrigerator

Refrigerators

Expensive

Large

Requires electricity

Difficult to service

ChotuKool

Affordable

Small

Requires no electricity

Easy to service

Chotukool: Targeting a Blue Ocean

As companies try to create new demand, they sometimes target “non-consumption” with an offering that might induce consumption. For example, more than 70 percent of households in India do not have a refrigerator because they are large, expensive, and require continuous electricity to run. So, appliance maker Godrej created a small refrigerator targeted at non-consumption—those 125 million households without a fridge. Using battery technology and solid state thermo electric cooling, they created a $49 cooler size refrigerator—called ChotuKool—that is bringing refrigeration to everyone in India.

Lid has all of the electronic components in it to make, including the battery and solid state thermoelectric cooling (doesn’t have compressor). Sold through Post Office; post man is trusted. Can pick up the lid to take it for servicing.

Categories Of Disruptive Innovation

Free Business Models

Free Upsell (Freemium): Zynga; Skype

Free Cross Sell: Mint.com; Ryanair,

Free 3rd Party Pay: Google, Craigslist

Free Bundled free: Cell phone service; printers, financial services (e.g. trades), etc.

Free, it’s pretty new the way we’re thinking about it in the sense that products or services are perpetually free and it’s important today to have an understanding of what are the options for competing using a free revenue model. Let me talk about some of the different free strategies, make sure that you understand them and ask questions. So, yeah, there’s a cost to everything including things like switching costs, but we define free as product has price of zero and it’s not a one-time promotion price. The price is free over an extended period of time. That’s, thinking about free and of course, the products that best fit this notion of being free are those where the marginal cost of providing it is zero or close to zero. That’s why software, digital, anything that’s software or digital, there’s an upfront cost to develop it or to build it but once you’ve developed it, once you’ve built it, then the cost really is zero on an ongoing basis.

So, why do we care about understanding free? Well, there’s two reasons. One is, you need to think about how you would react to the entry of a free product and you want to think should free be part of our strategy for our company? Different types of free revenue model. So, under what conditions might you want to make your product free and how do you create value?

Competing with FREE

1. Free Up-Sell Strategy (“Freemium”):

Offer a free version to gain attention and widespread use; then offer a premium product with advanced features for customers willing to pay.

Skype, Flickr, Zynga

Requirements:

A free product that appeals to a very large user base so that even a low conversion rate of free users to paying customers will generate substantial revenues

A high percentage of users willing to pay for the premium version

Let’s start a talk about some of the different free selling options. This is the free upsell, it’s the one we talked about with Skype. This is, Freemium, you offer the free version and then you offer a premium version to try and get them to move up. Zenga games, all of that, that’s the way they make their living. They want to hook you to get you trying something, it’s easy to use, and then you now want to go to that next level or whatever it might be and you’re willing to pay a little bit to do that.

So we’ve got Skype, all of the apps basically that you see on the iPhone, Flickr for photo sharing, does the same thing, you can use it for free but then there are also some premium services that you can pay for. Requirements. What do you need? Well you need to have a free product that appeals to a very large user base. Why do you need a large user base? Because the conversion rate tends to be relatively low of people who actually want to move to the premium version and the rule of thumb is sort of like one in twenty, five percent. On average, you might be able to get to convert to pay something for a premium version.

Competing with FREE

2. Free Cross-Sell Strategy:

Offer a free version to gain attention and widespread use; then offer other products for which customers are willing to pay.

Ryanair, Galderma, mint

Requirements:

A broad product line (preferably products that complement the free product)

The ability through partnerships to sell a broad line of products to users of the free product

The next one is, we think of as a cross sell. It’s not actually providing a premium version, but it is getting them using your free product and then trying to sell them other things and making money off of other things that you might see them. Probably for you, the one that’s probably most familiar is mint.com. How many of you use Mint? Ok, so a lot of you use Mint, right? And how do they make money?

What’s that?

Audience member: Intuit.

Intuit. So they actually upsell, they try, or you could think about it as cross-sell. Cause intuit is not actually a premium version of Mint, it’s a different product, right. They’re actually trying to sell you a different product. What other things do they try and sell you? Do they ever give you suggestions on insurance…

Audience member: retirement plan, investment portfolios, etc.

Audience member: they were pretty good targeting.

