biz model 4 method of value capture
DESCRIPTION
These slides summarize a method of value capture for business models as part of a course on business models for hi-tech productsTRANSCRIPT
Methods of Value Capture(and some value proposition and
scope of activities)
A/Prof Jeffrey FunkDivision of Engineering and Technology Management
National University of Singapore
Business Model
Value proposition: what to offer and how to differentiate
Customer selection: whom to serve and not serveValue capture: dominant sources of revenueScope of activities: what activities to carry out and
what relationships to haveStrategic control: how to sustain profitability (e.g.,
how to control architecture and standards)
Remember! Consistency Among Elements and an Iterative Process are Critical
Customer selection: whom to serve and not serve
Value proposition: what to offer and how to differentiate
Value capture: how to make moneyScope of activities: what activities and
relationships to haveStrategic control: how to sustain
profitability
For example, Method of Value Capture and Value PropositionMethod of value capture related to needs as
is value proposition, customers like to pay for those things that are important to them
As noted last week, key dimensions of performance change over time, this requires changes in method of value capture◦As dimensions of performance change, customers
monitor different dimensions and thus are willing to pay for different things
In Other Words
In choosing method of value capture, we want to maximize potential revenues while making all of our customers happy
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Methods of Value Capture
Revenue Model Basic Idea
Commission Fees levied on transactions where fees are based on level of transaction
Advertising End users subsidized by advertising
Markup Value added in sales
Production Value added in production
Referral Fees for referring customers to a business
Subscription Fees for unlimited use
Fee for Service Fee for metered service
Methods of Value Capture (more detailed ones)Dominantrevenue model
Basic idea Variants
Commission Fees levied on transactionsbased on the size of thetransaction
Buy / Sell Fulfillment, Market Exchange,Business Trading Community, BuyerAggregator, Distribution Broker, Virtual Mall,Metmediary, Auction Broker, Reverse Auction,Classifieds, Search Agent, Bounty Broker,Matchmaker, Peer-to-peer Content Provider
Advertising End-users subsidized byadvertising
Generalized Portal, Personalized Portal,Specialized Portal, Attention / IncentiveMarketing, Free Model, InfomediaryRegistration Model, Recommender System,Bargain Discounter, Community Provider
Markup Value added in sales Virtual Merchant, Catalogue Merchant, Clickand Mortar, Bit Vendor
Production Value added in production Manufacturer Direct, Content Producer, E-Procurement, Networked Utility Provider, BrandIntegrated Content
Referral Fees for referring customers toa business
Lead Generator
Subscription Fees for unlimited use ISPs/OSPs, Last Mile Operators, ContentCreators
Fee-for-service Fees for metered service Service Provider, B2B Service Provider, ValueChain Service Provider, Value Chain Integrator,Audience Broker, Collaboration PlatformProvider, Application Service Provider
Source: Afuah and Tucci, Internet Business Models and Strategies
At What Price?
After choosing one of the categories on the previous slides, an additional issue is: how much to charge for each element of the product or service?
What level of margins?Higher margins are needed when
◦cost of sales◦cost of R&D is high ◦maintenance is high and given for free
Has to do With Cost StructureWhat is your cost structure?
◦Cost of delivered product or service Internal costs Materials and outside services
◦R&D◦Sales◦Maintenance (if free to user)
Fixed costs vs. variable costs◦High fixed costs make volumes very important◦But can also provide barrier to entry
Gross margins for different types of disk drives and computers
For Many Electronic Products
The cost of assembly is very small, perhaps 5% of total manufacturing costs
Components make up 95% of manufacturing costs
Other costs can be very high◦Development◦Distribution◦Licensing◦And more
Cross Subsidization is Common in Many Industries
More income from complements than original product◦blades than razors◦printer cartridges than printer machines◦copier toner than copier machine◦i-pods (MP3 players) than music (iTunes)◦peripherals than computers (IBM mainframe)
More income from after-sale service than from product, particularly when switching costs are high◦Software, elevators, escalators, nuclear fuel, power generation
equipmentMore income from one customer than another customer
Cross Subsidization Between Customers is CommonIndustry Product Dual Customers Discount for
Real Estate Property sales Buyer, seller Buyer
Rentals Renter, owner Renter
Media Newspapers, Magazines
Reader, advertiser Reader
Network television Viewer, Advertiser Viewer
Portals and Web Publications
Web surfer, advertiser
Web surfer
Shopping Malls Merchant, shopper Shopper
Payment System
Charge/debit card Cardholder, merchant
cardholder
What if Another Firm Begins Offering Complements for Your Product?
