Most Firms, in Most Industries, Must Recreate Their Business Models

The internet has almost uniformly been positive for consumers--generating new value--while allowing some firms to ride new value propositions to huge business success. On the other hand, the internet has generally been difficult, financially, for nearly all incumbent firms.

“Digital is confounding the best-laid plans to capture surplus by creating—on average—more value for customers than for firms,” McKinsey consultants say.

Telecom service providers know the process well. A shift to over-the-top,  internet-based applications allows consumers to use product substitutes (WhatsApp, Skype, Netflix) instead of buying service provider products.

That both makes telco markets smaller, and reduces revenue and profit potential for the amount of consumer demand that remains. At least where it comes to intangible or software products (voice, messaging, content, apps and features), the cost of incremental usage is close to zero.

Prices become much more transparent, while new alternative suppliers emerge to provide lower-cost or free substitutes.

In other words, as with most other industries, use of direct internet distribution reduces the need for, and value of, intermediaries and distributors.

To the extent that the marginal cost of supplying the next unit of any product is nearly zero, retail prices will trend toward zero. But the problem is not exclusively faced by telcos.

Internet-based competition has “siphoned off 40 percent of incumbents’ revenue growth and 25 percent of their growth in earnings before interest and taxes (EBIT), as they cut prices to defend what they still have or redouble their innovation investment in a scramble to catch up,” McKinsey argues.

source: McKinsey

The point is that telcos and other internet service providers necessarily must replace legacy businesses and products with new business models and products.

That is why some of us believe retail service providers (business-to-consumer) must move up the stack. The incumbent business models are breaking down.

Suppliers in the business-to-business segments of the market might have other constraints or opportunities. It is hard to see how most capacity suppliers, for example, actually can move “up the stack,” though all such firms now have moved from a “voice capacity” to “data capacity” revenue model.

The arguably more-important growth has mostly been “new geographies” or “new and redundant capacity in existing geographies.”

Building or acquiring new routes outside the current footprint are an example of the former. Building new cables across the Pacific or Atlantic oceans are examples of the latter strategy.

The main point is that virtually every business faces similar challenges in making the transition from legacy to next-generation business models.