So this is the targeting because they can see what you’re buying or how much you’re spending and then they can actually recommend other insurance companies. Those insurance companies pay. Now, if you click on and go to an insurance company that’s selling something through then, then they’re going to get a payment from whatever insurance company that wins. Insurance companies are a big way that Mint makes money is because a lot of people, we all need to have insurance for different things and that’s one things that they can provide advice on cheapest insurance. That’s an example of how the certain cross-selling whether it’s intuit, whether it’s insurance. Orion Air, so you can occasionally get free seats on Orion Air. This is European low cost airline. And why would they give a seat away for zero? The bigger the marginal cost is basically zero, put you on the plane. I think we already talked peanuts. But they don’t actually give you peanuts for free. You have to buy your peanuts, you have to buy your soda. They’re going to make money. You’re going to have to pay to take any bag on, right? It’s going to be, if you’re willing to walk on with no bags and you don’t buy anything and you don’t look at anything, right? You can’t even look at the advertisements, then they make nothing off of you. But otherwise, you walk on, they’re having you pay for any bags, anything you eat, they’re trying to cross-sell you things on the plane, you’re seat tray table will have advertisements and they’re making money from companies. They get paid a certain amount from companies to put those advertisements as they know those seats are all going to be full. People are going to be looking at their ads. So they actually are combining the cross-sell and they actually combine it with ad support which is what we get to next. This tends to work better when you have a very broad product line. You have the ability to sell through partnerships and broad line to.

Competing with FREE

3. Free Third Party Pay (Advertising) Strategy:

Make the product/service free to generate a community (network externality) for which you get paid by a third party company who desires access to that community.

Google, Hulu, Craigslist, Blyk, Ryanair

Requirements:

A free offering that attracts either many users who can be segmented for advertisers or a targeted group that comprises a customer segment

AND

Third parties willing to pay to reach these customers

Alright, let’s move to third party pay. This is the advertisement model. This is the one that Google uses, you know, Hulu, Craigslist. Blyk was a company that gave free cell phone service in Europe. They gave you like two hundred and thirty minutes a month that was free but you had to be in like a certain demographic and then you had to accept advertisements over your phone in order to get those two hundred and thirty free minutes. And then they also had a premium model where if you went over that two hundred and thirty minutes you paid for additional minutes so they could get you buying a couple of things there. I mentioned Ryan Air.

I think you’re all pretty familiar with that and I want to just share with you a little bit of data. This is something that I put together with Dr. David Bryce and Dr. Nile Hatch, we were doing this article “Competing Against Free.” So we were trying to figure out how much does a company that has a free revenue model make per user.

Note: Data on Google and Yahoo are from 2005; other data are from 2010.

Example: Converting Product Users into Revenues

Right, you think about Google getting people to come per unique visitor or unique users, how much do they make? And we wanted to compare that with, Skype. So, Google’s the big winner here in terms of how much they make per user. Why do you think they make so much more than Skype?

Answer: Their advertising was phenomenal. Some businesses are willing to pay twenty or thirty dollars for an ad. They know there’s a customer willing to buy something and they know exactly what you’d want.

So here’s the targeted search. You type in snowboards or vacation in Paris, right, and they know you’re searching for information on that. Advertisers are much more willing to pay to be right there for someone who’s doing a search on a topic that is clearly related to what they provide. That is just, sort of, very clear model for advertisers that we can deliver customers to you who are looking for what you’re selling. That’s what advertisers look for. Show me you can deliver potential customers. And so, Google and Yahoo!, you know when you think about the search, they generate the most, then Facebook, this may be going up on Facebook over time. I don’t know. Zenga, Pandora and then Skype is actually, you have two, three hundred million users or four hundred million users but they’re only making a buck sixty per user because there aren’t that many in here, how many of you in here Skype? Raise your hands if you use Skype. How many of you have paid to use Skype? K, so a few of you have and that’s what they’re, they have a much smaller conversion rate for Skype. But it still works well but you want to make sure that you look at what that conversion rate looks like. For Skype, how many of you in here have used Flickr? So not very many have used Flickr. This is sort of the difference. Flickr was bought by Yahoo for forty million dollars and Skype was bought initially, around the similar time by eBay for 2.4 billion dollars. That’s because so many more people will use, even though I’m not sure what Flickr makes per user, even Skype’s not making a lot because it’s available to so many different users, it’s still generates some decent revenues.

Dollars

Google Yahoo Facebook Zynga Pandora Skype 15.96 11.18 3.5 3.09 1.8 1.6

Revenues Per Unique User Per Year

Competing with FREE

4. Free Bundling Strategy (Direct cross subsidy):

Bundle the free product with non-free products and derive revenues from non-free products; can’t get the one without the other.

Requirements:

Products or services that can be bundled with the free offering

A free product that needs regular maintenance or complementary products (e.g., free printer but costly ink).

The last one that has been around actually for a long is just the bundling strategy. You bundle a product with something else, service, and it becomes free. We all do that with cell phones, contracts, we sign a two year service agreement and we give you a cell phone, perhaps for free, or a lower price. Computers and printers, sometimes you’ll get the printer for free. They’re going to try and make money off of the ink anyway. Sometimes they’ll give you a set of free trades that’ll bundle if you have an account. Products or services that can be bundled with a free offering, it helps if a free product needs regular maintenance or some sort of complementary products like ink. This is sort of the razor blade model. You might think about that tends to work well, once you have an install base, you have a way to make additional money off those users selling follow up products, right. These are different ways that you can succeed competing with free.

