Don't Mistake Growth for Innovation

Here’s what we’ve learned from our innovation work with Fortune 500 companies:

• Product innovation is important, but…

• ...You can still fall behind if you don’t innovate your business model

• Your biggest competitors may come from outside your industry

• Your assets may become your biggest liability

• Figure out what makes your customers unhappy

Product innovation is important, but…

Our research shows that the current core products and services of at least one third of the Fortune 1000 are likely to become obsolete within ten years. Yet most companies are focused on improving these existing revenue streams.

The result is that the 33-year average tenure of companies on the S&P 500 in 1964 narrowed to 24 years by 2016—and is forecast to shrink to just 12 years by 2027. Meanwhile, the ramp to $100+ million in revenues by challenger brands is happening more quickly than ever.

For example, Gillette’s razors started as a single blade. Over the years they added more blades and different features. They've dominated the market for decades, but their endless product innovation also became a dead-end that required increased spending with less return.

As patents expire on meaningful innovations—and said innovations become industry standards—they have to be replaced with new, less meaningful ones that give an updated competitive edge.”

—VOX

Here’s how Gillette’s revenue growth stalled as they reached the point of diminishing returns after decades of product innovation:

As we’ll see, this left an opening for competitors to innovate where they could beat Gillette: New business models.

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...You can still fall behind if you don’t innovate your business model

Gillette controlled 70% of the US razor market in 2010. They dominated the business model of selling inexpensive handles and making money on the replacement cartridges. They had built a defensible moat of retail stores that carried their products.

Their innovation focused first on adding more blades, as well as battery power and other novelties, and second on creating low-priced options in countries like India.

Unfortunately, Gillette became complacent due to their dominance.

Dollar Shave Club launched in 2011 with a low-price mail-order “club.” Their initial sales video asked, “Do you think your razor needs a vibrating handle, a flashlight, a back-scratcher, and 10 blades? Your handsome-ass grandfather had one blade AND polio.”

Their website immediately crashed due to demand and they sold out within hours. By 2016, Dollar Shave Club had almost 2 million subscribers at an average of $10 per month each.

Sales have grown exponentially from $4m in 2012, to $65m in 2014 and $152m in 2015. It [was] on track to make $200m in 2016, according to Unilever, who acquired them for $1B [that same year]. [In 2016], Dollar Shave Club [had] a 15 per cent share of the total US shaving cartridge category and about 50 percent of the online channel.

—FINANCIAL TIMES

The beauty of Dollar Shave’s Club approach is that even though they talked about lower prices, their members actually spent two to three times more on razors than Gillette.

Harry’s launched in 2013 and quickly became another large player in this new market. The result?

“Gillette controlled about 70 percent of the U.S. market a decade ago. [In 2017] its market share dropped to below 50 percent, according to Euromonitor. The company, owned by P&G, was forced to slash its razor prices by an average of 12 percent [in 2017].” — CNBC

How big an opportunity was this new online razor market?

In May [2015], Slice had estimated that the online market for razor blades, virtually nonexistent prior to Dollar Shave Club’s arrival in 2012, had hit $236 million for the 12 preceding months, or 8% of the total market, the Wall Street Journal reported. That market is dominated by Gillette, which has 60% of the total. —Fortune

The grooming division—which contains Gillette—was the only part of P&G with a drop in organic sales in 2017.

Your biggest disruptors may come from outside your industry

Gillette and Schick viewed each other as serious competitors. They were at war over who could create the razor with the most blades and other features. It didn’t occur to them that the rug would be pulled out from under them both—not by new products, but rather by a new business model.

Dollar Shave Club was founded by a digital marketing manager from Sports Illustrated who partnered with a former retail expert.

Harry’s was founded by a former Bain consultant along with a co-founder of Warby Parker.

None of them came from the razor industry—or even the men’s health industry. They were all frustrated customers.

Similarly:

• Uber wasn’t started by taxi insiders. It was also started by frustrated customers who didn’t have to invent a new kind of taxi in order to decimate the industry. They simply had to evolve the business model to deliver a better experience to both riders and drivers.

• Jack Ma was a school teacher who never learned how to code. He started Alibaba because he couldn’t find anything about China on the Internet.

• Elon Musk has made his mark in finance with PayPal, automotive with Tesla, and rockets with SpaceX—all with no previous experience in those industries.

Your assets may become your biggest liability

The defensive moats that Gillette and Schick built over decades didn’t stop Harry’s and Dollar Shave Club from denting their business.

