 "<b>Book Extract:</b> Placing the right bets")
THE RISK-DRIVEN BUSINESS MODEL: FOUR QUESTIONS THAT WILL DEFINE YOUR COMPANY
AUTHOR: Karan Girotra, Serguei Netessine
PUBLISHER: Harvard Business Publishing
PRICE: Rs 895
ISBN: 9781422191538
How to go from recognising the impact of risks on business model performance to knowing which levers to push in order to innovate and create a superior business model. Let's look at how Zara dealt with the inefficiencies related to information risk.
If you had been performing a business model audit in a fashion firm prior to Zara's key innovation, you might or might not have thought to question the widespread industry practice of making high-stakes bets in June about what customers will want to buy the following March. As our assessment of information inefficiencies shows, it is these bets on different styles and trends that are the biggest sources of information inefficiency.
Compare the fashion industry problem with that of computer makers. Both industries are characterised by high-velocity change; clothing styles and computer capabilities quickly become obsolete. Few buyers want last year's fashion or a computer built around a last-generation microprocessor. As a result, unsold inventory ends up being either deeply discounted or written off. And predictive long-range bets on customer taste can easily miss the mark. For an example of how the traditional business model ratchets up the risk quotient, see what happened to Marks & Spencer, one of Zara's competitors, despite its 130 years of experience in the apparel industry: Convinced that grey and black would be in fashion during the 1998/1999 season, M&S developed its entire Fall/Winter collection around these two colors. Due to the lead times in its traditional value chain, M&S had to make this decision fully one year in advance of the season. Regrettably, they lost their bet: Both colors proved not to be in fashion that season ... As was reported in BusinessWeek, "M&S has slashed prices on $IB in goods in an 'Autumn Values' campaign, the biggest off-season sale in its history."
Zara's strategy for overcoming this potentially damaging risk was to innovate its business model by changing the who and the when of deciding which styles and colors of clothing to offer its customers. It redesigned its business model - and the cost structures, management processes, and manufacturing and logistics arrangements that support it - so that decision making about customer tastes could be done not six to nine months in advance but a mere two weeks before its clothing hit the racks. To do so, Zara had to move decision-making power from the central office planners, who were far removed from customer tastes, to frontline store managers.
Although some components of Zara's cost structure are more expensive than those of competitors (for example, it produces a large proportion of its clothing in Europe and delivers most of it by plane), its fast, local production system - and its empowerment of local store managers to provide input on design and assortment decisions - allows it to predict demand and design and produce fashion only a couple of weeks before selling it. As a result, it is able to continuously adjust its clothing line to reflect new and more reliable information about what customers really want. This allows it to operate with far greater certainty. In fact, the higher costs of Zara's local production are more than offset by the greater accuracy of its fashion bets, which lead to fewer disappointed customers and almost no unsold goods.
Zara doesn't do commercial advertising, a practice unheard of in the fashion industry. Yet, simply by changing the when and who of design and assortment decisions, Zara has given its customers good reasons to be continuously interested in making frequent visits to Zara websites and stores: because they will always see something new. Could it be that newness is addictive to the point of making advertising superfluous?
When we spoke to Jesus Eschevarria, chief communications officer of Zara's parent company Inditex, he summarized the firm's thinking: "Don't talk about yourself. It is the customer who should talk about you." Certainly, Zara accepts a degree of added brand risk by forgoing advertising, but that risk is more than compensated for by the constant newness of its assortment. The traditional fashion business model, on the other hand, faces the challenge of renewing depleted customer interest three or four times a year, which requires spending heavily on advertising. Zara can spend its marketing budget in other ways.
In that sense, the fast-fashion when innovation supported by who innovation becomes a virtuous circle. Not surprisingly, others in the fashion industry are now following suit, reducing information inefficiencies in pursuit of a host of potential benefits.
The point of conducting a business model audit is to prepare you to reinvent existing business models or create entirely new ones. That work is the subject of the coming chapters. Each of the decision pattern's four W levers has its own chapter. For each lever, we will describe three distinct innovation approaches and the conditions under which they are appropriate. By the end of chapter 6, we will have outlined a dozen varieties of business model innovation that you can accomplish by changing the decision pattern. For example, we would describe Zara's innovation as changing the when of the 'design and assortment' decision to delay it as much as possible, while also changing the who to delegate decisions to the party with the most information. These are just two of the dozen approaches to BMI innovation that we describe in detail in the coming chapters.
AUTHOR: Karan Girotra, Serguei Netessine
PUBLISHER: Harvard Business Publishing
PRICE: Rs 895
ISBN: 9781422191538
How to go from recognising the impact of risks on business model performance to knowing which levers to push in order to innovate and create a superior business model. Let's look at how Zara dealt with the inefficiencies related to information risk.
