Competing with Disruptive Business Models in Traditional Industries. Conceptualisation of a Strategic Framework

Table of Contents

List ofFigures

1 Introduction

2 Understanding Competition through Disruptive Business Models
2.1 The Distinctive Features ofDisruptive Business Models
2.2 The Three-Stage Model of Industry Disruption

3 Evaluation of Strategic Options along the Three Stages of Industry Disruption
3.1 Strategic Options at the Niche Construction Stage
3.2 Strategic Options in the Niche Overlap
3.3 Strategic Options in the Mainstream Spillover

4 Model Implications, Limitations and Recommendations

5 Conclusion

References

Abstract

An increasing number ofjournalistic articles and academic literature deal with the struggle of established companies to fend off the attacks by industry newcomers such as Airbnb, Spotify, Netflix, Google and many others. These companies enter traditional industries with innovative business models and compete in a manner, which makes it challenging for incumbent firms to understand their novel competition and respond effectively. This study introduces a typology of three stages of industry disruption that classify the newcomer’s developmental stage and describe the incumbent’s competitive position in terms of competition intensity and remaining time to respond. It is demonstrated how incumbents may conduct their strategic reasoning along these stages to arrive at a strategic goal and evaluate possible counter-measures

Keywords

Disruptive innovation, business model competition, competitive dynamics, strategy evaluation, inter-species competition, intra-species competition

Acknowledgements

I would like to thank David Edelshain for his openness and encouraging attitude. Our stimulating conversations enabled me to channel my thoughts and view the issue from different angles. Moreover, I would like to express my gratitude for the time and patience my family has dedicated to support my personal reflections during the design of this paper

List of Figures

Figure 1: The Three-Stage Model of Industry Disruption

Figure 2: The “Hockey-Stick” Development of Disruptive Business Models along the Three Stages of Industry Disruption

Figure 3: Visualisation ofPotential Outcomes of the Niche Construction Stage

Figure 4: Visualisation ofPotential Outcomes of the Niche Overlap Stage

Figure 5: Visualisation ofPotential Outcomes of the Mainstream Spillover Stage

1 Introduction

In the course of increasing globalisation and digitalisation, a series of new entrants has emerged challenging the position of established firms in various industries. Competing in an entirely different way, this novel type of competition evolves outside the core market and often takes incumbents by surprise when penetrating their market at remarkable speed. Despite the anchoring awareness of the imminent threat, legacy businesses are still struggling to develop a strategic response and thus remain vulnerable to disruption.

While academic research provides valuable insights on the dynamics of the so- called “industry disruptors”, the most striking issues of the phenomenon still require further consideration. Firstly, why does this phenomenon continue to repeat itself regardless of the type of industry? Secondly, why do market incumbents tend to take such a long time to react? Thirdly, which criteria need to receive primary attention when addressing industry disruptors? The topic of this paper has originated from the urge to find satisfactory explanations for these questions. Hence, this study takes on the task to design a strategic framework that may facilitate the anticipation of potential threats lying ahead and allow traditional companies to evaluate their competitive position within the complex environment of their disrupted industry.

In spite of an extensive exploration in the field of strategic management, the search for an explanatory model that reveals the mechanisms at work led into a dead end. With the assistance of evolutionary biological principles, which explain the dynamics of competition between two different species inhabiting the same niche, Part Two depicts the developmental stages of industry disruption that occur naturally under the condition of inter-specific competition in a comprehensive diagram. It illustrates how the advance of a disruptive firm into the market affects the competitive tension amongst incumbent firms and their degree of strategic agility. Accordingly, the industry disruptor is regarded as a novel species invading the market segments of established companies. Prior to introducing this model, the nature of disruptive business models (DBM) is analysed in more detail. To identify their distinctive features and provide a common basis of understanding, the business model concept is employed as the primary unit of strategic analysis.

Drawing on the findings in Part Two, the third part demonstrates how incumbents can employ the diagram as a tool to formulate their strategic goal and assess specific strategic options based on the respective stage of industry disruption.

Part Four outlines the implications the framework has on the competition with disruptive business models, explains how it supports existing approaches and highlights remaining lacunae in this field of research.

In Part Five, this work finally closes with a personal view on the key findings and an outlook into the future hoping to encourage further research.

