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a crash course in the evolution of business models
find the bottleneck, and own it

There’s no shortage of predictions about how the Internet will soon realign, redefine, disintermediate and even eliminate certain industries. “In most cases it will be much more evil than that,” says Jeffrey Sampler, Associate Professor of Information Management & Strategy at the London Business School. “For most companies, the Internet is the slow erosion and the death of a business model.”  At this Morino Institute Netpreneur.org Coffee & DoughNets meeting held October 18, 2000, he took the audience through a quick history of the effects of technology on business to prove that finding your real (not imagined) competitive advantage is the key to entrepreneurial success. It’s why investor and entrepreneur Mario Morino advises in his wrap-up, “Clearly articulate your business model and show a compelling understanding of how that model responds to change. That will go a long way in helping investors and others have great confidence in your approach.”

Statements made at Netpreneur events and recorded here reflect solely the views of the speakers and have not been reviewed or researched for accuracy or truthfulness. These statements in no way reflect the opinions or beliefs of the Morino Institute, Netpreneur.org or any of their affiliates, agents, officers or directors. The archive pages are provided "as is" and your use is at your own risk.  

Copyright 2000, Morino Institute. All rights reserved. Edited for length and clarity.

mary macpherson: introduction

Good morning.  On behalf of the Netpreneur.org team and Morino Institute, welcome to Coffee & DoughNets.  Thanks for coming out at this very early hour.  Now we Virginians know how the Marylanders feel when we do these events across the Potomac.

          If you picked up the December 7, 1998, issue of Fortune, you would have seen an article entitled “The E-Corporation,” which was how the editors described the new kinds of organizations popping up everywhere¾boy, it sure seems a lot longer than two years since the “e-“ thing was coined, but I guess we're in Internet time.  The article started with these lines: "Somewhere out there is a bullet with your company's name on it.  Somewhere out there is a competitor unborn and unknown that will render your business model obsolete."  It went on to describe how competition is not between products, but between business models.

          The co-author of that article is Jeff Sampler, and we're delighted to have him with us today to help us solve the riddles of competition in the New Economy.

          Jeff will spend the first segment with you this morning, then we'll open the floor to your questions with our esteemed counselor, Andrew Sherman, acting as moderator.  Last, but not least, our own Mario Morino will give us a quick wrap, and we'll have you out of here and back to building your companies.  Before we begin, however, I'd like to acknowledge the local alumni chapter of the London Business School. We have them to thank for getting Jeff here today.

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jeffrey sampler: 150 years of competition in 45 minutes

Well, I’ve got a couple of strikes against me this morning.  First, I have this digitally-connected whiteboard that you see, so clearly I don't know how to use PowerPoint and computers, right?  I probably don't even own a computer, you're thinking at this stage.  Actually, I do, but I have done an analysis of all great speeches back from Cicero to Lincoln to Churchill, and I found out that none of them used PowerPoint.  I've decided that if they can do without it, so can I.  Let's see how it works.  The other reason I don't use PowerPoint is because, as an American living in Europe, I have no idea how to spell anymore.  My American-spelling brain and European software don't work together.  I've been living in Europe for eight years where they also pronounce things differently there.  They throw in extra syllables, like saying “al-you-min-ee-um,” instead of “aluminum.”  I don't know why they do that, but they do.

          That was the warm-up introduction to make sure you're awake.  What I'm going to talk about this morning is the value chain and competitive advantage.  Let me be very clear what today will not be.  I will not talk about the future.  Number one, I don't understand it; number two, even if I did, I wouldn't tell you.  It's worth far too much money.

          It's a simple fact that you can get degrees in futurology.  There are people doing 500-year deltas¾Godspeed.  It's a good business model to get money today for predictions that won't come through until your great-grandchildren are around, right?  The checks have been long cashed and spent by then, so it's a good business model.  I can't do that; I just don't understand the future.  However, with traditional academic flair, you can see where the future's going by looking at the past.  What I'm going to do this morning is summarize 150 years of competition in 45 minutes.  I hope.  There will be some time compression and hopefully some insights.  You'll tell me later whether that happens or not.

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what did you do in the industrial revolution, daddy?

How many times do you hear the word “scalability” about a high tech business model today?

Audience Member:  Lots!

Okay, there's a quantitative man.  Lots.  Do you want to define lots?

Audience Member:  All the time, minus one.

I like that.  “All the time minus one.”  That's impressive.  We know that it is part of society when we see it's part of Hewlett-Packard commercials, right?  Kids are doing show and tell and talking about the “scalability” of their ideas.

          Why is scalability so sexy to talk about?  I mean, since it's being talked about all the time minus one.  Let's assume there's some logic to this madness.  Why is scalability talked about all the time minus one?

Audience Member:  Leverage.

