A brilliant digital strategy is like an egg of Columbus. It seems so simple and easy to figure out after the fact, but without the right balance of creativity and insight, companies can’t find it.
This blog explores the relationships between three key concepts to build a brilliant digital strategy: the S-Curve, Porters Five (now Six) Forces model, and the Business Model Canvas. But before I dive into theory, let’s look at how De Beers became the world’s most famous diamond company by executing a “brilliant” strategy.
Diamonds are forever
Between the Earth’s core and its crust, the pressure is high enough and the temperature just low enough for carbon to crystallize into its hardest form: diamonds. Two Dutch settler brothers owned a South African farm on which they discovered diamonds. Their land became a mine which carried the name De Beers, operated by a British company with the same name. De Beers found a great many diamonds beneath the sand in Botswana.
Instead of flooding the market, like the Spaniards had done with gold in the 18th century, De Beers kept tight control of supply, both by owning mines and by buying diamonds from other miners. At the same time, it conjured up demand by successfully advertising diamonds as a symbol of love and commitment. Their famous advertising slogan, “A diamond is forever,” became one of the best-known advertising slogans of the 20th century. Through the company’s influence in Hollywood, De Beers invented social rules, urging men to spend two months’ pay on a gift for their bride-to-be. Full control over demand and supply, combined with limited power of competitors, new entrants, and substitutes, permitted not only high margins for De Beers, but also suppressed the second-hand market, to the benefit of both the firm and its customers, who could be reassured their investment would hold its value.
In the spirit of brilliant strategy, let’s ignore the ecological, social, and political devastation that the (blood) diamond industry has caused. From a microeconomic point of view, De Beers brilliantly executed an equally brilliant strategy, straight from Michael Porter’s textbooks. Its success depended on manipulated supply and skilfully cultivated demand. They were able to control the diamond price throughout the 20th century.
But all good things come to an end. Eventually diamond mines started to break away from the De Beers cartel, which saw its market share fall from a peak of 90% in the 1980s to 33% in 2013.
Technological s-curves and the impact on strategy development
It is highly unlikely the De Beers history will repeat itself. The competitive landscape in the diamond industry has come to a point where no firm can charge a price that is significantly higher than the marginal cost of producing the product. If any enterprise tries to raise prices, it will lose its customers either to others that charge lower prices or to a new firm that will find it profitable to lower its price, to take customers away. Companies that operate in a mature industry find themselves competing in “red oceans,” a term coined by W. Chan Kim and Renée Mauborgne, professors at INSEAD, in their book Blue Ocean Strategy. When every company in an industry fights for dominance, the sea turns red with blood.
Technological advancement is widely considered an effective way to avoid the red ocean. Silicon Valley unicorns, like Uber, Airbnb, and Tesla, have found ways to disrupt existing industries. They have used technology to create “blue oceans” of almost uncontested market space, with the prospect of economic profits that are significantly higher than the industry average. But not forever.
Technological innovation follows an s-curve. When it emerges, the new technology operates far below its potential. After a period of slow initial growth, characterized by experimentation by early adopters, the technology sees rapid growth until it reaches the early majority. In this stage, the technology becomes highly profitable and thus vulnerable to substitution or obsolescence when a new or better-performing technology emerges. Every technology in the end will naturally reach a state where further improvement becomes very difficult to achieve. Economists refer to this as an s-curve: Slow market penetration at the start when the new technology is introduced, followed by diminishing returns towards the end of the lifecycle of that technology.
A good demonstration of the dynamics of s-curves can be found in the music industry. For years, it was dominated by music halls, then vinyl records, until the magnetic tape was introduced, followed by compact discs. Now we store music predominantly on flash memory or we stream it. Every new s-curve introduces the demise of the old one.
What does this have to do with digital strategy development? If the company’s goal is to increase profit, it should strive to have products and services that are positioned in the lower end of the s-curve, where the technology is highly profitable. For product categories in the maturity stage, new s-curves have to be created by means of R&D.
Porter’s Five Forces
There are many frameworks that advisory firms like McKinsey, BCG, and Accenture use to develop strategies for their clients. They have tools like the 3C’s framework, SWOT, BCG matrix, and the 7S model at their disposal. There is no wrong or right way to select a model for developing a strategy, but the most common framework to recognize when to jump to the next s-curve is Porter’s Five Forces. It describes three threats (or “forces”) from horizontal competition: the threat of substitute products or services, the threat of established rivals, and the threat of new entrants; and two threats from vertical competition: the bargaining power of suppliers and the bargaining power of customers.
An effective strategy to increase sustainable profitability would, according to Porter, have at least five dimensions in which these elements’ influence becomes reduced. For example:
- Increase switching costs of customers, increase capital needs, or create cost disadvantages to reduce the threat of new entrants.
- Adjust price, increase switching costs, or differentiate the product to reduce the threat of substitutes.
- Reduce the total amount of trading, reduce prices, or increase dependency on existing channels to reduce the bargaining power of customers
- Vertically integrate, switch to different inputs, or increase the strength of their distribution channel to reduce the bargaining power of suppliers.
- Innovate, increase advertising expense, or improve customer experience to reduce rivalry.
Porter’s model helps companies understand the level of competitive intensity within an industry and therefore the attractiveness or profitability of that industry. The strategy deployed by companies in that industry, i.e., their core competencies, business model, and network, defines whether they can achieve profits above the industry average.
A new force is on the rise
In today’s digital world, these five forces are still very relevant, but not complete. Professor Brandenbuger from the Yale School of Management, using game theory raised the notion of a sixth force: “complementors.” Complementors are businesses that sell products to complement the product of another company, adding value to mutual companies.
Today complementors are the emerging economic order. New business models emerge where companies leverage other companies’ knowledge, assets, data, and market access to increase their value proposition to current and new customers. They are competing as an ecosystem. Apple is probably the best example. Tesla is partnering with Mobileye to launch driverless cars. Starbucks and Spotify offer a first-of-its-kind music ecosystem. It is a true sixth force in Michael Porter’s Five Forces model.
The business model canvas
One of the leading tools to design blue ocean strategies is the Business Model Canvas (BMC) by Alexander Osterwalder. It brings together the six Porter dimensions into one visual reference model. Using the BMC, an enterprise can easily describe its business model in terms of:
- Why: the value proposition, revenue streams, and cost structure
- How: customer segments, channels, relationships
- What: key activities, resources, and partner networks
This framework is proven to effectively test and refine new digital business models. It explores market forces, key trends, Porter’s six industry forces, and macroeconomic forces. These angles are indispensable when creating innovative and brilliant business models. The visual aspect of this tool allows for a more tangible understanding of the environment. Furthermore, the BMC provides people from various parts of the organization a common vocabulary to discuss their business model. It increases the propensity to uncover new opportunities and avenues for the development of new and innovative business models.
This blog post was inspired by a lecture on strategy by INSEAD Business School: Professor Jay Kim, Jason Davis and Phil Parker (INSEAD Singapore on Monday May 15, 2017)
For more on digital marketing, see Primed: Prompting Customers to Buy.