2 Understanding Competition through Disruptive Business Models

2.1 The Distinctive Features of Disruptive Business Models

Despite its ubiquity in business practice, the term “business model” (BM) only recently stepped into the focus of academic research (Teece, 2010) and thus lacks a commonly accepted definition amongst scholars (Markides, 2006). Similarly, the definition of disruptive innovation (Christensen, 1997) remains disputatious because it arguably oversimplifies the complexity of the phenomenon (Markides, 2008). In accordance with the aim to provide a more practical understanding and a new perspective on strategic counter measures against the novel form of competition, this paper deliberately refrains from participating in the debate. Instead, it concentrates on finding an applicable definition of “disruptive business models” that best serves the purpose of this research. Hence, the “business model” is herein understood as a stand-alone concept that solves the problem of “identifying who are the customers, engaging with their needs, delivering satisfaction and monetizing the value” (Baden-Fuller and Haefliger, 2013, p. 1). By translating a firm’s operating manner into a set of generic level descriptions (Baden-Fuller and Morgan, 2010) along these dimensions, the business model concept functions as an abstract of a business (Teece, 2010) that allows to distinguish and sort firms based on their distinctive kinds of behaviour (Baden- Fuller and Morgan 2010). Consequently, it enables a systematic comparison between old and new business models and thus reveals the sources of competitive advantage and customer value (Stähler, 2001) that arise under certain economic, social and cultural conditions. In addition to its static function, the business model is also regarded as a dynamic concept that firms can employ to experiment, change and re-invent their existing business models (Demil and Lecocq, 2006) in response to external economic factors (Teece, 2010). Especially in a rapidly changing economic environment, the business model construct offers an effective tool to assess the disruptive potential of new business models (Stähler, 2001; Osterwalder, 2004).

Essentially, the term disruptive innovation refers to innovations that generate new markets through the identification of new customer categories (Christensen, 1997). Innovation in this context can be technology-, product- and/or business model- driven (Christensen, 1997; Teece, 2010; Markides, 2008; Casadesus-Masanell and Ricart, 2011). Disruptive innovation stands in contrast to sustained innovation, which enhances the value of an existing product or service through incremental improvements but does not create new markets (Economist, 2015).

Combining the notions above, this paper understands the “disruptive business model”, as a re-defined system of customer identification, engagement, value delivery and monetization (Baden-Fuller and Haefliger, 2013) that creates new markets (Christensen, 1997) by making a radically different value proposition (Markides, 2008) and thus changes the rules of competition in the industry.

The prominent cases of Airbnb and Spotify provide excellent examples to illustrate this definition:

Airbnb is an online marketplace, which enables individuals from all over the world to rent out their private accommodation (Airbnb, 2015) by providing them with the required access and tools to market themselves to a global client base.

The company has restructured the traditional business model (TBM) of the hotel industry because it provides accommodation by simply matching hosts with travelers without running physical assets such as hotel rooms or holiday apartments itself. Profits are not made by setting the price but by collecting a fixed fee on each transaction agreed between the two parties.

Whereas hotels are valued for their consistent service quality and reliable customer experience, Airbnb makes an entirely different value proposition through emphasising the variety and uniqueness of its listings and using transparent peer evaluation mechanisms to ensure quality (Choudary, 2014).

At inception, the firm’s novel offering did not appeal to usual hotel bookers who were not fond of the idea of staying at a stranger’s apartment. Yet, at the same time, it was exactly the thrill of meeting new people and getting to know the area from a local’s perspective (MacGregor, 2014) that attracted a particular group of low- budget consumers and thus created a new market.

Today, Airbnb hosts over 1.5 million listings that range from single bedrooms to private mansions and cover all price categories (Airbnb, 2015). Though it does not yet affect the revenues of business and luxury hotels (Economist, 2014), in places where it has established a solid presence, the company evidently cuts the revenues of budget hotels by approximately 5% which is expected to increase up to 10% by 2016 (Zervas, Proserpio and Byers, 2013). This happens as a result because Airbnb has not only re-invented the lodging service but has also shaped the way it is consumed. Over time, the company has turned the uncomfortable idea of living in an unfamiliar place with a random person into something exotic and adventurous, which today forms the essence of travelling to many tourists.

Similar to Airbnb, Spotify is now starting to reshape the music industry:

Spotify is an online music library that uses the internet as a platform on which customers can stream almost any song they like (Spotify, 2015).

The main difference between Spotify’s streaming business and traditional online record vendors such as Apple’s iTunes lies in the fact that Spotify does not create value by selling a song but by providing the access to it (Seabrook, 2014). In contrast to iTunes where consumers can only listen to the songs they download, Spotify users can listen to as many songs as they wish. Moreover, the company operates two revenue streams via its so-called freemium concept: The free version permits consumers to enjoy the music without being charged. Revenues are generated through commercials placed between the songs. Alternatively, users can switch to the premium service without advertisements. In return, Spotify collects a monthly subscription fee (Spotify, 2015).

Contrary to traditional download platforms, which promote ownership, Spotify’s value proposition lies within the abundance and variety of music. Due to their personal budget restrictions, iTunes customers cannot play as many songs as they like. Spotify users on the other hand do not gain physical ownership of the songs, i.e. the ability to store them e.g. on a CD, but have the opportunity to discover and consume an unlimited amount of titles. At the beginning, this value proposition did not appeal to mainstream listeners whose music taste was rather limited to chart hits and therefore would not have benefited from the vast array of (less popular) songs. Instead, Spotify attracted passionate music-nerds who used to spend a huge amount of money or download music illegally to satisfy their special demand for variety.

