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A disruptive business model innovation

A disruptive business model innovation

What CEOs need to know about cloud computing.

Cloud computing represents a disruptive idea, or business model innovation, and a disruptive technology to virtually all of the players in the IT market space. What is a disruptive business model innovation? A disruptive business model or technology innovation that upsets established markets often first appears as a wolf in sheep’s clothing.

In 1995 Joseph Bower and Clayton Christiansen, both now professors at the Harvard Business School, invented a new term, namely, a “disruptive” innovation or technology.

A disruptive innovation may be a technology, such as a microprocessor or prescription drug, or it may be an idea, political movement or business model.

Initially, a disruptive technology or business model innovation is incomplete but it addresses the requirements of an under-served segment of the total market better than the existing incumbent technology or business model.

It is often derided by the then industry leaders as inadequate when compared with the established products or services.

Very soon, however, rapid incremental improvements to the fledgling new market paradigm results in technology and business model refinement that, if it has “legs”, quickly usurps the establishment, and become the new mainstream.

Study after study has demonstrated that even when competent incumbent firms have full visibility of emerging disruptive technologies or business models, they often fail to adjust and are wiped out as a result. The reasons for this lack of responsiveness are well canvassed in Christiansen’s highly regarded books “he Innovator’s Dilemma and The Innovator’s Solution.

The risk for current IT firms providing existing technology and operating unchanged business models is reflected by the story of the boiling frog. The idea of a boiling frog is based on the premise that if a frog is placed in boiling water it will jump out. A frog placed in cold water that is slowly heated will not perceive the danger and will be cooked to death.

Although the premise of the story is, apparently, not true it is often used as a useful metaphor for the inability of firms and people to react to important changes that occur gradually. They may not know when to switch from the old to the new before it is too late.

The disruptive technology, or disruptive business model innovation, threat of cloud computing can be viewed from a number of aspects. The response and reaction from most IT industry vendor participants, seen in terms of announcing new cloud services and technologies, as well as plastering the word “cloud” on many of their existing

products, is testimony to the disruptive impact cloud computing is making on them.

The impact of this disruptive technology and disruptive business model on traditional IT departments and their staff, as well as on traditional IT outsourcing firms, is considered further in this article.

Other disruptive business model innovations

We provide below three examples of how traditional or conventional business practices are being turned upside down with new ways of providing traditional fixed asset investment as a service.

1) “Military Intelligence-as-a-Service”

In Afghanistan at present, not all members of the NATO partnership have their own unmanned aerial vehicles, or spy drones, to seek military intelligence. Prior to sending out a patrol, it would be very helpful to know who is on the other side of the hill, where they are and how many there might be.

It happens that not all NATO members share their military intelligence for tactical reasons. What should a NATO member without a spy drone do? The obvious answer is to buy one, as other NATO members do.

However, there are options. At least 20 companies currently rent spy drones as a service. For example, a division of Boeing, Insitu, rents a spy drone for US$2,000 per hour.

This means the NATO member’s decision-making entity is faced with the classic, enduring business dilemma of “make or buy” or “rent or own”. Let us consider what the decision criteria might be. Even though this is not a typical business product or service, the same principles apply. What are the issues and considerations in this

decision analysis?

• Capital expenditure

Obviously capital expenditure approval will be necessary. Is it available? How long will it take to obtain under the normal budgeting cycle? Is time-to-market critical? With an “as-a-service” business model, the capital expenditure is avoided completely.

• Skills required

Are high-level or low-level skills required to operate spy drones? For the operation of more sophisticated spy drones, a high level of skill is required. How will those skills be secured and how will such scarce skills be retained?

A key benefit of the “as-a-service” model is that skills required to operate complex systems are not required at all. The service provider packages the skills with the service provided.

• Scalability

Is the use of spy drones easily scalable? There are many types of spy drones with differing capabilities. What size, quantity and function should be bought? What happens if there is not enough resource or the wrong type of resource?

The “as-a-service” business model means that the service provider manages the problems of scalability, delivering just the right amount of resource, as required, when it is required.

• Obsolescence

Would you expect spy drones to have a high level of technical obsolescence? The technology of robotics, surveillance video and communications is rapidly evolving, so the risk of technical obsolescence is very high.

By contrast, the service provider absorbs all of the risks of technical and functional obsolescence.

• Predictable costs

How predictable is the cost of operating spy drones? If the total cost of acquisition, operation and support were divided by the number of surveillance missions, the cost

per mission could be calculated.

