As we discussed in our recent blog post on HBR Blogging Network, it finally seems that the uproar over Marissa Meyer’s diktat banning flexible work policies at Yahoo is dying down.  While good arguments were made on both sides of the issue, what got lost in the charged debate was the potential for evolving traditional business models through changing the employee-employer relationship.

Our research on identifying replicable templates for business model innovation shows that innovating how a company engages with its workforce is an often overlooked way of increasing business model performance. The basic structure of the firm-employee relationship has not changed much over the last 50 years.  Relying on a forecast of organizational needs, firms select the nature and number of employees, who are then assigned some working hours and tasks to do in those hours. But a few pioneering companies are challenging each aspect of this traditional model and are offering unprecedented opportunities along the way.

Rethinking Who Your Employees Are

Traditional organizations identify a set of individuals as their “employees” before they are fully aware of the employee’s talents and their needs. LiveOps is a fledgling provider of customer contact services maintains a virtual workforce of independent agents who, based on their schedules, signal their availability to join a pool of talent waiting to be “hired” once a call that matches their skills and experience comes in. Agents are paid only for their time spent on the call, and LiveOps gathers enough data on agent performance and abilities to intelligently route calls to the bets available agent.

Agents, for their part, have incentives to work hard to keep their ratings high in the system. This setup eliminates the multiple inefficiencies associated with traditional call centers: idle employees, long wait times, calls routed to uninterested or incompetent agents.  Changing “Who” the employees actually are, has allowed LiveOps to shake up the customer contact industry. Today over 200 companies use LiveOps technology to support their multi-channel customer contact efforts.

Rethinking Where and When They Work

Automattic Inc, the parent company behind WordPress, the leading platform for powering blogs is a company that is 100% distributed. All Automattic employees work from home, or wherever they may be located, and the firm has been very successful with this strategy. Automattic employees have no set working hours, nor do they have to check in to any office.  While there are many cultural issues that allow Automattic to manage and thrive with this distributed model, it is fundamentally challenging the key assumption regarding physical presence of employment.

Rethinking What They do

Traditional organizations assign employees to teams, projects and tasks. Based on their best assessment of an employee’s talents and interests, managers assign different employees to projects that they might be best suited for. Google’s famed 20% time to work on passion projects directly challenges this notion of clearly defining what each employees does.  Reportedly, 50% of new projects came from this 20% of time including Gmail, Google News, Orkut, and AdSense.

Even the best informed manager does not know exactly what his/her employees are most passionate about and where they can excel. Giving employees (some) freedom to choose what they do, transfers this matching problem to the decision maker that has the best information to make this choice: the employee.  Not surprisingly, employees are more likely to choose what they are interested in doing and might achieve better results. For instance, LiveOps agents know their skills and interests best, so they pick products to sell that best match their personalities and knowledge.

To be sure, the firm needs to retain some control to ensure employee efforts are aligned with firm goals, but this unshackling of employees can lead to dramatic increases in productivity. This is why Southwest replaced hundred-page long manuals of what the gate agent must do with a simple directive: “do whatever is necessary to get the plane out of the gate, fast”.  Certainly, from time to time employees will go overboard and spend too much time and money trying to get job done, but it is easier to deal with these individual cases than to create constraining, enterprise-wide rules.  The resulting productivity of employees at Southwest is several times higher than at any legacy airline, more than compensating for their higher salary.

Not all of these innovations are likely to be appropriate in every organization, and each of them comes with its own caveats, but they all highlight how powerful it can be to challenge assumptions around the employee-employer relationships.  Most often, changes in the way company employs people will involve changing why people work (i.e., their compensation structure).  But for organizations that heavily rely on the workforce to create value these alternative approaches can be equally, if not more, effective.

In our recent blog post on HBR blogging network we discussed the Tesla Model S, which is arguably the most promising all-electric contender for a slice of the luxury sedan market, but was panned recently by New York Times reporter John Broder, who finished his test-drive on the back of a flatbed truck. Elon Musk, co-founder of Tesla Motors, was quick to respond with accusations that the test was not performed under fair conditions. Whatever the rights and wrongs of the dispute, though, one thing is clear: Tesla has some way to go before it can get motorists to buy into its vision of an all-electric no-compromises luxury sedan.

There’s little doubt that the Model S is an excellent car. It has received numerous automobile awards, and it integrates many of the latest technological advances in electric powertrains and charging technologies. To support the new car, Tesla also plans to install a network of quick charging stations (which charge the battery to 50% capacity in about 30 minutes). The costs of the investments explain the vehicle’s high price tag, well above that comparable gasoline powered cars.