Thus, Spotify created a new market primarily by converting illegal downloaders into free subscribers of its convenient service and slowly convincing them of the advantages coming with the premium option. In Sweden, Spotify’s country of origin, the company has conquered the market within 5 years after inception. When music sales declined by 50% due to illegal downloading in 2008, Spotify launched its service and managed to increase national music sales by 25% in the same year. Together with other streaming services, the company accounted for 75% of the national music industry’s revenues in 2013 (Milne, 2014).

The cases of Airbnb and Spotify have exemplified the extreme difference in the nature of traditional and disruptive business models, which justifies the classification of DBMs as a new type of species.

The dominant feature that distinguishes DBMs from TBMs is the mechanism that drives their seemingly unstoppable expansion into the mainstream. This rapid growth stems from technological and/or business model advantages, which enable them to reach scale and improve their value proposition simultaneously (Raynor, 2011). Unlike traditional companies, they move upmarket without compromising on their intrinsic performance advantage. Also referred to as the “extendable core” (Wessel and Christensen, 2012), this trait allows disruptive business models to upgrade their service offering along their original performance metrics and enhance it with the traditional value attributes mainstream consumers appreciate (Markides, 2008).

The key advantage of music downloads over streaming services used to be the possibility to copy songs onto several storage devices, such as MP3 players or mobile phones, and play them at any time without requiring a steady internet connection. Spotify’s extendable core was revealed through the sophisticated way its business model tackled this deficit. The company has shortly introduced an additional download function, which permits its users to save songs directly on their mobile devices in a new format that can be played off-line but prevents the digital transfer of songs to other devices. Hence, Spotify has managed to adopt the traditional value attribute of download libraries and has even improved it by technically preventing illegal file sharing.

Airbnb’s extendable core is inherent in its platform business model and becomes visible when comparing its ways of reaching scale and improvement to those of traditional hotel chains. A hotel chain scales up its business by building additional hotels in new locations and enhances the quality standard of its service and facilities through employee training and investments in high quality materials. In contrast, Airbnb increases quality and scale almost simultaneously by leveraging its digital platform and strong networking effects. Instead of scaling up by setting up additional facilities, Airbnb simply raises the number of its listings and hence matches more users via its platform (Choudary, 2014). By doing so, the company indirectly boosts the quality of its listings at the same time. The competitive pressure on listing users rises along with the growing number of hosts whojoin the platform. Due to the customer feedback that is publicly available to all travelers, private hosts are automatically incentivised to guarantee or even improve their service quality if they want to remain competitive. In other words, Airbnb benefits from a significant performance advantage over regular hotels because it does not have to make additional investments in order to increase scale and quality.

2.2 The Three-Stage Model of Industry Disruption

Driven by the extendable core explained above, disruptors like Airbnb and Spotify display a specific growth pattern that is observed in several industries. Skype (communication), Amazon (bookselling), Netflix (television), Uber (car rental), booking.com (travel agencies) and eBay (retail) represent just a tiny fraction of DBMs that currently disrupt traditional industries and all inhibit a similar growth pattern.

As depicted in Figure 1 overleaf, this pattern is translated into a generic model consisting of three developmental stages: Niche Construction, Niche Overlap and Mainstream Spillover. The diagram at hand is designed in correspondence to the assumption that companies employing DBMs represent an entirely new “species”, which cannot be treated as regular competition. It provides a macro-level perspective to gain an overview of the actual competition that takes place between DBMs and TBMs.

The reason for this approach lies in the argument that the entrance of a new species triggers certain competitive effects that must be analysed in more detail. More explicitly, this paper argues that the evolutionary biological concepts of inter- and intra-specific competition (Connell, 1983; Townsend, Begon and Harper, 2008) form an analogy to recent phenomena in the business world and thus offer valuable insights on the competitive dynamics that affect the strategic maneuvers of market incumbents.

Accordingly, the regular competition between traditional firms is regarded as intra­specific, while the competition between incumbents and disruptors is classified as inter-specific. As the findings from evolutionary biology state, intra-specific competition for scarce resources between members of the same species reduces their natural fitness (Chase and Leibold, 2003). If a new competitor from a superior species invades their natural habitat and claims the same resources, the degree of intra-species competition amongst the incumbent species is amplified and further weakens its competitive position (McGinley, 2014). In the following section, this biological analogy is transferred to the competition for customers between established firms and industry disruptors.

Starting from the bottom, Figure 1 visualises the growth pattern of disruptors in three basic stages:

illustration not visible in this excerpt

Figure 1: The Three-Stage Model of Industry Disruption

[...]