Another firm begins offering inexpensive◦blades for your razors◦printer cartridges for your printers◦toner for your copiers◦MP3 players for your iTunes music site
Another firm begins offering inexpensive services for your hardware◦Software, elevators, escalators, nuclear fuel, power generation
equipmentYou might lose your key revenue stream and thus your
profitability
Outline
Overview of Value CaptureExamples of Value Capture Methods
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet ◦Video◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Rolls Royce Jet EnginesA leader in providing jet engines for
aircraft manufacturersWhere do its revenues come from, i.e.,
what is its method of value capture?Most of its revenues used to come from
sale of enginesBut over time, things have changed………
Rolls Royce Jet Engines
Where are revenues?◦Selling engines or spare parts?◦Servicing the engines?
Investment analysts estimate that some engine suppliers ◦get seven times as much revenue from servicing
and selling spare parts as from selling engines◦Do they sell engines at a loss? hard to know due
to long-term contracts ◦The problem is that these large margins have
attracted independent servicing firms (and engine-makers after each other’s business)
Source: Economist, January 8, 2009. Britain's lonely high-flier
Rolls Royce’s New Method of Value CaptureInstead of selling first engines and then parts
and service to airlines, Rolls-Royce ◦ receives a fee for every hour that an engine runs◦promises to maintain it and replace it if it breaks
down“They aren’t selling engines, they are selling
hot air out the back of an engine,” says an investment analyst (i.e., new value proposition) More than half of its engines in service are covered by such contracts, as are about 80% of those it is now selling.
This New Method of Value Capture Requires New CapabilitiesRolls Royce continuously monitors performance of its
3,500 jet engines around the world, ◦ raising an almost insurmountable barrier to any rival
(method of strategic control)This data enables it to predict when engines are
more likely to fail, letting customers schedule engine changes ◦ fewer emergency repairs and fewer unhappy passengers
The data are equally valuable to Rolls-Royce◦ Spotting problems early helps it to design and build more
reliable engines or to modify existing ones◦ Aided improvements in fuel efficiency and extended the
operating life of engines tenfold (to about ten years between major rebuilds)
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet ◦Video◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Alstom Transport (1)Alstom is a leading provider of transport
equipment and (e.g., rail) solutions in the worldProblems with train downtime caused rail
companies to demand and pay for lower downtimes
London Underground specified in a contract that 96 trains be available for service each day
This required Alstom to gradually take over customer’s operational activities and to redesign the system for lower downtime
Should Alstom charge for time and distance that trains travel?
Alstom Transport (2)Another change Alstom made to support lower
downtime of its transport division was to create two customer-facing divisions:◦Alstom Systems provides turnkey solutions for trains,
signaling systems and maintenance services◦Alstom Services offers operational services, such as
train maintenance, technical support, product upgrades and renovation
This change represents a form of organizational capability. For example, feedback from Alstom Services enables Alstom’s Systems design better turnkey systems
Similar Examples (1)
Many providers of ◦mobile phone infrastructure providers (e.g.,
Ericsson)◦electrical generating equipment◦nuclear fuel◦manufacturing equipment
are selling services (value proposition) and getting paid (method of value capture) for doing services
Similar Examples (2)These providers of equipment and service
know the equipment and service better than the customer – thus they do the service
One reason they know the equipment and service is because they spend a lot on R&D
They spend a lot on R&D because they sell systems to many customers
Related to method of strategic control◦economies of scale in R&D◦covered a few weeks ago
Remember
Changes in business models often cause the shares of firms to change……..
Change creates opportunities
ExceptionsSome providers of services design their own systems
and do their own R&DThis is common in Japan
◦NTT DoCoMo in mobile phone services◦Japan Railways (JR) in train services◦NTT in Wireline phone services
This leads to high R&D costs per sales and thus high costs for final services
One reason they can do this is because of high barriers to entry for foreign firms
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet ◦Video◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
How About Electric Vehicles?Do potential users want to pay for electric
vehicles in same way they pay for regular cars (i.e., internal combustion engines)? ◦Separately pay for cars and for electricity charging◦But what if there are no charging stations?
Alternative business model◦What if users mostly pay for use of car, i.e., pay for
miles driven?◦Could do this for rental or ownership◦Then suppliers have incentive to provide good
coverage of charging stations (just like mobile phone companies have incentive to provide good coverage of base stations)
Two Distinct Choices for Electric Vehicles
Sell electric vehicles Sell miles driven
Customer selection
Conventional customer Risk averse customer
Value Proposition
Provide electric vehicle Provide driving with electric vehicle
Scope of Activities
Design and make automobile
Manage charging stations
Value Capture Receive payment for automobile
Receive payment for miles driven
Method of Strategic Control
High entry cost for design/manufacture of auto
High entry cost of charging stations
OutlineWhy do you think Singapore might be a better place
for the “sell miles driven” business model than doing it in Malaysia, Indonesia, or the U.S.?
