Game-Changing Strategies: How to Create New Market Space in Established Industries by Breaking the Rules

Introduction

Common sense as well as academic research argues that attacking bigger competitors will most likely lead to failure. For example, a series of studies undertaken at London Business School in the early 1990s examined how new market entrants in several U.K. industries fared against much bigger established competitors.¹ Not surprisingly, the failure rate of new entrants was quite high—more than 85 percent of them failed within five years of entry. The established competitors had few difficulties repelling these smaller attackers: the studies found that the top-ranked firm in a particular industry had a probability of about 96 percent of surviving as No. 1—a near certainty.² For the second-ranked firm the probability of survival was 91 percent, and for the third-ranked firm 80 percent. In fact, most of the turnover that occurred among the top five in an industry was due to mergers rather than smaller entrants outcompeting market leaders.

Yet, without disputing the statistics, we all know of examples of companies that attacked much bigger competitors with great success. In several instances, not only did the smaller firm survive, it managed to emerge as one of the leaders in the industry! IKEA did it in the furniture retail business, Canon in copiers, Bright Horizons in the child care and early education market, MinuteClinic in the general health care industry, Starbucks in coffee, Amazon in bookselling, K-Mart in retailing, Southwest, easyJet, and Ryanair in the airline industry, Red Bull in the carbonated soft drinks industry, Lulu in publishing, Enterprise in the car rental market, Netflix and Lovefilm in the DVD rental market, Honda in motorcycles, Wit Capital in investment banking, Skype in telephony, Priceline in the travel agent market, Casella in the wine market, Metro International in newspapers, and Home Depot in the home improvement market. The list could go on!

The Secret of Success: A New Business Model

What explains the success of these outliers and what can we all learn from their experiences? After studying more than seventy such firms, I believe that the answer to this question is simple enough: successful attackers do not try to be better than their bigger rivals. Rather, they actively adopt a different strategy (or business model) and aim to compete by changing the rules of the game in the industry. Over and over, what I have observed is that significant shifts in market share and company fortunes took place not by trying to play the game better than the competition but by playing a different game—in a sense, by avoiding head-on competition. The box lists a number of such business-model innovators from a variety of industries—both high-tech and low-tech, growing and mature.

Examples of Business-Model Innovators

Consider, for example, Enterprise Rent-A-Car, the biggest car rental company in North America. Rather than target travelers as its customers (as Hertz and Avis did), Enterprise focused on the replacement market (that is, providing cars to customers who’d had an accident). Rather than operate out of airports, it located its offices in downtown areas. Rather than use travel agents to push its services to end consumers, it uses insurance companies and auto mechanics. Rather than wait for the customer to pick up the rental, it brings the customer to the car. In short, Enterprise built a business model that is fundamentally different from those of its biggest competitors. This allowed it to start out in 1957 as a new start-up firm in the industry and grow into the biggest competitor in less than fifty years.

Consider also the case of MinuteClinic, a company founded in 2000 and already an industry leader in the retail-based health clinic industry in the United States. The company is based on the premise that certain simple health problems can be more quickly and cheaply diagnosed and treated at a walk-in clinic than in a doctor’s office or an emergency room. Unlike traditional clinics that treat a wide variety of health problems, the company treats only common ailments such as strep throat and ear infections. It employs nurse practitioners armed with software that helps them test for and treat a handful of medical conditions. The software has the most up-to-date medical guidelines for diagnosis and treatment and applies strict rules that help ensure consistency of service. A doctor is generally available for phone consultation only. Prices are posted for all to see. Patients who come in with complaints not on the list or symptoms that indicate something more serious are referred to a doctor or an emergency room without a fee. The service does not require an appointment; it is quick (about fifteen minutes from start to finish), and it is cheap—a visit to test for strep throat costs $44 versus an average of $109 at a doctor’s office or $328 in an emergency room.

Both examples highlight a generalization at the heart of this book: without the benefit of a technological innovation, it is extremely difficult for any firm to successfully attack bigger competitors or to successfully enter new markets where big established players rule. The strategy that seems to improve the probability of success in these situations is the strategy of breaking the rules—of discovering and exploiting a different business model from the one that the current leaders employ in a given industry.

So What?

Obviously this is not the first book to proclaim the virtues of this kind of innovation, and this is not the first time that managers have been encouraged to seek and exploit a new business model in their industry. Numerous books have been written and many ideas have been proposed on how firms could innovate in this way. For example, Kim and Mauborgne (2005) developed the beautiful concept of blue ocean strategy and formulated a number of analytical techniques (such as the Strategy Canvas and the concept of the Value Curve) to help companies identify ways in which they can create new market space for themselves through business model innovation. Similarly, Christensen (1997) and Christensen and Raynor (2003) developed the concept of disruptive innovation and then used it to advise companies on how to develop new growth businesses using disruptive innovation as a platform.