Leverage.  Okay, let's define leverage.  What's unique about leverage?

Audience Member:  Lowest per unit cost for whatever you're selling.

“Lowest per unit cost for whatever I'm selling.”  We're starting to get closer.  The interesting thing about leverage, scalability and such is very simple¾I get more out than I put in.  An economist calls this “fundamental economic growth,” right?  This is how the pie gets bigger rather than worrying about efficiency and reallocation.  I get more out than I put in.

          The whole idea about scalability and leverage is that I put a lot of work in, but, at some point, I put in a small delta of work and I get more out.  That's called “new wealth creation.”  It is not an Internet-driven phenomenon; it is a technology-driven phenomenon.  It is what technology has done throughout history, and what it continues to do, yet we act as if we have stumbled upon it and think it's some great insight.  It's what technology has always done.

          Let's look at competition from the Industrial Age forward.  If we take a generic industry value chain, we see the three simplified players¾producers, intermediaries and customers.  

The Industry Value Chain

Whether a customer is a business or a consumer, it doesn’t matter right?  Looking at those three players, what happened during the Industrial Revolution is very, very simple.  Technology was introduced, where?  At the point of production.  We had the looming machine, the steam engine and so on.  We had the harnessing and leverage of physical labor.  If you don't think that this was a big deal, go look at England.  Go to places called Bradford and Sheffield.  They aren't exactly on the tourist circuit, but, if you go there, you'll see the heart of the steel industry and the looming industry.  You’ll also see some deserted factories today, and you’ll see how people lived.  You'll see a transition from tiny terraced housing, little cottages next to each other, to magnificent stand-alone mansions.  You’ll see the rise of the middle class and fundamental wealth creation.  Lester Thurow, an economist at MIT, documented in his last book, The Wealth Pyramid, that there are only two times in the history of the world when billionaires¾that's billionaires with a B¾have been created en masse: the Industrial Revolution and today.  Clearly, something must be interesting if there is that much new wealth creation occurring.

          In the Industrial Revolution it was very simple.  They had economies of scale and scope¾that's how an academic talks about leverage and scalability¾but these economies of scale and scope were all around the act of production.  Manufacturers made the lion's share of the profits across the entire value chain.  Why did they make all the money?  Because it was the only point where there was leverage throughout the entire value chain, so they made a ton of money.

          What happened after the Industrial Revolution’s introduction of technology?  Basically, three nations became the dominant economic powers of the world: the UK, Germany and the US.  They took this technology, adopted it more quickly than other nations, applied it to different industries¾industry after industry after industry¾and they made a lot of money doing that for roughly 100 years.  It was a very good game plan and it worked.

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lawn sprinklers, pad thai and other distribution problems

          What happened again in the 1970s and 1980s?  We had technology introduced again, this time at the intermediary level, and this time it was information technology (IT).  Why did we have the rise of the category-killer retail store in about the span of a decade?  Companies like Wal-Mart, Toys-R-Us, Home Depot, Circuit City, Best Buy, on and on and on.  Did God wake up one day and say, “Let there be big stores?”  What technologies enabled the rise of the category-killer retail store?

Audience Member:  EDI (Electronic Data Interchange).

Audience Member:  Cars.

Okay.  Clearly there had to be cars and roads and stuff like that to make that model work, so I'll buy that externality, but, particularly around IT, there are three simple things: scanner data, EDI and affordable mainframe computers.

          Do you imagine that Wal-Mart could carry the numbers of items that it does at the price and inventory levels that they do and at the stock outage levels they do, if it weren't for EDI, scanner data and mainframe computers?  No way. Wal-Mart is the world's largest purchaser of mainframe computers.

          Let's assume that those mainframes are part of a productive business strategy, not just a back-up heating system.  They have made a ton of money by taking a fragmented industry and consolidating it through the powers of technology.  As a result, they could become much bigger.

          It's happened not just in retail, but in many industries, such as financial services.  How many companies refer to themselves as “financial supermarkets” today?  They even use the same metaphors, right?  You get 600 types of mutual funds, 200 different type of credit cards, put them under one roof and sort it out.

          God bless you, and good luck if you have ever read Federal Reserve reports.  They are incredibly boring but occasionally insightful.  In the early 1990s, the Federal Reserve analysis suggested that the efficient size of a bank in the US had increased 50% during the 1980s.  During a decade, banks could be 50% bigger and still be more efficient.  Why?  Because of the introduction of technology in a very pervasive way into the back office.  All of a sudden, banks could be bigger and still have economies of scale before the diseconomies of size set in.  As that information starts to trickle around the Beltway here in Washington, DC, all of a sudden the commissions and agencies said, “Maybe bigger banks are better for consumers.”  They started to allow bigger mergers, so this has had a pronounced effect.