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet ◦Video◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Computers (1)Most of us buy computers at retail outlets
and retail outlets pay the computer manufacturers
But this is just the last step in a long process of modification◦firms have modified methods of value capture
(and other aspects of biz model) many times both to survive and find the most profits
Each “discontinuity” has involved a new method of value capture◦Also differences between firms for the same
discontinuity
Computers (2)Mainframe suppliers such as IBM used to
lease computers and software for a monthly fee◦this low monthly fee and IBM’s large software
library created a barrier to entry for other suppliers
Mini-computer suppliers found a niche by selling computers and providing documentation for engineers and scientists who developed their own software
Computers (3)PC suppliers took mini-computer method of
value capture one step further◦More documentation in the form of more “open
system,” which enabled greater choice of software for users
◦Purchased microprocessors, other ICs, software from other firms, sold computers through retail outlets
◦Low development costs, no sales people, and higher volumes enabled them to have lower margins (see next slide)
Software suppliers tried various methods of value capture◦Microsoft received licensing fee for each PC sold
Lower grossmargins formini than mainframeand even Lower for PCs
Computers (4)PC software
◦IBM offered Microsoft a lump sum payment for OS
◦Microsoft wanted a licensing fee per PC◦What are the advantages and disadvantages
of each approach?Now, service revenues are now greater
than licensing fees (see later slide) for software
Software is moving towards services
Service/Usage Fees are even more Important with Software as a Service (SaaS)Value proposition
◦Provides software for lower price than packaged softwareCustomer selection
◦Small organizations (security software is exception)Scope of activities
◦No installation activities, instead a focus on delivering new products/services
Value capture: subscription/usage fees as opposed to high initial cost of packaged software and installation
Utility/Cloud Computing: Complete outsourcing of IT to utilities (similar to electricity)
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet ◦Video◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Internet
Many Examples of New Methods of Value Capture in Internet
Will focus on one here, PayPal, and some others later
PayPal (1)
Problem addressed by PayPal’s service◦Difficult for individuals to receive payments with credit
cardsFirst method of value capture
◦Although always free to senders, it was initially free to receivers and PayPal planned to use e-mail as identifier and make money from interest when receivers left money in accounts
The PayPal Wars: Battles with eBay, the Media, the Mafia, and the Rest of Planet Earth by Eric M. Jackson
PayPal (2)Resulting Problem
◦Receivers quickly removed cash and used credit cards to make payments
◦PayPal was forced to pay credit card fees (about 2%) since users didn’t have any cash in their accounts
Second method of value capture◦Charge large receivers (>$500 in six months) transaction
fees ◦Large receivers must upgrade or cannot receive payments
via credit cards
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video, eBooks◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Producers of Videos/MoviesTheater tickets from about 1900Broadcast television ad revenues from late 1940sCable (from 50s) & satellite (from 90s) subscription
feesRental and sales income from VHS from late 1970s,
from DVDs in 1990s◦Rental stores pay movie companies fixed fee or percentage
of rental/sales income◦Netflix extended this model to mail delivery service and
Redbox extended it to rental kiosks in 2000sInternet services
◦Big changes occurring now
Internet ServicesIndependent sites control most of the Internet
businesses, but some of them are owned by content owners/broadcasters
Movies/programs mostly viewed on computersThree methods of value capture
◦Sell digital movies (e.g., Amazon, Apple iTunes)◦Provide movies/programs for free, make money on ads
(Hulu, YouTube, CBS)◦Subscription services (Netflix, TV Everywhere)
Innovations (and new methods of value capture) are also needed in television receivers◦Google TV◦Apple TV
Source: Netflix, valuing a new business model, HBS Case 9-113-018
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video, eBooks◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
What about e-Books?If you are an online book provider, should
you sell files for a specific reader or other types of files?
Should you sell your own branded readers?Should you sell or rent books?What percentage of revenues should you
share with publisher (or author)What should be the price?Who sets price?
◦Online book provider: may sell low and at a loss to promote sales of readers
◦Publisher: may set high price to discourage sale of eBooks
What about e-Books? (2)In the long run……….Libraries and stores (i.e., private libraries)
can rent out individual books to the public online (i.e., anywhere in the world)
While it takes a while for users to return physical books, a copy of an e-book could be returned much faster
This would lead to much lower rental prices (perhaps daily rental fees) and thus◦a much larger rental market◦and perhaps a smaller purchase market
OutlineOverview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Phone Manufacturers
Until recently, traditional cost plus fee pricingStrategic control: Economies of scale in R&D provided
advantages to large manufacturers such as Nokia Emergence of modular design/vertical disintegration has
reduced cost of R&D and thus enabled new entry (Apple, Google)
More importantly, other revenues are emerging and phone manufacturers want some of these revenues◦Content, Application, Advertising
How can phone manufacturers obtain some of these new revenues?
