How much are you spending on subscriptions each month? If you are like 84% of Americans, you do not have a clue. The average American pays $237 a month for subscription services and they got there without any conscious awareness. Here is a question: How many of the charges on your last credit card statement were made without you even having to pull your credit card? There is likely charges for Netflix, Spotify, Amazon etc. Subscriptions are exploding because billions of digital consumers are increasingly favoring access over ownership, but most companies are still built to sell products…
For the past 120 or so years, we’ve been living in the product economy . Companies designed, built, sold, and shipped physical things under the asset transfer model. Business was about inventory, shelving, and cost-plus pricing model. The product was the only governing principle – it organized everything across perfect straight line (just like in Hendry Ford’s assembly line). Post war American corporations organized themselves around strictly delineated product divisions and did not have to answer to anyone. The emergence of enterprise resource planning (ERP) systems only exacerbated this problem. These systems did a good job of measuring operational efficiency, inventory, purchase orders, shipping, payroll but they did a lousy job of measuring customer experience. Thankfully around 20 years ago (thanks to Jeff Bazos) corporate America woke up to realization that all this relentless focus on productivity is coming at a cost – relationship with the customer.
Fast forward to today and most successful companies look nothing like soulless corporations of the past. Today they are designed around customer need whether it is transportation as the service (Uber), streaming as the services (Netflix), compute as the service (AWS). While they offer different services, they have one common denominator – access to raw customer need. They do not compromise on direct customer access to be able to analyze their behavior to determine the raw need. Raw need is the essence of what a customer values, independent of how the need is addressed today. They are relentlessly focused on building direct digital relationships with their customers. This unique insight into the customer allow them to evolve their services around that need.
Let’s look at the ultimate product company of our generation, Apple. In 2007 Steve Jobs introduced iPhone and went on to sell over 2.2 billion units to date. However, in recent earnings call, the company said that it would no longer break out unit sales of the iPhone or its other products. As CFO Luca Maestri said, “a unit of sale is less relevant for us today than it was in the past given the breadth of our portfolio.” Wait….what? Every MBA program teaches that fundamental goal of every business is to create a hit product and then sell as many units of that product as possible, thereby diluting fixed costs in order to compete on margins. Well if that is you, sorry to break it to you, that model is over. Today Apple is more concerned with getting your data rather than shipping iPhone units… They are loud and clear on that point ” we collect information regarding customer activities on our website, iCloud services, our iTunes Store, App Store, Mac App Store, App Store for Apple TV and iBooks Stores and from our other products and services”. As result of all this data collection, Apple is able to rollout brand new offerings – Apple Music, Apple TV +, Apple Arcade, iCloud, Apple News +, Apple Fitness + for small fee of $14.99/month (not a bad deal if you ask me) and collecting whopping $54 billion in revenue. Apple also realizes that the job we hired our phones to do ten years ago (text, call) are no longer the jobs customer needs the phones to do today (e.g. tele-health, fitness, news). The data crunching allows Apple to move from linear transactional model to circular, dynamic relationship around the customer (Picture 1).
In the old world companies used to focus on “getting a product to market” and selling as many units of that product as possible: more cars, more razors, more pens, more laptops. They did this by getting their products into as many sales and distribution channels as possible (e.g. Disney selling its merchandises at Wall-mart, Dell selling PCs through BestBuy). But that is not how modern company thinks. Today successful companies start with the customer. They recognize that that customers spend their time across many channels, and whenever those customers are, that’s where they should be meeting their customers’ needs. And the more information you can learn about the customer, the better you can serve there needs, and the more valuable the relationship becomes. That’s digital transformation: from linear transactional channels – > a circular; dynamic relationship with the customer.
Big changes are coming. If you don’t find out who your customers are in the next five to ten years, you fail. This explains why smaller startups are able to take down big enterprises by simply knowing whom they are selling better than big competitors. If you look at new establishment companies such as Amazon, Google, Facebook there were never product companies – no transformation was needed. From the start, these companies were relentlessly focused on building direct digital relationships with their customers.
Now if your company is not one of the digital natives with sophisticated AI algorithms analyzing the customer data, do not panic.. yet. There are great examples of old incumbents transforming itself into services based business models. Let’s look at few examples.