If you had been performing a business model audit in a fashion firm prior to Zara's key innovation, you might or might not have thought to question the widespread industry practice of making high-stakes bets in June about what customers will want to buy the following March. As our assessment of information inefficiencies shows, it is these bets on different styles and trends that are the biggest sources of information inefficiency.
Compare the fashion industry problem with that of computer makers. Both industries are characterised by high-velocity change; clothing styles and computer capabilities quickly become obsolete. Few buyers want last year's fashion or a computer built around a last-generation microprocessor. As a result, unsold inventory ends up being either deeply discounted or written off. And predictive long-range bets on customer taste can easily miss the mark. For an example of how the traditional business model ratchets up the risk quotient, see what happened to Marks & Spencer, one of Zara's competitors, despite its 130 years of experience in the apparel industry: Convinced that grey and black would be in fashion during the 1998/1999 season, M&S developed its entire Fall/Winter collection around these two colors. Due to the lead times in its traditional value chain, M&S had to make this decision fully one year in advance of the season. Regrettably, they lost their bet: Both colors proved not to be in fashion that season ... As was reported in BusinessWeek, "M&S has slashed prices on $IB in goods in an 'Autumn Values' campaign, the biggest off-season sale in its history."
Zara's strategy for overcoming this potentially damaging risk was to innovate its business model by changing the who and the when of deciding which styles and colors of clothing to offer its customers. It redesigned its business model - and the cost structures, management processes, and manufacturing and logistics arrangements that support it - so that decision making about customer tastes could be done not six to nine months in advance but a mere two weeks before its clothing hit the racks. To do so, Zara had to move decision-making power from the central office planners, who were far removed from customer tastes, to frontline store managers.
Although some components of Zara's cost structure are more expensive than those of competitors (for example, it produces a large proportion of its clothing in Europe and delivers most of it by plane), its fast, local production system - and its empowerment of local store managers to provide input on design and assortment decisions - allows it to predict demand and design and produce fashion only a couple of weeks before selling it. As a result, it is able to continuously adjust its clothing line to reflect new and more reliable information about what customers really want. This allows it to operate with far greater certainty. In fact, the higher costs of Zara's local production are more than offset by the greater accuracy of its fashion bets, which lead to fewer disappointed customers and almost no unsold goods.
Zara doesn't do commercial advertising, a practice unheard of in the fashion industry. Yet, simply by changing the when and who of design and assortment decisions, Zara has given its customers good reasons to be continuously interested in making frequent visits to Zara websites and stores: because they will always see something new. Could it be that newness is addictive to the point of making advertising superfluous?
When we spoke to Jesus Eschevarria, chief communications officer of Zara's parent company Inditex, he summarized the firm's thinking: "Don't talk about yourself. It is the customer who should talk about you." Certainly, Zara accepts a degree of added brand risk by forgoing advertising, but that risk is more than compensated for by the constant newness of its assortment. The traditional fashion business model, on the other hand, faces the challenge of renewing depleted customer interest three or four times a year, which requires spending heavily on advertising. Zara can spend its marketing budget in other ways.
In that sense, the fast-fashion when innovation supported by who innovation becomes a virtuous circle. Not surprisingly, others in the fashion industry are now following suit, reducing information inefficiencies in pursuit of a host of potential benefits.
The point of conducting a business model audit is to prepare you to reinvent existing business models or create entirely new ones. That work is the subject of the coming chapters. Each of the decision pattern's four W levers has its own chapter. For each lever, we will describe three distinct innovation approaches and the conditions under which they are appropriate. By the end of chapter 6, we will have outlined a dozen varieties of business model innovation that you can accomplish by changing the decision pattern. For example, we would describe Zara's innovation as changing the when of the 'design and assortment' decision to delay it as much as possible, while also changing the who to delegate decisions to the party with the most information. These are just two of the dozen approaches to BMI innovation that we describe in detail in the coming chapters.
Karan Girotra & Serguei Netessine
- Karan Girotra is a professor of Technology and Operations Management at INSEAD. His research has appeared in top academic journals and has been featured by the Financial Times, Businessweek, Sloan Management Review, and Harvard Business Review
- A former entrepreneur himself, he continues to engage actively with start-ups, largely as an adviser, and mentor
- Serguei Netessine is the Timken Chaired Professor of Global Technology and Innovation at INSEAD and the research director of the INSEAD-Wharton Alliance. His research has received extensive media coverage in CIO Magazine, the Economist, Forbes, and the New York Times. He consults extensively and advises companies ranging from start-ups to Fortune 100 corporations and US governmental agencies
Reprinted by permission of Harvard Business Review Press. Excerpted from The Risk-Driven Business Model: Four Questions That Will Define Your Company. Copyright 2014 Harvard Business Publishing Corporation.
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All rights reserved.