Hypercompetition

Hypercompetition- A term coined by Professor Rich D’Aveni to refer to his argument that competitive intensity has increased and that

periods of competitive advantage have decreased.

Business Model

Threat

(change business model)

Delayed

Threat

(co-exist or delay launch of free product)

Immediate

Threat

(launch free product immediately)

Minor Threat (monitor situation)

Growth Rate

(of number of users of the free offering)

Defection Rate

(of paying customers to the free offering)

High

(5% per year or more)

Low

(less than 5% per year)

Low

(less than 40% per year)

High

(more than 40% per year)

Example: How Big a Threat Is Free Competition?

If you are competing in a market, and a free offering comes in, the questions is how quickly do we have to respond? Do we have to respond really quickly, like immediately, or can we afford to wait?

What we did is we looked at a number of cases and looked at whether or not, you know, this is just a minor threat, which means basically the number of users of the free offering is growing less than forty percent a year and less than five percent of your customers are defecting to the new offering. Still, you know, could be a threat down the road. Certainly this is where, for Merrill Lynch, initially it was a minor threat, but this could change over time where you could start to have larger defect rates. Of course, the extreme opposite Business Model Threat there is a lot of growth and a lot of your current customers are defecting. So if you think about newspapers, classified ads, when Craigslist started to come in, they started to blow all of the classified ads for existing newspapers out of the market because it was free. It was easy to use. Only one media company that I know of in the top fifty markets was able to beat craigslist and that was KSL. They developed a better site, invested heavily early on trying to build that sort of offering and so they actually compete pretty effectively with Craigslist and that’s huge for Deseret media. If they had lost all of that, this is actually, this is actually their big money maker is KSL.com because again, it’s ad support and a lot of us are going there to look for things and a lot of companies are using advertisements because, again, we’re going to look for certain things and they want to target certain products or services to us and that’s one way to do it.

If, in fact, you’ve got a lot of defections and its growing too fast, it means you’re probably going to have to change your business model to compete with free, and this is why what we saw happen at Deseret News, they brought in actually Clark Gilbert who was actually a professor at the Harvard Business School. Clark had actually studied newspapers and looked at free and realized that they were going to have to change their business model very quickly. They actually had to cut their staff by like fifty, sixty percent. We can’t support the staff. And they had to crowd source a lot more of their content. Then they tried to focus on a particular type of customer. Not only in Utah but also they’ve now also started to build a more nationwide audience with a particularly sort of targeted set of articles and things that are all around, sort of family and values and things like that. And they’re actually doing quite well.

Right. So right now Skype is a minor threat. It’s grown quickly but there aren’t a lot of people that are dumping their cell phones to move to Skype. So until a technology comes along that allows for that, it’s probably going to stay a minor threat and why would you want to lower your price to cannibalize, you don’t really want to do voice over IP. Now, what we’ve seen is the cable companies have jumped into voice over IP but how have they done? They’ve actually use one of these strategies they’ve used this one here, the bundling strategy, the triple play. What’s the triple play? Internet, phone, TV, right? Now, they’re bundling, they’re just bundling the phone in cause they already have the pipe into your homes. So they’re bundling the phone in, they’re doing voice over IP, it’s basically costing them almost nothing. So they’re bundling it in and that’s their strategy is we’re going to bundle this in with other things even thought, it’s interesting, they haven’t actually picked it as free. They could if they wanted to. They could say, look, here’s your price for your price for your internet and our price for your TV and by the way if you buy both of those for this rate, we’ll throw in your phone for free. They could do that and then maybe a lot more people would say, oh, if I get my phone for free, maybe I’ll go ahead and do phone service, but they haven’t really pitched it that way up to this point in time. Alright, last question.

Audience: I was curious doing the reading. You’ve got a company that creates a drug and then sold that drug for free.

Professor: Galderma

Audience: Can you talk a little bit about that, I thought that was super interesting what they would be willing to do with an actual product, I mean sure, it’s a pill, very low marginal cost there, how is that…

Man: It was all around cross-selling other products. It was actually a Galderma (on cross-selling slide). It was like, yeah, the marginal cost of the pills that were so low, they figured that if they could get you using that product, that they had these other complementary products that they could sell you for skin care and other things and they figure, let’s get them using it, we’ll let them use it for free for a period of time. At some point maybe we’ll cut that off, but let’s just see how much other stuff we can cross sell.

Innovation And The Product/Business/Industry Life Cycle (S-CURVE)

Introduction – Early adopters

Growth – Early majority

Maturity – Late majority

Decline – Falling demand

Innovation And The Product/Business/Industry Life Cycle (S-CURVE)

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