However, the cost per mission would be highly uncertain, as the cost per mission is very sensitive to the number of missions flown. As most of the operational costs are fixed in nature, and do not vary greatly with the number of missions flown, the average cost per mission will range from very high to very low, depending on the number of missions. Accordingly, there is very poor predictability of the cost per mission.

As only the amount of service consumed is paid for under an “as-a-service” business model, the precise cost per mission is known in advance.

• Focus on core competency

What does the NATO member country’s military unit actually need? Do they want to own and operate spy drones or do they just want the military intelligence?

This is a classic question. Placing the “make or buy” decision criteria in a military framework helps to clarify the essence of what is important. The similarity or parallel between the military and business context makes it clear that “owning” a resource poses many challenges that are avoided if the actual outcome required, military intelligence in this case, is secured “as-a-service”.

Let us consider two further examples of business model innovation.

2) “Tyres-as-a-Service”

Bridgestone, among others, provides tyres-as-a-service to heavy haulage trucking firms in Europe and North America. This means that Bridgestone owns the tyres, services and changes them and manages the operations relating to them.

For example, a truck hauling goods from a dry, high temperature region to a sub-zero temperature region would normally need to carry snow tyres. Bridgestone takes responsibility for maintaining the stock of snow tyres, where required, and changing them en route.

Instead of trucking firms owning the tyres and managing their use in a conventional way, the trucking firm only pays for the actual usage, as determined by a mileage or

kilometre rate.

What benefits accrue from the “tyres-as-a-service” business model?

• Capital expenditure

No initial or replacement capital expenditure is necessary.

• Complexity

At first glance the management of truck tyres may not sound complex. However, the resources and complexity in optimising the use of 16 and 20 tyres per truck for hundreds and perhaps thousands of trucks is clearly non-trivial. Accordingly, this complexity and technical resource is eliminated.

• Pay only for actual usage

As the trucking firm only pays for the actual kilometre usage, there are no costs incurred with respect to tyres for any time the truck is idle.

• Predictable costs

The gross margins earned in the trucking business are typically low. Because the precise cost per kilometre of running the tyre cost component is known with precision,

the trucking firm is better able to price its services with more accuracy. The precise predictability of costs with a “tyres-as-a-service” business model means that margins are more likely to be preserved.

• Focus on core competency

Is the ownership and self-management of tyres on a truck an essential core competency in delivering goods from A to B? The answer is obviously “no”. Accordingly, the trucking company is better able to focus on its core competencies and the areas where it can create value for its customers.

3) “Thrust-as-a-Service”

Manufacturers of commercial aircraft jet engines are now offering a “thrust-as-a-service” option to airline operators, rather than engines as a product.

Because the jet engine manufacturers are able to track the usage and performance of their engines from electronic sensors, they can offer their customers an alternative way to pay for what would otherwise be conventional capital expenditure, and only pay for actual usage.

Payment by per 1,000 kg of thrust per hour, or similar, substitutes for fixed lease payments or depreciation charges plus the operating and servicing costs.

Most aircraft are leased, but this is simply an alternative financing method for what is capital expenditure.

What benefits accrue from the “thrust-as-a-service” business model?

• Capital expenditure

No initial or replacement capital expenditure is necessary.

• Complexity

The coordination challenges and technical resource required for the maintenance of jet aircraft engines is high. This is significantly reduced.

• Pay only for actual usage

The airline operator only pays for the actual usage of the jet engines, rather than the fixed costs of ownership, whether leased or not. If the aircraft are idle on the runway, no charge is incurred.

• Predictable costs

The gross margins earned in the airline industry are traditionally low. Because the precise cost of operating an aircraft’s jet engines is known with certainty, the airline may develop a more accurate fare pricing model. The precise predictability of costs with a “thrust-as-a-service” business model means that margins are more likely to be preserved.

• Focus on core competency

Is owning, whether leased or not, and self-managing jet engines on an aircraft an essential core competency in flying people and goods from A to B? The answer is

obviously “no”. Accordingly, the airline is better able to focus on its core competencies and the areas where it can create value for its customers.

What is changing in these new business models?

Conventional ways of doing business are being turned upside down and are being replaced with new innovative business models.

• Heavy-weight capital expenditure and fixed costs are being transformed into lighter-weight variable costs. Rather than making what we now understand to be a capital expenditure decision for an investment in fixed

assets, the transformation of a fixed asset or product into a service means that only operating expenses are paid, depending on the actual consumption of the service.

• The ownership of assets and the liability for their performance is being shifted to a third party.

• Disruptive innovations are taking place as companies adopt new ways of doing business.

• New business models which allow for payment only for usage, or, ideally, only for value, have a high attractive value for organisations.

