Chapter 2 Notes and Reactions

I need to begin with a personal reaction. The reason I was determined to go to the 6^th edition of this text was this chapter. The updated cases are important too, but this is the chapter that brings the most original thinking to the book. It begins with a pretty fundamental question -

What business are you in?

The chapter then explains that there are more businesses for you to be in than you may have thought. Those of you who have read Peter Drucker may recognize some of the basic framework for the discussion, but the authors do the most clear and comprehensive job of listing possible businesses that I have seen anywhere.

In the table below I have taken the liberty of adding a few additional business models and briefly describing the business models they name.

Evolving Business Models

Direct sellers	Profits enhanced through disintermediation
Retailers – brick and click -tangible	Control inventory, set prices, sell physical products online.
Retailers – brick and click - digital	Hotel reservations, airplane reservations, tour guides, bank services. No product is shipped.
Retailers – digital only	On-line gambling and sales of pornographic materials. Evolving to include gaming services among multiple players (fantasy sports, etc). Initial efforts at ebooks, music, film, have not yet been successful
Focused Distributors	Focused on one industry or niche market.
Retailer	Control inventory, set prices, sell physical products online.
Marketplace	Sell products and services, but do not control physical inventory. Revenue is based on commission or sales fees.
Aggregator	Present information about products, but do not sell directly. Collect service fees for referrals.
Infomediary	Sell digital information – news, entertainment, industry information. May be B2B or B2C
Exchange	eBay. Price is negotiated by buyer and seller. Exchange never holds inventory. Revenue comes from transaction fees and possible ads.
Portals
Horizontal Portal	AOL. Gateway to all the web
Vertical Portal	Web MD. Tied to a single industry. Try to organize related materials with more depth, some screening, some ease of navigation.
Affinity Portal	Targeted to a market segment – age, ethnic characteristics, gender or geographic region. MySpace is a current leader.
Producers
Manufacturers	Internet integrates the supply chain
Service Providers	Online service delivery
Educators	Digital course presentation
Advisors	Newsletters and regular emails to reinforce customer contacts
Information and news services	Additional on-line distribution channels

It may take some re-readings to fully understand some of the more arcane definitions of these business models, but it is the central point that is most important – the ubiquity of the Internet has created a significant number of new business models. Business approaches that were barely tenable a decade ago now represent significant opportunities.

This would be a good point for each of you to stop and ask what business you are in and what business you could be in. As you think through the possibilities, let me describe a business you may already know – American Airlines.

The SABRE Story

In the early 1980s American Airlines created one on-line reservation system (SABRE) and United Airlines created another (APOLLO). By 1990 SABRE was bringing in $500 million each year in revenues with a 30% pretax profit margin. The two systems fought for dominance as each tried to be the system of choice used by travel agents.

Competing airlines were concerned about the advantage these systems gave American and United because while American and United would list the other airlines’ flights on the system, if you asked for flights from X to Y, somehow American flights always showed up first on SABRE and United flights showed up first on APOLLO. Competitors also complained that their flight schedules and fares where often out of date, while American and United said they were keeping up as best they could, it takes time to update computers, so sorry, etc.

What never came up in court cases and congressional hearings is the issue that seems far more important to me – business intelligence. Since these two airlines were doing bookings for the others, they knew which flights flew full and which were losers, which airfares worked and when fares crossed the wrong threshold. So American and United were always in the best position to know how to grow their own companies.

A recent analog is Dell Computer. They have sold HP and EPSON printers for years. As they sell these printers they know which models and features are popular, and which price points matter. Six months ago they announced that they would now start selling their own brand of printers. Presumably they have had their product design and marking research done through the sales data they have amassed over the years.

My point is this -- new business models not only provide the potential for new businesses (SABRE is now an independent company), but they can significantly inform the decisions of the original business.

Now back to my question – what business are you in? What business could you be in? How could that new business improve the performance of your current business?

American Express and Amazon.com

I haven’t been a fan of American Express because of some poor dealings I have had with them over the years, but you have to give them credit for one decision described in the chapter – they decided to add online travel services to their face-to-face travel services. This increases their initial costs for service, can be blamed for “cannibalizing” their existing travel service, and of course causes some internal turmoil when the two sides of their travel business compete. But they are leveraging existing knowledge to expand into a new delivery method, and having learned the new rules of online services, then expand naturally into those other businesses. This is classic “economies of scope.” It was the first move online that must have been tough for management, but the rest follows fairly naturally from that.

The Amazon story starts online and then expands as opportunities appear. Two points I would add. First, Amazon is in Seattle for a reason. This is one of the most striking examples of a modern business going where the natural resources are. In this case the natural resources are talented software and network engineers. Without that easy access to talent, much of the rest of the story couldn’t take place, or wouldn’t have taken place so quickly. Management deserves great praise for HR planning. Second, we have all read Amazon’s obituary a dozen times in the business press. It was supposed to die with the rest of the dotcoms. The fact that it didn’t says a great deal about its ability to adjust to business opportunities (and cut their loses where needed), and the tenacity of their management. It must have been hard driving home on a rainy evening when everyone is saying you are the next bomb to hit e-commerce. Somehow they managed to get out of bed the next morning and keep the business going.

Back to Drucker

Page 75 in the book gives a series of steps for businesses to use in analyzing business models. I have no objection to any of the steps, but I do enjoy Drucker’s simpler model –

1. Know what is happening in the world and what opportunities exist.
2. Create a theory of business for how you will take advantage of those opportunities.
3. Know what your core competencies are so you know what you can do and what you can’t.

In terms of Chapter two, I would translate Drucker this way: Be aware that business has evolved to create many more business models than existed ten years ago. Create a business theory that uses these new models in your industry. Examine your own abilities to determine what you and your company can successfully achieve.

Questions for the week

1. Using the definitions of Chapter 2, what business are you in? What business could you move to? What positive and negative impacts could that new business have on your current business?

2. Most of this chapter could be described as using economies of scope to leverage a presence in a new field or bring a new product into an existing field. Do economies of scale matter? Is there a right size for businesses wishing to move into new business models? Can you be too big or too small?