But look closely and you’ll see an interesting disconnect. The innovativeness of Tesla’s technology is not matched by the innovativeness of its business model. In fact, there is no change to the business model at all. Tesla is simply proposing to replace the standard gasoline car and gas station business model with the model S and a supercharge station network.

The electric car market will never take off unless this disconnect is fixed. What the model S needs is not a network of charging stations but a different business model.

Better Place offers a candidate. This start-up’s founders have focused as much on innovating the business model as on bringing new technology. Instead of a network of charging stations, Better Place proposes a network of battery swap stations at which electric vehicle owners can swap their depleted batteries with fully charged ones in just a few minutes. The vision is to have enough of these stations so that getting a new battery would be no different from filling up a tank of gas. Further, the company owns all batteries (including those in vehicles), taking full responsibility to supply charged batteries at these stations — the customers only pay for the miles driven.

This effective “leasing” of the battery brings the initial purchase price of the vehicle down to that of a gasoline vehicle and even though per-mile costs are a bit higher than those of an electric vehicle with battery ownership, they are still much lower than for a gasoline vehicle. To be sure, Better Place has had its troubles recently but it is running successfully in Israel and is refining its model as it goes along.

The best organizations innovate their technology and business models at the same time. Think of Apple. Apple designed products with widely praised user experiences long before the breakthrough success of the iPod. What Apple created with the iPod was not just another well designed product but a product accompanied with a new business model for content provision, the iPod/iTunes ecosystem, a perfect marriage of product, technology and business model — something the Electric Vehicle industry is still waiting for…

Will Better Place or Tesla be the iPod/iTunes of electric vehicles? The jury is still out on that, and perhaps it will be neither. In any event, though, the bigger question is: will electric cars help reduce emissions? In our recent (rather academic) paper we show that the answer is far from straightforward: electricity in most countries is produced using fossil fuels, which means that electric vehicles are not necessarily that much greener.

In a recent post on Harvard Business Review bloggers network, we discuss the extreme focus business model of Germany’s famed Mittlestand:

Quick test: name one company that does one thing and does it very well. The companies that occupy the limelight are typically diversified giants that achieve growth through constant expansion into new markets and the introduction of additional product lines (just think P&G, GE, and Microsoft).

But the truth is that the really successful companies are highly focused, achieving unprecedented efficiencies by designing a business model with a razor-thin focus and learning to do the one thing really well. Many of us academics still teach an old case about Shouldice Hospital, which only treats simple cases of hernias and nothing else but does it better than anyone. A more recent example is Quidsi, the driving force behind Diapers.com web site which sells only baby consumables. Some of readers may also recall ING Direct, which is focused on a narrowly defined set of simple financial services, and Southwest Airlines, which still has one class (economy) and one aircraft type (Boeing 737).

Thanks to this extreme focus there is no need for complicated processes, expensive equipment and underutilized (and expensive) resources. As a result, Southwest Airlines turns planes around much faster than competitors, ING Direct can avoid having hundreds of physical bank locations and Shouldice can schedule surgeries in a well-oiled production process with no downtimes or waiting.

Despite these advantages, such companies are actually quite rare in much of the Western World and it is much more “normal” to see complex conglomerates in which none of the above applies.

in Germany (and to a lesser extent in other German-speaking countries).

The amazing resilience of the German economy is often attributed to its reliance on Mittelstandcompanies, small to medium sized enterprises. These typically family-run businesses employ more than 70% of all German employees in the private sector, and are export-oriented, making Germany the second-largest exporter in the world. There is a wonderful account of these companies in the book Hidden Champions by Hermann Simon, former INSEAD professor and now Chairman of Simon, Kucher & Partners. During a recent presentation at INSEAD Hermann described some of their common features:

• Most Hidden Champions are extremely focused in what they do. To give a few examples: Jungbunzlauer supplies citric acid for Cola-Cola worldwide (and a few other salty and sweet chemicals), TetraMin is the number one producer of fish food, Uhlmann is the world leader in packaging systems for pharmaceuticals, and Flexi is the number one manufacturer of dog leashes worldwide.
• They do one thing but they do it extremely well by achieving tremendous efficiencies, making them cost-competitive despite their location in a very expensive country.
• Due to the simplicity of their product lines, their organizations avoid complexities and intricate structures, resulting in very lean management hierarchies.
• To compensate for their razor-thin focus on just a single product (or product category), they diversify internationally and enjoy great economies of scale.

