Do We Need to Re-Think Business Strategy? (Part 2)
Are You Playing to Lose?
Strategy and Digital Transformation - Part 2: The reasoning and the answer
In my last article - Part 1 about Digital Strategy - I started looking at the question if digital is rewriting the rules of strategy (based on case made in [1]). Here in Part 2, I will provide my take on the answer. But first, let's continue our reasoning with a challenge: are you playing to lose?
Competition: playing to lose
When a focused company needs to compete with a player that provides an offering based on a "razor" in the company's core business and a "blade" in another industry it will become extremely difficult to defend its position in a sustainable way.
To stay with our example: if Amazon decides to provide personal loans along its e-commerce business for its customers it will be difficult for banks to compete. Since banks are only in one of the two businesses in this example, they need to make money with their loans while for Amazon, loans are just the 'razor' to sell more stuff online in its thriving e-commerce business.
It's cost leadership re-defined: undercutting the competition by offering below cost in a sustainable way because the core business of competitors is just a complement for the digital/platform contender. It is sustainable to cross-finance it because it makes the contender's flywheel spinning - and that's the strategic logic behind it.
We can observe this also in business models enabled by IoT (Internet of Things). For example, in the smart home domain: Apple (Apple TV, HomePod, etc.) Google (Chromecast, Nest products) or Amazon (Echo and Fire TV products) are cross-financing their products (their 'razor') to claim a dominant footprint in people's homes and lives in order to fuel customer insights for advertising, online retail, and digital business (their 'blade'). This leaves even TV/entertainment giants like Samsung and Sony in difficult positions, which decided to opt for co-existence and integration of their competitors' technologies like Siri or Alexa.
In health tech, a very different industry, one can see that it may become harder for focused product companies to compete against platform vendors. For example, a focused company's class-leading medical device for measuring some vital patient data in hospitals may become difficult to position against a low-priced (maybe inferior) product of a large player for which it is their 'razor' (in the same industry but a quite different solution space) while its 'blade' is its hospital management solution, where it makes its money with end-to-end process automation, data collection, and data-driven services.
“It’s cost leadership re-defined: the strategic logic of digital ecosystems allows to undercut competitors in a sustainable way based on a business model flywheel across industries.”
Not a conglomerate
I think it is important to note that what we observe here are not conglomerates in the traditional sense.
By definition, a conglomerate is a corporate group consisting of multiple businesses. Expanding scope means to diversify into different lines of business and entities. The argument for conglomerates are economies of scale/scope realized from synergies - some easier to justify (e.g. sales, distribution, scale economies, leveraging cost-efficient technologies, etc.) and some more difficult to justify (e.g. general management, market power, finance, capabilities, integration, etc.). Risk management, on the other hand, is not considered to be a good argument for conglomerates. Risk management provided by a conglomerate's diversified portfolio of businesses is not in favor of investors, who value transparency and focus and prefer efficient financial markets to take care of risk management instead. In summary, scope increases create value primary by exploiting synergies where businesses are related.
Platform and digital leaders such as Amazon or Google are only seemingly in unrelated businesses. Actually, their 'razor and blade' approach is rather a product bundling across industries. That is the significant difference to traditional conglomerates. It's a product management and business model approach. It's not diversification - it's quite the opposite: it's adding value by connecting and fulfilling diverse customer needs in different domains or industries.
“Digital ecosystem leaders are in the business of product bundling across industries.”
Products and bundling across industries
Moving from single products in a single industry to multiple products (which are complementary, create synergies, and more value together) across industries should be addressed from a strategic product management perspective. Clearly, this is not limited to the B2C space but includes complex B2B solutions, which by definition consist of products and services addressing an end-to-end client problem over extended lifecycles.
In the domain of digital product strategies, bundling with 'razer and blade' approaches spanning different industries may mean that you are bringing one product far below competitors' prices to market - maybe even below your marginal cost - to also attract customers that initially see little or no value in your 'razor'.
From a strategic product management perspective multiple offerings across different industry sectors can be considered as a bundle (multiple items that are sold together). Bundling and tying in combination with advanced multiproduct pricing of heterogenous items is a complex topic by itself. Therefore, I will provide a bit of a deeper dive into digital products and bundling in one of my next articles, "Product Bundling in the Age of Digital".
In my option, product strategy - and product-driven organizational design - are absolute key for digital transformation. Later articles will focus on the product perspective to provide important insights and show the far-reaching consequences for strategy, innovation, and organizations.
“Product strategy and product-driven organizational design are key for digital transformation.”
The Business Model Test
My argument to view the prototypical digital players not as conventional conglomerates but as companies with highly related businesses, which are in fact integrated, complementary, create synergies, and create value in concert - simply put: tied together in one business model.