• The new business rationale of paying for value is creating a range of innovative business models.

Why cloud computing is a “Computing-as-a-Service” business model

Cloud computing is a similar business model innovation to the innovative ideas of “tyres-as-a-service” and “thrust-as-a-service” for the following reasons:

• Computing is consumed as a service.

• A third party provides the hardware, software and technical resources, in different combinations to an organisation’s users.

• Computing services are purchased as and when needed.

• Only the services required are paid for.

• Organisations no longer need to own and manage computing resources.

Each factor reviewed in the three examples of “as-a-service” business models is considered below in the context of the cloud computing business model.

• Capital expenditure

A third party provides all of the investment in fixed assets required to solve the IT business problem. The user of cloud computing does not need to invest in fixed

assets.

• Skills required

The cloud computing provider provides all of the skills required to operate the systems and technology assets required to deliver the computing function. As a result, the user organisation does not need to build and maintain those skills.

• Complexity

As the cloud computing provider manages all of the complexity behind its own “firewall”, or secure boundary wall, the user organisation is shielded from complexity. Accordingly, cloud computing removes complexity and provides simplicity.

• Scalability

Another key benefit or difference in cloud computing is that the user organisation does not need to consider whether they have too much, too little, or the wrong type of technology resource. The cloud computing provider matches the user organisation’s requirements, both increasing and decreasing, exactly with the demand.

• Obsolescence

Computer technology is subject to notoriously fast obsolescence. If the user organisation invests directly in computer technology, it will be subject to high obsolescence. As the cloud computing provider owns the technology, the user organisation avoids technology obsolescence completely.

• Predictable costs

Organisations that own their computer technology do not have predictable costs.

In contrast, cloud computing providers deliver services which allow complete predictability of costs.

• Focus on core competency

The ownership and delivery of computing resources rarely, if ever, provides any competitive advantage to an organisation. We consider this point in some depth later.

Accordingly, organisations employing cloud computing are able to focus on the core competencies that provide their competitive advantage and create value for their clients and customers.

It is important to recognise that cloud computing is a disruptive business model innovation rather than a technology innovation. Just as tyres and jet aircraft engines have not changed materially in their inherent technology, when provided “as-a-service”, cloud computing does not reflect any significant change in technology capability.

In comparison with the history of information technology, represented by the evolution of the mainframe, the mini-computer, the personal computer and the internet, cloud computing is not a technology revolution.

While there are cloud computing technology innovations taking place, and these innovations will help to drive the success of the cloud computing paradigm, cloud computing, in its essence, is a disruptive business model innovation.

Sidebar: Two views on the cloud

Andrew Wilshire - Former CTO, Fonterra:

Michael Snowden tips his hat to business scholars Christensen and Bower (of disruptive technology fame) and the acclaimed IT soothsayer Nicholas Carr.

Michael’s examination of how the cloud computing paradigm translates to business outcomes is easily digested by senior audiences, and presents some excellent examples of how other ‘high touch’ industries have adopted service-oriented business models.

Michael successfully illustrates that cloud computing is not some radical technology invention, but rather a disruptive business model which creates an enormous opportunity and an even larger threat for the incumbent participants in the IT marketplace.

From a local perspective, Michael reflects the growing demand for cloud computing to achieve more than simply moving existing applications and IT operations off-premise and onto the Internet, but instead to deliver customers highly-flexible, variable-cost and value-centric solutions.

The lesson that IT organisations should take from this is that the value for customers from cloud computing will not be achieved by simply offering ‘tin on a string’ - processing capacity from some Internet data centre.

Instead they should focus on developing business process solutions which help customers realise their business goals through capital efficiency and value-based pricing.

Stuart Shirvington, general manager, GEON Print:

In today’s world of slim margins, increased competition and higher demand for customer facing and servicing technologies, why would any company want to dedicate internal human and capital resources to manage rigid infrastructure and generic applications when trying to grow a business?

Michael Snowden de-myths for the senior executive what cloud computing is all about and in a plain style, demonstrates the virtues’ of cloud computing and

how it can apply to your business. Throughout his book, Michael continually draws on practical applications and examples to illustrate the benefits of taking advantage of a secure externally managed cloud.

Michael describes cloud computing as a “radical transformation of the IT industry”, which essentially builds on the evolving technologies of the PC, the internet and communications technologies that, as a disruptive business model, cannot be ignored by CEOs, CFOs or CIOs in any business if your vision is about business growth, working capital efficiency and bottom line sustainability.

Michael Snowden is the CEO of OnetNet. This is an excerpt from his book The CEO’s Guide to Cloud Computing.

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