All of these characteristics make these companies perfect examples of focused business models, which seem to thrive even in harshest economic conditions. Which raises some interesting questions: why don’t we see more of these firms in other countries? Is there something about their cultures that is hard to sustain? Does public ownership bring pressures to continually grow by going into new areas?

Whatever the answers to these questions, we do believe that extreme focus is an often-overlooked way to innovate a business model — for startups and established companies alike. Our own favorite US-based examples of such successful companies are Diapers.com and messenger bag manufacturer Timbuk2. What new focused company will come next?

In a recent blog post on the Harvard Business Review bloggers network,  we discuss the sustainability of the advantage that come  from innovating the business model.

With the Winter holiday shopping season, fashion apparel retailer Zara has been the focus of media attention — the New York Times recently profiled the innovative fast fashion business model pioneered by Zara, while Elizabeth Cline’s book on the costs of fast fashion has climbed up the sales charts.

Despite this very recent popularity, the novel business model of Zara has gone virtually unnoticed for over 30 years, allowing Zara’s parent company, Inditex, to grow from zero to almost $20B in revenues. Why wasn’t it copied immediately? How can it be so sustainable and continue growing? The answer lies in a different type of innovation that Zara used: Business Model Innovation.

We have long been fans of the Zara business model. We have written about it and have been teaching it in the classroom for years. The model is designed to enable fast response to fashion trends, which allows Zara to ensure that its store shelves are always stocked with the trendiest clothes. While most of the recent attention on the Zara model has focused on what makes the model work — we continue to be amazed by the sustainability of the gains from the model.

Zara was founded in 1975 and its parent company, the Inditex group went public in 2001. Within the first 5 years of its founding, Amancio Ortega, the founder of Zara figured out the responsiveness and speed were key to dominance in apparel retail as opposed to costs so Zara produced in expensive locations and used expensive shipping modes to react to trends faster. This business model innovation served Zara well for an unusually long time, over 30 years now.

Sure enough, the Zara model has attracted its fair share of imitators and followers in recent year — Uniqlo, Mango and H&M being the most prominent. But what continues to amaze us is how long it took for the world to catch on to Zara’s model and to start imitating it. For over 20 years, Zara’s model was rarely mentioned by press and understood by the competition, with reactions ranging from dismissive mockery to indifference. It is only in the last 5 years that Zara has even been recognized as an innovator in the popular press, but even today few people sufficiently appreciate the Zara model.

In contrast, consider the following: Pfizer’s blockbuster drug Viagra was patented in 1996, and went on the market in 1998. Within 5 years, it had two mighty competitors — Cialis and Levitra. Before long, despite all the first mover advantages of Viagra, the competitors reduced Viagra’s market share from over 90% to around 50%. At best, the once in a lifetime blockbuster discovery of Viagra gave its parent organization about 5 years of market dominance before the competition caught up. And this in an industry with perhaps more patent protection than any other.

Consider the fate of another innovator: Apple revolutionized the smartphone market with the iPhone launch in 2007. Within months, its innovative touch screen interface adorned surprisingly similar looking phones from Samsung (the exact chronological sequence of events is at the center of the commercial dispute between Apple and Samsung). And today, 5 years since its launch, the revolutionary interface, and the subsequent application platform are all standard features in smartphones from many of Apple’s competitors.

Now compare the fate of Apple and Pfizer to that of Zara. While Pfizer’s advantage from its technology innovation and Apple’s advantage from product innovation were imitated by the competition in 5 years, why does Zara continue to profit from its business model innovation? Was Zara better at protecting its innovation?

We believe the answer lies in the substance of these innovations — in particular, Zara innovated its business model, as opposed to product or technology as in the case of Apple iPhone or Pfizer Viagra. Business model innovations share some unique characteristics that make the benefits from them more sustainable.

First, the innovation is often in the firm’s processes that may not even be directly visible to competitors. While a new product design must be launched with some fanfare, business model innovations remain relatively hidden.

Second, copying a business model innovation from the competition is much harder than imitating the competitor’s product design. Business model innovations are often embedded in the firm’s DNA, they define its core operating logic and for the competition to change and adapt its business model is much harder.

