Business Models That Facilitate the Creation of New Products

A company with a business model that incentivizes and facilitates the creation of well-designed new products can avoid disruption indefinitely. Integrated Versus Modular Business Models

Apple's business model is based on hardware profits. To grow these profits -- and survive -- Apple has to create innovative new products. To create innovative new products, Apple makes sure it controls the key technologies and integrates the key functions of design, engineering, and manufacturing. As a vertically integrated company, Apple can create almost any piece of computing hardware it wants, creating new product categories, moving upmarket with sustaining improvements, or moving downmarket with simpler, more affordable versions of existing products. Companies that do this can avoid low end or new market disruption indefinitely -- they just keep creating new stuff, squarely addressing different jobs that need done.

Modular companies that assemble standardized components have to rely on component manufacturers to innovate. When a standardized component becomes good enough, additional improvements to the component won't drive additional sales for the company that uses it. HP and Dell's PC businesses have struggled, at least in part, because Windows 7 and existing Intel chips are good enough for many people. And because they aren't vertically integrated, HP and Dell lack the design, engineering, and manufacturing resources and processes needed to create attractive new computing devices. They're basically stuck in the low to middle end of the PC and tablet markets, selling standardized, modular devices based on different chipsets and different versions of Windows, Android, and Chrome OS.

Another drawback with modular assemblers like Dell, HP, Lenovo, Samsung, and others is that their reliance on standardized, modular components often leads to bad design. Because they're putting together modular components, their design options are limited -- they have to operate within the parameters of the standard components they're assembling. And if you're a modular assembler competing with other modular assemblers, you have to at least match your competitors' technical specifications. So to compete, modular manufacturers end up abandoning good design principles, often using components that overserve the job that needs done or putting too many features into the final assembled product. This ultimately results in: (1) poorly designed, undifferentiated products and price-based competition; (2) little to no meaningful new product innovation (just immaterial improvements to things like screen resolution or "speeds and feeds"); and (3) the kind of industry-wide overserving that developed in the Wintel PC market.

And that's exactly the kind of market that's ripe for disruption by an integrated competitor. An integrated company isn't stuck with standardized components and cut-throat, modular style competition, so it can design products based on the job that needs done and avoid overserving. The outcome is frequently a simple, beautiful product that happens to be more affordable than many overserving, modular alternatives (e.g., Apple designing the simpler iPad as an alternative to laptop PC's).

The Importance of Business Model Incentives and Resource Scarcity

Google and Facebook have ad-based profit models. With the acquisition of Nest, Google may be shifting toward a hardware-based profit model (as noted by Horace Dediu at asymco.com). To duplicate Apple's ability to efficiently create new hardware products, Google will probably have to vertically integrate thousands of design, engineering, and manufacturing activities. And that's not going to be easy. See post titled "Acquisitions, Rivalry, and Strategic Trade-Offs."

Some people see an ad-based profit model (Google or Facebook), or a business model based on tremendous scale and operational effectiveness (Amazon), and think the relevant company is a safe, monopoly-type business with predictable, growing earnings. But as Horace Dediu at asymco.com has noted, ad-based models may lose traction as Internet usage starts growing less in developed economies, which have higher personal incomes, and starts growing more in developing economies, which have lower personal incomes.

Additionally, when a company's business model doesn't really depend on the periodic creation of new products, it's not going to be as good at developing them. A company focused on collecting user data and churning out profitable ads, such as Google or Facebook, or trying to efficiently grow retail sales volume, such as Amazon, isn't really focused on creating entirely new product categories -- these companies are focused on improving the efficiency and performance of the dominant, profitable business models they've already established, whether it involves data collection, ad targeting, or operational effectiveness.

Clayton Christensen has noted that disruptive new products are generally developed in a context where resources are scarce. Most startup companies with a disruptive idea have scarce resources, so they have to be impatient for profit. That's because they need early profits to fund ongoing product sales and development. Early profits also test whether the product is truly disruptive, appealing to new and low end markets. Without resource scarcity, and the need for early profits, a company can keep wasting time, talent, and money on a product that lacks the market appeal to sustain itself. See Concepts page and discussion of Clayton Christensen.

You can see Google and Amazon doing this, at least to a degree, with: the subsidized/break-even Kindle Fire; the break-even Nexus products; Google's lackadaisical approach to the Motorola acquisition and to Motorola's hardware; and the high end Google Pixel (which doesn't even qualify as a low end or new market disruption). Because Google has a dominant, highly profitable ad business, while Amazon has a dominant, profitable retail business, neither company has to deal with resource scarcity. As a result, both companies are willing and able to continue subsidizing break-even hardware. Analysts looking at Google justify this by saying that Google uses subsidized hardware to collect data for its profitable ad business. Analysts looking at Amazon justify it by comparing the Kindle Fire to a storefront (which may arguably be true, although Amazon's customers already have an optional Amazon app storefront on most tablets and smartphones). The bottom line is that neither Amazon nor Google is strongly motivated to focus on disruptive new hardware that performs a specific job well, because their business models don't depend on profitable hardware sales.

Apple shares at least some of this motivation problem, since past product successes have provided it with abundant resources, especially cash. Apple doesn't have to deal with resource scarcity, so it must be vigilant in saying "no" to unfocused product ideas that don't squarely address jobs that need done; unfocused products waste time, talent, and money that could be productively used elsewhere. The big difference between Apple and companies like Google and Amazon, however, is that Apple depends on profitable new hardware to survive. Hardware isn't a side-game, so despite its resources Apple is still strongly motivated to design any new device around a job that needs done, which increases the odds of market success, prevents overserving, and often results in more affordable products that appeal to new and low end markets.

Maybe that's what Steve Jobs meant when he counseled others to "stay hungry, stay foolish" -- namely, to avoid complacency, and to keep creating well-designed products that squarely address important jobs. A good business model facilitates and incentivizes this effort.

The author owns stock shares of Apple.