Other authors have proposed even more radical ideas. For example, Hamel (1996, 1999, and 2000) proposed ideas such as making the strategy process democratic and bringing Silicon Valley inside the organization as ingredients to business-model innovation. Markides (1997, 1998) argued that corporations could learn from the success of the capitalist system by importing into their organizations those features of capitalism (such as decentralized allocation of resources and experimentation) that promote innovation. And Markides and Geroski (2005) suggested that big firms should help start-up firms create new business models and then use a fast-second strategy to acquire the start-up firms and scale up the new ways of competing. In short, the list of ideas on how to discover new business models is rather long; interested readers are also referred to the work of Charitou (2001), Gilbert (2003), Gilbert and Bower (2002), Hammer (2004), Kuhn and Marsick (2005), Mitchell and Coles (2003), and Slywotzky (1996).

But here’s the catch—and the reason this book has come about. Despite all the advice and despite the wealth of ideas, it is very rare to find a business-model innovation that originated from an established big company. According to the available evidence:

The majority of business-model innovations are introduced by newcomers in an industry (rather than established competitors).

Not only do established competitors find it difficult to innovate in this manner, they also find it next to impossible to respond to such innovations in an effective way.

Most of the time, the established firms’ response is to imitate the innovation (rather than consider ways of neutralizing it or even destroying it).

The majority of the responses fail because the established firms find it difficult to manage two different and conflicting games at the same time.

Why—despite all the ideas and advice—do big, established firms fail to pioneer new business models in their industries? These firms have the resources, the skills, and the technologies to do a much better job at innovation than the new start-up firms. Furthermore, the advice that has come their way on how to do so is good advice coming from some of the best academic minds. Yet they continue to allow new firms to take the initiative when it comes to business-model innovation, despite the obvious benefits of this type of innovation. What can explain this?

Creativity Is Not Enough

The purpose of this book is partly to explain the reasons behind this puzzle but mainly to use the insights from that explanation to develop practical ideas on how established companies could not only discover new, game-changing business models but also implement them next to their existing business models. As it turns out, all business-model innovations display certain characteristics that make them particularly unattractive to established firms. This suggests that giving more and better advice to established firms on how to become more creative so as to discover new business models is pointless. The issue is not discovery. The real issue is organizational, and the only advice that can prove helpful to established firms is how to overcome the organizational obstacles that hamper the implementation of new business models. This is exactly the emphasis of this book—not on discovering new business models but on implementing them.

At the same time, it should be obvious to all that despite all of the wonderful advice to the contrary, most new business models will be introduced by newcomers rather than by established firms. This is not because the established firms are stupid or bad at innovation. Rather, it’s a reflection of how many companies inhabit an industry at any given time compared to how many potential entrants could invade that industry. For every established company trying to develop a new business model, there may be thousands of entrepreneurs attempting to do the same thing. Simple probability theory indicates that the chance that it will be a new entrant that discovers the new business model is much higher than the chance that it’s going to be an established firm.

What this implies is that in addition to telling firms how to innovate, perhaps we also need to tell them how to respond if somebody else introduces a business-model innovation in their industry. This is another differentiating characteristic of this book—rather than dealing only with how firms can develop new game-changing business models in their industries, it also explores how firms can respond to this kind of innovation. Just as new entrants have advantages over the big firms when it comes to generating new business models, so do established firms have advantages over new entrants when it comes to responding to these invasions. The book will explore this theme.

This book has a third differentiating element. Over and above the fact that business-model innovation is an interesting phenomenon that deserves careful treatment, and over and above the fact that this kind of innovation is different from all other kinds of innovation, another major motivation behind this book is the desire to clarify a number of misconceptions and mistaken beliefs that have developed in the last few years about business-model innovation.

As I explain in the first chapter, business-model innovations tend to be disruptive to established firms for a number of reasons. As a result, many people have equated business-model innovation with disruptive innovation, as defined by Christensen (1997). This is a mistake. In his original formulation, Christensen focused primarily on technological innovation and explored how new technologies came to surpass seemingly superior technologies in a market. Over time, he widened the applicability of the term to include not only technologies but also products and business models. For example, Christensen and Raynor (2003) list as disruptive innovations such disparate things as discount department stores; low-price, point-to-point airlines; cheap, mass-market products such as power tools, copiers, and motorcycles; and online businesses such as bookselling, education, brokerage, and travel arrangements.

Although I agree that all these innovations are disruptive to incumbents, treating them all as one and the same has actually confused matters considerably. This is because a disruptive technological innovation is a fundamentally different phenomenon from a disruptive business-model innovation or a disruptive product innovation—these innovations arise in different ways, have different competitive effects, and require different responses from incumbents. Lumping all types of disruptive innovation into one category simply mixes apples with oranges.