This is all good news for business model innovators — the gains from such innovation continue to persist even when product and technology innovations might be imitated…

In a recent blog post on Harvard Business Review we discuss one of these frequent situations in which business model innovation is necessary to bring technological innovation to life. In case you missed it, the 2012 World Food Prize went to Daniel Hillel, an Israeli scientist who, in his own words, “…helped to develop the principle of shifting from low-frequency, high-volume irrigation to high-frequency, low-volume irrigation”, the system known as drip irrigation. Irrigation is a big deal in many countries: in just the last 50 years, the world population has doubled and irrigation water is increasingly becoming a critical constraint in many parts of the world. Study after study has shown that improved irrigation systems like drip irrigation can set in motion a new dynamic of development that has the potential to change the face of these regions, relieving vast numbers from the vicious cycle of poverty, insecurity and underdevelopment. But drip irrigation is not a new technology, it has been around for over 120 years, and many companies have developed and marketed it. So why are we celebrating drip irrigation only now? The answer is because it’s only recently that the technology has begun to catch on, thanks to a business innovation by an Israeli company, Netafim. Netafim now controls over one-third of the market for this seemingly commoditized micro-irrigation equipment market.

What is Netafim’s secret? Like many of its competitors, Netafim invested in R&D to produce improved products. In the 90′s it introduced modern electronic control technology, including sophisticated sensor arrays that help fine-tune water application to respond to water content, salinity, fertilizer and meteorological data. By Netafim’s measures, such a contemporary drip irrigation system increases crop yields by 300-500% and is a very lucrative investment.  But despite these exceptional economics, the system simply didn’t catch on.

The reason is a problem common to almost all new technology adoptions. The developer of the new technology has the best information on the performance of the technology and on the benefits it could deliver to the adopter. But the incentives of the adopter and the technology developer are typically not aligned: while the technology developer has all the incentive to sell as many units as possible, the adopter would only like to make investments with the highest rates of return.

To achieve this alignment and to reduce risks for the farmers, Netafim started providing a new offering, called IrriWise Crop Management System. IrriWise was an integrated proposition that included the system design, all the required hardware, installation and regular service of the system. Most importantly, farmers often did not have to buy the system. The system would be installed at Netafim’s expense (essentially costs would be reallocated to Netafim), but Netafim would get a further payment tied directly to the increase in crop yields.  With more skin in the crop-yields game, Netafim was now incentivized to modify service, adapt and maintain the equipment, to get the best possible outcome. Netafim went so far as to change into mission statement from “making the best drip irrigation equipment for customers” to “helping the world grow more with less”, an objective far more aligned with the objectives of its customers, the farmers. This allowed it to dramatically grow revenues, increasing its market share, all while making a life-changing impact on some of the most impoverished of the world’s citizens.

But why is Netafim willing to take on this risk of installing equipment and being compensated later for crop yields? Counter-intuitively, increasing risk exposure is to Netafim’s advantage and actually makes everyone better off. First, given Netafim’s expertise and access to the latest forecasting technologies, the risk is a lot smaller in Netafim’s eyes than it is for the farmers. Secondly, Netafim is much better able to manage this risk: given its size and diverse market base, the risk has much lower chances of catastrophic losses for Netafim than for a farmer. Netafim can now share some of these benefits from the more efficient risk bearing in the new model with the farmers. This helps Netafim increase its sales and, in fact, even improve the risk-return calculus of the farmers.  As we argue in our recent HBR article and on our blog, to really get your new technology off the ground you’ll have to look at innovating your business model as well.

       Apple gets a lot of stick about manufacturing in China, and the issue came up again recently with the release of the iPhone 5. A recent article on the “Cult of Mac” contrasts Apple to Timbuk2, a US producer of traveler and messenger bags, that proudly locates most of its of its manufacturing in San Francisco, one of the most expensive places on earth. The workers in the factory are neither overworked nor are they underpaid, yet Timbuk2 is not struggling financially unlike many other US-based manufacturers. This begs the question: can’t Apple do the same and move jobs back from China?  We covered this issue in a recent post on HBR network.

As it happens, one of us actually authored the case on Timbuk2 cited in that article and both of us have taught it for many years at INSEAD and Wharton and we also blogged about Timbuk2 recently as an example of an innovative company. So it’s with some authority that we can say that there is no good business rationale for Apple to manufacture in the United States; if it were to try it would almost certainly get into serious trouble. It is not an issue of labor costs. In fact, labor costs play a very small role in the equation — both for Apple and for Timbuk2. According to most sources, component costs (which are about the same everywhere) are responsible for a lion’s share of Apple’s expenses.