          Here’s a lateral example, but it drills it home.  Has anybody ever been to a restaurant called Tumnut Thai in Bangkok?  It used to be the world's largest restaurant seating in excess of 5,000 people.  Unfortunately, a restaurant that seats in excess of 5,000 people, coupled with a severe Asian recession in the early 1990s is not a good business model, so they didn't survive the transition.  Anyway, you'd see a restaurant spread out over acres and acres.  It's not like Oktoberfest in Munich where you put 5,000 people in an area about the size of this stage; it's a very different concept of how to allocate people.  You sit on these small islands interconnected with bridges over the water while native Thai dancers perform.  A fascinating restaurant.  My wife and I went there eight years ago as part of our honeymoon.  We were sitting there and a waitress came¾not to be sexist or anything, but it's always a waitress¾a petite person who weighs about 50 pounds, carrying a menu that must weigh 30 pounds.  It's this huge, leather-bound monstrosity that looks like the Manhattan telephone directory.  She struggles and drops it on your table.  You open it up and see a menu with hundreds, if not thousands of menu items.  It has Thai food, Chinese food, German food, Italian food, American food, on and on.  English cuisine somehow didn't make it.  I don't know why, but fish-and-chips just didn't make it; still, there were thousands of menu items.

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          When you order, the waitress never writes down a thing.  This intrigued me, right?  I'm a vegetarian, so, if nothing else, I'm worried about this.  I watched the waitress very carefully.  She takes the order, then goes to a little kiosk in her work area and types it on a computer.  Maybe 20 to 25 minutes later, a person on roller skates carrying a tray of food delivers it to the waitress who brings it to your table and bows.  That's the model.

          For me, this was one of those great moments of insight.  Actually, it was the best and worst of times for me on different levels.  I knew that something had happened between computer and roller skates that was very interesting.  At the same time, I was naive enough to ask my wife, “Do you mind if, on the way out, I talk to the manager to see what's going on?”  Keep in mind that this is our honeymoon, not exactly the time she thought I should be doing field research, so I got the look.  I did not know what the look meant at that time.  Now I do.  It basically meant, “Please proceed.  You're in as much trouble as you can be, and, by the way, I hope you like the lobby of the hotel because you're not coming in the room.”  Like I said, there were multiple levels of learning going on that day.

          On the way out, I stopped to talk to the manager.  I gave him a business card.  He was really excited that somebody wants to understand their system.  The first thing he does is take me into the kitchen where he points out that they have more than one chef.  Thank you very much for that keen insight, sir.  I thought they had one little guy with a ginsu knife on speed or something.  Then he says, “Look at each chef.”  Each chef has a computer display above his or her work area. As soon as an order is entered, it gets parsed by the system and appropriate dishes get sent to chefs specializing in Thai cuisine, chefs specializing in Italian, German chefs, etc.  The computer breaks up the orders and the chefs make whatever appears on their screens.  The subtlety of the system is that, since a stir-fried Oriental dish takes much less time to prepare than a baked lasagna dish, the system does load balancing.  It looks at the time to prepare a dish and inserts the item in the appropriate place in the queue.  All the chef does is make the items in whatever order they appear; they're all tagged, reassembled on a tray and delivered.  All food ordering occurs electronically.  Can you imagine the waste and spoilage in such a diverse system?  It would make the economic model absolutely nonviable without the computers.

          What we see in that example are the things that technology always does for us, and yet we're always amazed.  Technology always does the same four things: makes something faster, cheaper, more reliable or solves more complicated problems.  Technology always does one or more of those things, and yet we're always dumbfounded.  Faster, cheaper, more reliably or to solve more complicated problems.

          All of a sudden, companies like Wal-Mart are making a lot of money.  Why?  Because there's a fundamental power shift from producers to intermediaries.  When academics say “power shift,” they mean money.  That's what I mean, money.  Anybody who's been in retail knows exactly what happens next.  Wal-Mart or whoever starts telling Procter & Gamble, “Excuse me, let me explain exactly the profit margin you're going to make on that new detergent.  You don't like it?  Take a hike, because I've got 50% of the channel.”

         God forbid, you might want to introduce a new lawn sprinkler into the US.  Home Depot has 80% of that market.  There's no way you can introduce a lawn sprinkler in the US unless you have their approval, and that's why Home Depot could do what they did last year in saying, “By the way, Mr. Manufacturer, if anybody tries to set up a Web site marketing directly, you're out of our stores tomorrow.”  It really sobers the mind when you think, “I know the Internet is growing like crazy, but can I give up 80% of my sales tomorrow?”  It makes you pause.  This is what's happening, and everybody in the world has been playing this game.  It's a fantastic game.  Unfortunately, it didn't last 100 years; it probably lasted 20 to 30 years.

[continued]

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