This is a quite revealing test and maybe the single most relevant criteria to assess if a company is a conglomerate or not.
For my proposed "Business Model Test", ask the following question: "Are a company's seemingly unrelated businesses tied together by a single business model?"
If the answer is 'yes', then the company is not a conglomerate in the traditional sense (since it is combining different domains or industries with an integrated/interlocked business model to create value)
If the answer is 'no', the company can be viewed as a conglomerate (since it is in different lines of business for diversification)
For example, Google did not enter the car navigation business with its Google Maps for diversification (and to compete with TomTom in this domain) but to provide location-based search - tightly integrated with its web search and advertising network. Since Google Maps is free for end users, competitors in the map and navigation business are unable to match Google's zero cost offering. This is the brutal logic of the "cost leadership re-defined", where horizontal digital players undercut competitors in a sustainable way. In this case, Google should not be viewed as a conglomerate because the multiple domains are tied together with a single business model. Moreover, offerings on the market with a price tag of zero are powerful and hard to beat because they are convenient, accessible, and (perceived) risk-free for consumers/users.
“Zero is a powerful number.”
In the competitive landscape, a horizontal digital player should not be mistaken as a conglomerate with one of its businesses happen to be in your space. With the discussed 'razor and blade' business model across industries a digital player may be an existential threat for your operations. You will need quite a different strategy to cope with such a shift in your industry.
“Horizontal digital players should not be viewed as conglomerates as long as they combine their activities in different industries and domains into one integrated business model.”
Gravitational forces towards conglomerates
Nevertheless, for such digital platform players there seem to be gravitational forces at work that move them towards traditional conglomerates.
For example, when we take a closer look at Amazon, we can see evidence of diversification and elements of traditional conglomerates. As a case in point, Amazon's successful cloud businesses AWS could be viewed as a separate business. It is - as far as I know - the only significant* business of Amazon in the B2B space.
There are internal synergies (cost and asset synergies) from AWS' flexible cloud infrastructure with its own e-commerce platform (that's where it came from originally). However, it is unclear why and how a separated customer base in the consumer space (B2C) should be combined into a overarching business model with its business/enterprise customers (B2B). Also, there are growing conflicts of interests with AWS because Amazon also competes with its business clients in the consumer space (such as Netflix or Walmart in retail, music, video, or smart home domains). This is a situation that Microsoft starts exploiting with its value proposition. From an investor's perspective, the point can be made that AWS could be worth more as a separate company in the future. The financial market may think it is better in allocating money than Amazon's management and may prefer to be able to invest selectively in Amazon's consumer business or in the growing AWS B2B cloud business.
[*Amazon does also target small and large businesses, e.g. with its store-in-store concept in e-commerce and procurement solutions.]
Another example is Google, which in 2015 became a subsidiary in the newly formed holding company Alphabet.
This helped to address risks of antitrust and create more transparency in its financial reporting regarding subsidiaries and income streams. However, the financial market cannot invest in subsidiaries directly. Alphabet is definitely a technology conglomerate with diverse businesses in web/search/advertisement, life sciences, biotech, capital and ventures without a business model that ties them together.
In addition, the conventional wisdom for evaluating the validity of a conglomerate still applies of course. In essence:
The "better off test": are the individual businesses worth more than the conglomerate?
Ultimately: are you the best owner of this business?
Re-shaping industries
For digital strategy, it is imperative to challenge how to think about industries and their boundaries. It is often at the intersections of industry sectors and across domains where innovation happens, novel business models emerge, and new value is created. Clearly, in digital strategy it helps not only to understand business strategy but also corporate strategy**. The key in digital strategy is to create value by connecting the different domains. For strategists, the question of "Where to Play" is less limited than ever. It is certainly not limited by a single industry or domain these days (otherwise the question would be called "In which industry to play" - and trivial segmentation and targeting is never insightful and will not achieve differentiation).
[**The peculiarities between business and corporate strategy in this context are a topic for another article. The same goes for the systematic re-shaping of industries and Blue Ocean Strategy in the age of digital transformation.]
As we have seen, it is very hard for a focused company to cope with contenders with horizontal digital strategies. It's because focused companies cannot compete on the product (better or cheaper) alone anymore.
However, I would argue that the rules of strategy have not changed. Digital is not rewriting the rules of strategy - but it is changing the terrain.
So, there are no new rules but different context, new possibilities, new ways to compete.
A field commander on the battlefield needs to know the terrain to win. For the strategist, a deep understanding of the terrain is imperative.
“Digital is not rewriting the rules of strategy but is changing the terrain.”
References
[1] Driving Digital Strategy: A Guide to Reimagining Your Business, Sunil Gupta, August 2018