Timbuk2 manufactures in the US because it produces custom-made bags, orderable through its handy web site, and customers ordering custom bags cannot wait for weeks for a bag to come from China by boat, while shipping by air is expensive and there would still be some uncertainty due to customs clearance. A very similar logic lies behind fashion retailer Zara’s choice to manufacture in Europe, also an expensive location in terms of labor costs. Of course, Timbuk2 does also produce many bags in China but these are mass-produced, non-customized bags, sold wholesale at a fraction of a price of a custom bag, and they are not time-sensitive.

Apple does not produce custom products and so it does not need to deliver quickly — all of its products are standard and mass-produced; just like the standardized bags for Timbuk2, so there is no reason to stay close to end-customers. Moreover, Apple does not change its assortment often — the new iPhone will probably be for sale for another year or two. The much bigger issue for Apple is supplier availability, engineering changes, and flexibility. Apple is a huge company and as a New York Times article published in January this year details, its production volumes and often unpredictable engineering changes require manufacturing flexibilities and engineering capabilities on a scale that is simply unavailable in the USA.

In China, by contrast, manufacturers can deploy thousands of collocated engineers to introduce needed changes overnight, and large supply of labor allows to ramp up and ramp down capacity quickly. There is simply no factory capable of employing 250,000 workers day and night in the USA, surrounded by flexible and capable suppliers. So the location decision isn’t really about labor costs — it’s about manufacturing risk and where that risk is best managed (for a fuller discussion of risk in Business Models, see our recent HBR article).  Bottom line: there may be many companies that ought to locate manufacturing back from China to the US because of the advantages in terms of delivery speed and other capabilities that the USA has, but Apple is not one of them.

Competition in the automotive industry is fierce and global automotive manufacturers must tackle a number of mounting problems: unstable demand due to increasing gas prices, influx of competitors from emerging economies and growing pressures from governments to produce more efficient, greener vehicles.  While Big Three US automotive companies have gone through some challenging times recently, Volkswagen seems to be doing remarkably well.  This cannot be easy given the fact that the company offers consumers 245 (!!!) different car models under 10 brand names, which also differ dramatically in prices and market niche: you will find cheap SEATs as well as extraordinarily expensive Bugatti in the mix.  Nevertheless, Volkswagen has always been highly successful in Western Europe, and now it is also a best-selling car manufacturer in China and South America.  Moreover, its sales grew a whopping 30% even in the U.S. this year so far.  There must be some innovation behind this remarkable performance.  While, of course, there is no single reason that leads to such an astonishing performance, it appears that the major role was played by what I would characterize as a careful and centralized risk management approach in the Business Model, an engine behind all Renaissance Innovations.  Demand for existing cars is quite hard to predict, and demand for new cars is all but unpredictable.  In such an environment it is easy to make a very costly mistake by betting money on something that does not sell.  In the automotive industry such mistakes are extremely expensive: factories and tooling cost hundreds of millions of dollars and unionized labor is often paid no matter if there is demand or not.  What Volkswagen did to mitigate this problem is focus all engineering efforts on using the same basic parts in multiple cars, even cars of different brands.  Under this strategy – which is known under the names of component commonality (the company calls it “toolkit strategy”) or platform sharing – demand for individual components is quite stable because risks associated with demand for any one car are mitigated by pooling them together.  Certainly, predicting aggregate demand for a few components is easier.

Executing such strategy is, of course, a relatively easy task if all cars for which components are common also look and feel the same, but this would be a recipe for disaster: the key is to make sure that the customer is clueless!  The now-famous cover of Fortune magazine in 1983 contained a picture of 4 different cars manufactured by General Motors (from cheap Chevrolet to expensive Cadillac) which looked exactly the same because of common parts.  Volkswagen avoids this pitfall by putting very different bodies on very different car platforms.  This is perhaps not a good news for someone paying more for, say, an Audi while many of its interiors are exactly the same as for the more mainstream (and much cheaper) Volkswagen.

The latest achievements of the platform sharing/component commonality are what Volkswagen calls “modular longitudinal matrix” for large cars, launched in 2007.  It allows using the same key components in 16 cars.  Better yet, the newest “modular transverse matrix” (or MQB in German) does the same for 40 small cars which add up to 7 million cars per year.  These components include transmission, steering, front axle, steering, heating, air conditioning and ventilations, more than 60% of the cost of the car!  Of course, it remains to be seen if Volkswagen will be successful in executing this strategy given new acquisitions of Ducati and Porsche with products which do not quite fit the component commonality paradigm.  However, this business model innovation through managing risks is clearly a necessary part of the company’s product innovation strategy and something which allows Volkswagen to dramatically increase profits.