Service Providers
Very high fixed costs: Subsidize phones to attract new subscribers
Voice era: combination of subscription & fee for serviceSMS and roaming: is lucrative market in which prices are
much higher than are costsOther revenues are emerging and service providers want
and need some of these revenues (think of wireline telecom providers)◦Content, Application, Advertising
How can service providers obtain some of these new revenues?
Outline
Overview of Value CaptureExamples
◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Mobile Phones and Services
Top Ten Business Models of 2010Conclusions
Conclusions (1)
New technologies, new markets, and new levels of value (dis)integration often require new methods of value capture
But there are no simple answers to the best methods of value capture
Of course you want to maximize revenue, but without losing customers and collaborators
One firm’s method of value capture depends on ◦method of value capture by competition, collaborators◦customer needs
Conclusions (2)
Contrasting industries and analyzing whether methods of value capture can be borrowed from other industries is a good place to start
Also look for consistency among different elements (customer selection, method of value capture, value proposition, scope of activities) of business model
For Your PresentationsDo not just tell me the sources of revenue for your firm
◦Identifying these revenue streams is just one step in your analysis
Analyze alternative methods of value capture. As stated on previous slide◦Contrasting industries and analyzing whether methods of value
capture can be borrowed from other industries is a good place to start
◦Also look for consistency among different elements (customer selection, method of value capture, value proposition, scope of activities) of business model
Appendix
Early Years of Mobile Internet (<2004)
Japanese service providers ◦Charged subscription fee (5 SGD/month) and fee
for service (for data downloaded)◦Charged monthly fee for content and gave about
90% to content providers in micro-payment service. Encouraged content providers to modify content for mobile phones
◦Offered inexpensive mail servicesEuropean and U.S. service providers
◦Did not devise micro-payment service◦Expected content providers to devise own method
of value capture◦No growth occurred
Inexpensive Mail Facilitates Browsing (1)
Users subscribe to mail services and click on URLs inside mail to access additional information
Many content providers use such mail service to increase the number of visitors
Such mail services are more important for phones than for PCs because◦Phones have inferior user interfaces, particularly in early 2000s
Japanese service providers made mail services a standard function on all mobile phones by year 2000
Western service providers did not introduce such mail services because they did not want to cannibalize their SMS revenues
Inexpensive Mail Facilitates Browsing (2)
Example: new Japanese fashion company Xavel (site name is Girls Walker)◦Offers “mail magazines” that are written by 3rd parties◦Xavel does not have to pay to send mail◦Users pay less than $0.01 to receive mail◦Links to fashion products in the fashion-related mail magazines
has led to sales of fashion-related products (cosmetics, perfume, vitamins, clothing)
◦<1% of mail magazine readers purchased products in 2004◦Achieved greater than US$ 40 M in sales and 4M$ in profits in
fiscal year ending September 2004
Responses by U.S. and European Service Providers by 2004
Began offering micro-payment system and sharing some content fees with content providers
But differences remained. U.S. and European service providers◦only shared about 50% of revenues with content providers◦did not provide inexpensive mail services since they did not
want to cannibalize SMS revenues◦could not solve many standards-related problems and thus
could not offer sophisticated content and applications. These applications and content had to wait until phones had processing power and memory sufficient for PC Internet standards
But why Couldn’t NTT DoCoMo Export its i-mode Service?
NTT DoCoMo’s Efforts to Export i-Mode
Attempted to make its i-mode service a global standard
Needed to but failed to create a critical mass of◦Service providers◦Phone manufacturers◦Content providers◦Users
Only convinced a few small service providers and phone manufacturers to adopt i-mode
Key Questions by Western Phone Manufacturers when they Considered i-Mode
Will the market be large for i-mode?◦Will many service providers adopt i-mode?
Can we make profits? i.e., method of value capture◦Doesn’t NTT DoCoMo control everything in Japan?◦Isn’t this why Japanese phone manufacturers don’t make
much money in Japan?◦Also, aren’t development costs very high for i-mode phones? ◦If costs are high and benefits are low, why should we support
i-mode?
NTT DoCoMo’s Mistakes
Didn’t hire Western executives before creating global strategy
Believed that technology (e.g., c-HTML) was the reason for i-mode’s success
Underestimated difficulties of creating critical mass of service providers and phone manufacturers outside of Japan
Didn’t modify i-mode for outside JapanDidn’t work with Western press wellAttempted to be the sole source of information on i-
mode and mobile Internet in Japan