This confusion can be seen more clearly if you compare the effect on incumbents of disruptive technological innovations to the effect of disruptive business-model innovations. A key finding in Christensen’s work is that disruptive technological innovations eventually grow to dominate the market. Christensen and Raynor (2003, p. 69) make this point forcefully by arguing, Disruption is a process and not an event. . . . It might take decades for the forces to work their way through an industry but [they] are always at work. Similarly, Danneels (2004) summarizes the existing theory on disruptive innovation by pointing out that disruptive technologies tend to be associated with the replacement of incumbents by entrants. If correct, such a fact carries a serious implication for incumbent firms—namely that the only way to respond to the disruption is to accept it and then find ways to exploit it. Christensen and Raynor suggest that established companies could exploit a disruption only by creating a separate unit.

Yet, as I argue in this book, the evidence on business-model innovation does not support such an extreme position. What often happens in the case of a business-model innovation is that the new way of competing in the business grows (usually quickly) to a certain percentage of the market but fails to completely overtake the traditional way of competing. For example, Internet banks and Internet brokerage firms have grown rapidly in the last five years but have captured only 10 percent to 20 percent of the market. Similarly, budget, no-frills flying as a way of business has grown phenomenally since 1995 but has captured no more than 20 percent of the total market. In market after market, the new ways of playing the game grow to a respectable size but never really replace the old ways. Nor are these innovations expected to grow in the future to 100 percent of their markets.

If that is the case when it comes to business-model innovation, then some of the accepted wisdom on disruptive business-model innovation needs to be modified. First, new business models are not necessarily superior to the ones established companies employ. This implies that it is not necessarily an optimal strategy for an established company to abandon its existing business model in favor of something new or to grow the new business model alongside its existing business model. The decision should be based on a careful cost-benefit analysis of the specific circumstances of the firm as well as on the nature of the innovation.

The truth of the matter is that established companies simply find most business-model innovations unattractive. This is not for the reasons articulated in Christensen (1997)—though these reasons undoubtedly play a role. Rather, most business-model innovations simply do not make economic sense for established companies. In its efforts to grow, the established firm has many other alternatives to consider—including investing its limited resources in adjacent markets or taking its existing business model internationally. Given its other growth options (and given its limited resources), the decision to invest in the disruption may rank low on a firm’s priority list. In any case, the decision to invest in a new business model is not (and should not be) an automatic one.

A second sacred cow about disruptive innovations is that the best way for an established company to adopt and exploit such innovations is through a separate unit. Presumably, this is the best way to overcome the inherent conflicts between the established business and the innovation. Yet as I explain in Chapters Four and Five, established companies could exploit disruptive business-model innovations in a number of ways—and they don’t necessarily have to use a separate unit to do so.

Finally, even if the disruptive innovation is not superior to the established business model, incumbents need to find a way to respond to it. However, this does not necessarily mean that they have to adopt every innovation that comes along. They could respond to an innovation not by adopting it but by investing in their existing business to make the traditional way of competing even more competitive relative to the new way of competing. They even have the option of counterattacking the innovators by trying to disrupt the disruptors.

Thus, to summarize what I have argued so far: this book emphasizes the implementation of new business models rather than their discovery. It tackles not only the issue of introducing new business models but also that of responding to them, and it dispels a few misconceptions about this type of innovation along the way. Whether all this justifies the writing (or reading) of yet another book on innovation is for the reader to decide. Suffice it to say that the content of this book represents the summary of more than fifteen articles and chapters on this topic that I have published over the past ten years.

A Very Specific Type of Innovation

It is important to stress from the very beginning that what I say in this book applies only to a very specific type of innovation—the discovery and exploitation of a game-changing strategy (or business model). I want to alert the reader to this simple point because it has become common lately for all of us to talk about innovation in general as if all types of innovations are one and the same. Nothing could be further from the truth. Business-model innovation is not the same thing as product innovation. And it is certainly different from technological innovation. Treating them as one and the same is misleading.

Every company wants to achieve growth and profitability; what better way to do so than by creating totally new market space through innovation? Who wants to get messy and bloodied by fighting battles for market share with aggressive competitors in existing markets when there’s virgin territory to discover and colonize? Therefore, discovering (or creating) new market space (that is, innovation!) should be the goal and ambition of every company.

While this is obvious and noncontroversial, the devil is always in the detail. For example, what exactly does the phrase create new market space through innovation mean? As we all know, there are different types of innovation with different competitive effects, each one capable of producing huge new markets. Which of these should a company then pursue to create new market space? And are the prerequisites for achieving one type of innovation the same as those for achieving another type of innovation?

New markets could be created in a variety of ways. For example, Apple, 3M, and Nestlé created new market space by discovering the iPod, Post-It note, and Nespresso, respectively. This is what we traditionally call product innovation. On the other hand, Enterprise Rent-A-Car created the huge replacement market in the car rental industry without even introducing a new product—instead, it creatively segmented the market in a new way. Similarly, Schwab and Amazon created new market space by using the Internet to grow online brokerage and bookselling, respectively—this is what is now called business-model innovation. And Canon, Honda, and P&G did it by using innovative strategies to scale up existing product niches—the copier,