With  increasing  specialization,  technological complexity, and globalization, firms now buy a long list of products and services from many outside providers. In industries like automobiles, consumer electronics and retail, reliably sourcing a multitude of products from supply chain partners is the key to success. Li and Fung limited, one of the worlds fastest growing companies,  is fundamentally altering this  sourcing landscape and is simultaneously changing the game in these industries which rely deeply on sourcing. It is a company which owns no production, transportation or retail facilities, but by becoming the key link in  the sourcing  practices of some of the worlds best known companies like Gap, Benetton  and Walmart, has found a novel winning formula. So how has this firm created a multi-billion dollar business for itself by outclassing companies like established sourcing champions like Walmart at the game of sourcing?

Traditional sourcing relied  on floating tenders and other competitive rituals that ensured low prices with acceptable quality. As more strategic components and services were sourced externally,  buyers would change specifications often,  benefit from jointly developing products with supplier and in such a context, competitive rituals became more and more cumbersome and impractical for most items but simple commodities. And these rituals were increasingly replaced with long-term partnerships with suppliers. Firms designate a small number of favored suppliers and stick to sourcing from them, replacing competitive bidding rituals with evergreen partnerships. With an evergreen partnership, firms felt more confident sharing their key secrets and integrating the suppliers ever more into their operations. Companies like Toyota and Ikea mastered this long-term sourcing approach.

This model served many industries well, but in a fast changing world, this model also has  an evident disadvantage. By its very nature, a long-term sourcing arrangement, restricts firms to employ new suppliers too often. In a rapidly changing environment, this can make firms less responsive, In a recent article,  Elena Belavina  and I explain how Li and Fung, a sourcing intermediary has created a world–beating business out of relieving just this constraint of long-term partnerships.

Li & Fung Ltd. provides sourcing services to major brands and retailers worldwide, including Walmart, Target, Zara and Levis. Typically, it completely takes over the sourcing function– it  selects, verifies and approves suppliers,  allocates business between different suppliers, and manages the relationship with each supplier, including provision of incentives for investments, performance and compliance. Li & Fung has grown at a compounded annual rate of 23% for the last 14 years to achieve annual sales of over HK$ 120 Billion. While best known for sourcing apparel and toys from the low-cost economies of Asia, the group today operates in an expanding range of categories. It is present in over 40 economies across North America, Europe and Asia, with a global sourcing network of nearly 15,000 international suppliers, as well as thousands of buyers. It has abilities to provide both low-cost and quick, responsive sourcing. Yet, Li & Fung does not own any means of production or transport, nor is it in the business of directly retailing the vast majority of the products it sources. The company provides only an interface between multiple buyers and suppliers.

Instead of entering into long-term sourcing arrangements with one suppliers, firms like Li and Fung encourage buyers to enter into long-term sourcing arrangements with an intermediary firm like themselves. It then pools the sourcing needs of different buyers and using the pooled demands it is better positioned than individual  buyers at incentivizing suppliers and at encouraging suppliers to also enter into long-term arrangements. Interestingly, while Li and Fung enters into long-term relationships with many buyers and sellers, it can still provide some flexibility. Within its network of buyers and suppliers, it can keep changing the suppliers that are matched to different buyers at any point, thus providing a modicum of flexibility while maintinaing uninterrupted relationships with different buyers and sellers.  Essentially, sourcing for multiple buyers provides intermediaries with a certain flexibility in meeting the commitment to provide future business to a supplier– the flexibility of choosing which buyer to match to which supplier.

Firms like Li and Fung ltd. have exploited this relational advantage  of intermediation to create a new business model, a business model based on simultaneously providing the flexibility of competitive sourcing and the confidence of long-term relationships. As with many other organizations that we discuss on this blog, Li and Fung did not invent any new products or services, but by rethinking the business model around one of the world’s oldest services, it has created a new billion-dollar business model, a true renaissance innovavtion.