Disney Company is 97 years old. On October 12, 2020 it came out with announcement “The Walt Disney Company Announces Strategic Reorganization Of Its Media And Entertainment Businesses” . The subtitle to this announcement explains reasoning behind the restructure ” New Structure Designed to Further Accelerate the Company’s Direct-to-Consumer Strategy“. That’s right. It is all about “Direct-To-Consumer” strategy. No more selling Disney merchandises through 3rd party channels or selling movies via movie theaters. It is now all about direct streaming and engagement with the customer (no more middle men). Profit and loss responsibility is the ultimate indicator of control, the org change puts distribution and particularly direct to consumer services at the top of P&L hierarchy which will allow Disney to be more nimble and allow to go to customers directly with Disney + instead of solely retaining on TV and Theaters (both fading businesses).
By changing profit and loss responsibilities Disney is ensuring the whole company is a beneficiary of its content efforts
The evidence is clear with Disney’s recent announcement of Soul, its next Pixar film, will be released exclusively on Disney Plus. Setting it up to be the most idealized piece of Disney content ever.
I’m not referring to the actual movie, which looks great; rather, consider how Disney is poised to make money from Soul:
- Disney will earn money from Disney+ subscribers, and keep 100% of the margin.
- Disney will create Soul-derived merchandise, much of which it will sell through its stores and at its theme parks, and keep 100% of the margin.
- Disney will create Soul-derived features at those theme parks, most of which it fully owns-and-operates, and keep 100% of the margin.
You get the picture. And, at every transaction along the way, Disney will build an ever fuller picture of its customers. Disney, as always, will be selling Disney — it is just getting better and better at it as it more fully integrates its entire value chain.
My personal favorite transformation from linear transaction to circular business model is – Adobe. It illustrates boldness and courage needed to transform the business. Founded in 1982, Adobe built its business on a page description language, digital fonts, an electronic document format (PDF) and a suite of desktop applications for photo editing. In 2011 it was bringing $3.4 billion in revenue at a 97 percent gross margin. Most management teams would be hard-pressed to find much fault with these kind of numbers. But there were some troubling signs – the business was growing primarily because of price increases, and the overall user base was not growing. At the same time – Instagram, online video – was exploding. They were literally and figurately stuck in the box. The management team was left with two options. One was to treat Create Suite as bank account (perpetual licensing model) for a new line of business that would go after digital publishing or to adapt its business model to the new realities of social, mobile, analytics and cloud (a.k.a. SMAC). It has chosen to move from selling mainly perpetual-license desktop software to a subscription-based model incorporating a mix of desktop software, mobile apps, SaaS applications and cloud services. Which brings us to November 2011 when , Adobe’s CEO, Mark Garret, told dozens of Wall Street analysts that he was going to try as hard as he could to make his company’s revenue earnings fall as quickly as possible. Let that sink ink for second….“Adobe is doubling down in the Digital Media and Digital Marketing categories, markets rich with opportunities for innovation and growth. Moving into FY2012, Adobe will focus its research and development and sales and marketing investments on these two opportunities. In Digital Media, the company expects to attract new customers and increase recurring revenue through its new subscription offering. In order to drive increased Digital Marketing bookings, which are recognized as recurring revenue, the company will reduce its investment, and expected license revenue, in certain enterprise solution product lines. These changes will reduce FY2012 revenue growth by approximately four to five percentage points.” They actually managed to keep up with revenue in 2012, with dip experienced in 2013, 2014.
This dip in revenue right after switching to subscription based business represents “Fish model” and during this transition company must “swallow the fish” (I think they mean raw fish, not cooked) as the revenue curve temporarily dips below the operating expense curve before climbing back up.
Management teams chasing after quarterly numbers generally don’t like to look at that fish. They would just avoid it all together. There are boards and investors to consider, not to mention the fact that traditional unit-based, Wall Street measures them on strict GAAP – realized profits, not growth rates based on deferred revenue. This was the challenge Adobe team faced in 2011. So how did they do it? Well, once executive team committed, they relentlessly overcommunicated the vision. Essentially drowned controversy worth transparency. Their transition was well documented by Bloomberg BusinessWeek How Adobe Got Its Customers Hooked on Subscriptions. 50,000 customers even signed a Change.org petition demanding the company abandon the scheme (subscriptions). Despite all this pressure, executive team pressed on. Today Adobe brings $6 billion in revenue and 80% comes from subscriptions. Melissa Webster, program vice president for content and digital media technologies at researcher IDC, calls it a great example of “smart paranoia.” Says Webster: “If they didn’t reinvent, someone might reinvent them out of business.” Indeed “swallowing the fish” for Adobe paid off and now enjoying much closer relationship with customer and easier access to their raw needs to continue to innovate.
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