Gillette and Schick both spent millions of dollars on product development that had become the butt of jokes. “Gillette reportedly spent $200 million on advertising and $750 million to revamp its production system to make that first triple-blade Mach 3 in 1998,” according to Vox.

Their assets became their weakness. Gillette and Schick offered so many options that it overwhelmed their customers. All of that retail shelf space was a liability versus a new mail-order option. And their razors were so expensive that their customers became offended.

“I figured there was nothing to lose so I gave Harry’s a try,” said Greg Lesko, who said he became “fed up” with Gillette’s high prices. “I wouldn’t go back if you paid me.”

—CNBC

Blockbuster experienced something similar. Their biggest assets were 1. their national network of physical stores and 2. their late fees (which infuriated customers). Netflix didn’t have to invent a better DVD to bankrupt them. Instead, they evolved the business model to do away with both late fees and physical stores. Netflix also experimented with streaming early. In fact, Reed Hastings tried to sell Netflix to Blockbuster for $50 million to become their streaming division.

Blockbuster said no because they couldn’t imagine a big enough market without physical stores, DVDs, and late fees.

What does the world look like when your multi-billion dollar company’s hard-won assets become liabilities?

Here’s Interbrand’s chart of Gillette’s brand value from 2000 to 2014:

Yes, that’s a scary chart. Executives have lost their jobs trying to explain those results.

But it’s also a tremendous opportunity to invent the challenger business model from inside your organization, rather than waiting to be disrupted.

So where do you look to evolve your business model?

Figure out what makes your customers unhappy

Start with your customers. Ask them what they find most frustrating about your product or service. Is it price? Is it the customer experience? Is it something else?

Then look for the 10X solution. How can you make their experience ten times better?

This is where most companies fall short. Adding a fifth blade to a four-blade razor doesn’t come close to having that kind of impact. It’s a 10% improvement at best. Yes you need to iterate your products—but you also need to evolve your business model.

Want to 10X your business model?

Start with the ExO Canvas

Another place that successful companies stumble is on encouraging employees to experiment and learn quickly. The price of failure is often their jobs, which stops people cold.

Encourage your teams to practice customer validation by engaging with early adopters. Affirm that your value proposition or new business model is effective by running experiments with your customers (or test groups) during the early development stages. Then build on what you’ve learned before scaling.

As an example, Schwab is testing monthly subscription models for their robo-advisor’s premium service.

[Schwab] has added $1 billion in assets since making the pricing change, with a 25% increase in account openings [and] a 40% increase in the average household income for customers using the robo-advisor since the change.

"The move to subscription-based financial planning came as a direct result of client feedback about the appeal of this pricing approach, and it's clear from these early results that we've struck a chord," said Cynthia Loh, Charles Schwab's VP of digital advice and innovation.

But giving up asset-based pricing means wealth managers will earn less from their wealthiest customers, so some are skeptical about how widely the model can be deployed.

—BUSINESS INSIDER

The risks to Schwab are that overall revenues decline because they make less money off of their wealthier customers. Will that be offset by increasing the size of the market due to more affordable pricing? Only time and further experimentation will tell.

Your biggest challenge is that your organization will fight you every step of the way. We call this the corporate immune system and it’s incredibly effective at killing—or massively watering down—promising innovation early. JPMorgan recently shuttered it’s Finn app targeted at millennials:

"Imagine if you were running the checking account business for Chase and then some other internal group is like, 'I'm going to launch a checking account, but don't worry, it's just going to be for millennials. I swear it won't impact your business.' And you, as the head of the checking account business, have no say into what it is, how it is structured."

—BUSINESS INSIDER

True, but if enough millennials are signing up that it’s impacting your core business then that probably means that you’ve discovered something valuable. If you don’t pursue it, someone else will. Perhaps your biggest challenger brand will be started by millennials who can beat your customer experience.

Your biggest challenge will be your company’s culture—not the lack of breakthrough ideas. Tony Saldanha, our vice chairman and CIO of Gillette from 2005 to 2007, as well as the author of Why Digital Transformations Fail: The Surprising Disciplines of How to Take Off and Stay Ahead, recommends:

"Create legitimacy for your disruptors by clearly communicating that continuous improvement is not the same as disruptive innovation. The challenge is that in disruptive times, the amount and scope of disruptive [business model] innovation needs to increase. This needs to be clearly articulated to the entire organization—not just to provide air cover for your disruptors but more importantly because an over-emphasis on continuous improvement is a mistake.”

This article was originally featured on ExO Works on July 25, 2019.