The latest issue of Harvard Business Review features an article “The Darwinian Workplace” on promoting healthy competition in the workplace that I co-authored.  The key message of the article is based on several research projects with highly innovative technology companies that implemented tournaments among its workers to increase worker productivity and, at the same time, to increase firm’s profitability. Competition in high-end jobs in industries ranging from movie making to professional athletes to politics is nothing new but can the same principles be applied in industries as mundane as retail, call centers and restaurants, which usually employ minimal-wage workers, with minimal motivation and incentives to work hard?  Labor costs in these industries typically represent the largest operating expense and the number of people employed constitutes a significant proportion of population of any developed country.  Yet, there are few success stories when it comes to improving productivity of this huge labour force.  However, a  wave of innovative companies is changing this status quo, and in my research and consulting I had an opportunity to analyse data from such companies and see effects of workplace competition first hand. In my mind, these companies are excellent examples of the Business Model Innovation.

In the US restaurant industry alone, almost 13 millions of workers (most of them paid close to minimal wage)  provided $580B of meals in 2010.  Various workforce management software products attempt to simplify this task by forecasting demand for work and scheduling supply of employees. In comparison with traditional organizations that strive to distribute work among employees in identical positions evenly, the winners-take-all organization allocates work along the performance hierarchy, starting from the top and letting each subsequent worker to cut as big a piece of the work pie as he or she can handle. The key difference here is that a traditional organization plans its workload with the average performer in mind, while the winners-take-all organization constantly raises the performance bar above the current average.  The key to adopting this approach to workforce management lies in recognition of the fact that workers dramatically differ in their productivity due to skills or abilities or attitude to work, and these differences often cannot be diagnosed at the time of hiring a person.  This is exactly what a startup company Objective Logistics Inc. achieves by measuring worker performance in real time.

The screenshot below demonstrates what each employee sees after logging into web-based system using, for instance, an iPhone.  Servers can clearly see their current rank (based on past sales and customer satisfaction captured through tips), they know what they can do to improve, and of course they have the choice of upcoming shifts which depend on their ranking. Perform well and earn the opportunity to work at the busiest times like Friday or Saturday evening, which are also associated with best tips.  If you would like to experience the system for yourself, the chain of Boston-based restaurants Not Your Average Joe’s is implementing the system right now and the HBR article contains interviews with the CEO of the chain as well as interview with an employee. The system works – by having best employees work at best times, the restaurant increases its revenues and best employees receive better tips, all essentially at no extra cost!

Another company in the article is LiveOps Inc., an innovative call center company which processes streams of inquiries and purchase orders generated from infomercials broadcast by the LiveOps’s clients on cable television. LiveOps provides call center sales services through its hosted technology platform and its community of about 20,000 agents located all over the US who work as independent contractors from home by processing inquiries and orders over the phone using the Internet to log transactions. The distinguishing feature of the LiveOps is the proprietary performance-based work allocation system that turns the company into an ideal example of our “winners-take-all” organization. The firm has a platform technology that allows clients to evaluate an agent’s performance across a range of call performance metrics, such as: the conversion rate which equals to the percentage of calls ended in sales, the average size of the order on sale calls, and the average call time. An incoming call is routed to the best available agent for that product among those agents who have scheduled themselves to work during the current 30-minute block through the scheduling system. Because agents get visibility to their own ranking for each product they sell, they are motivated to improve any particular unsatisfactory score or sign up for the programs and calling times  when the products for which they are highly ranked are presented in the infomercial. Those who cannot meet client program performance metrics earn little in compensation, because they are routed fewer calls and sales programs are commission based, paying agents only when they successfully close a sale. Although the average utilization rate of agents at LiveOps is lower than at a “traditional” call center (55% vs 66.4%), the utilization rate of high performing agents is much higher than the utilization rate of low performing agents (70% vs 30%), allowing LiveOps to achieve higher sales at a lower cost.

These two innovative companies are excellent examples of Business Model Innovation, the subject of our blog, in two industries (call centers and restaurants) in which little innovation usually happens.  Employees in these industries constitute the “last mile” of the service delivery system and often the biggest risks that companies face are associated with uncertainty in performance of the employees.  Just like many other Business Model Innovations we discuss in the blog, Objective Logistics and LiveOps reduce these risks by reallocating work from worst employees to the best. Naturally, not every business setting is amenable to such approaches – I would not recommend it in situations which require teamwork and mutual help, for instance.  Nevertheless, tournament-like organization of work has, in my opinion, enormous potential in a number of other industries which have not seen productivity improvements in a long time and I continue seeing examples of it in the most unusual places such as, for instance, warehouse stocking…

In the minds of both consumers and managers going green is typically thought as being associated with an additional expense.  We see this in food stores, for instance, where organic products cost more.  Despite this general perception, there exists a simple approach for just about any organization or household to become more sustainable and make more money in the process.  The miracle solution  lies in Energy Efficiency projects. For instance, replacing old incandescent and halogen light bulbs with new energy efficient compact flourscent bulbs, installing additional insulation, motion-activated light switches, replacing old-leaky windows, buying energy-efficient heaters, are all known to lower carbon footprint while dramatically lowering energy bills!  In fact, Energy efficiency projects are the easiest and the fastest way to reduce greenhouse emissions, their return on invested capital is large, and these projects do not rely on any new or unproven technology.  Nevertheless, only a miniscule proportion of houses and organizations implement them.  This certainly looks like a paradox and, in a way, it is: here is a simple solution to one of the world’s most vexing problems, but it is not adopted at any significant rate.  The problem lies in the alignment of incentives induced by the business model and the situation calls for a Business Model Innovation. 

http://climateprotection.org/our-work/sonoma-county/energy-efficiency

Let us analyze the situation first.  Take an energy efficient bulb, for instance.  As consumers, we see that a standard CFL (compact fluorescent lamp) costs perhaps 3–10 times more than an equivalent incandescent lamp, which stops most of us from making the high upfront investment.  Of course, we understand that the CFL probably lasts longer (or at least so the label claims), and that its power consumption is probably dramatically lower, but does this really pay off?  Precise calculations will tell you that a CFL lasts 8–15 times longer and uses 3–4 times less energy.  A recent article in U.S. News even stated directly “A household that invested $90 in changing 30 fixtures to CFLs would save $440 to $1,500 over the five-year life of the bulbs, depending on your cost of electricity. Look at your utility bill and imagine a 12% discount to estimate the savings.”  But these calculations are neither simple nor are they certain: we rarely known how much energy we consume (perhaps one recalls an average utility bill but how much of it is one lamp?), and prices of electricity fluctuate wildly making it hard to pinpoint the true electricity cost.  Plus, nobody can ascertain exactly how long the CFL bulb will last and, with the prices going down steadily, it always seems that  waiting  another year or two helps one  save even more.  Finally, there is always a box of spare incandescent lights somewhere in the house (purchased in a bulk at a discount), which never seems to run out.  The result: status quo.

The root of the problem is that neither consumers nor organizations have certainty about benefits of the energy efficiency improvements, while the costs are all too obvious: higher price of energy-efficient equipment.  This is a clear example of an inefficiency caused by significant uncertainty about electricity consumption and prices, longevity of the equipment and, ultimately, by the return on investment.  In other words, buying a CFL bulb is associated with a moral hazard problem: the consumer (or the organization) wishing to replace old equipment with new technology takes all the risk, while equipment manufacturers (General Electric, Phillips etc.) take none: they just sell the product and pocket the margin.  This is never good for a value chain.

While solving the consumer problem is still a little tricky, but Energy Efficiency Services Companies (EESCOs), have offered a viable solution to this dilemma in the commercial sector. Although many different arrangements exist in this industry, the basic idea is the same: An EESCO comes to the client with a simple business proposition—first, we jointly ascertain the current utility bill, then the EESCO implements whatever energy efficiency projects it deems fits, and in subsequent years, all savings relative to the initial bill are shared between EESCO and the client.  The benefit to the client arises from risk reduction – there is no more upfront payment for technology that might or might not deliver benefits.  Of course, this risk-reduction comes at a price: the benefits of increased energy efficiency must now be shared with the EESCO, and typically these contracts are long-term, to assure that EESCO has enough time to recoup costs of investing into energy-efficient equipment. What is interesting here is that EESCOs innovate by taking upon themselves risky projects and making money on the way, a general approach we described in our recent Harvard Business Review article.  As one would expect, companies that manufacture energy-efficient equipment are the best informed experts out there on energy efficiency and many of them have been expanding into implementing energy efficiency projects (e.g., Honeywell, Trane, Siemens etc.).  Another segment of such companies is affiliated with utilities.  Whatever be the origin of the EESCO, it typically has a substantial informational advantage over the client, i.e., it is better able to understand, quantify, price and manage these risks.  Sometimes this arises directly out of the EESCOs experience, expertise and in other instances, the companies installing superior monitoring equipment that alerts it to any swings in demand or supply, and appropriate corrective responses can be initiated.

Not surprisingly, the EESCO industry has grown at a rate of more than 7-8% per year, even during the economic crisis.  No technology innovations can possibly help in this case: no matter how much time and effort we spend creating better, more efficient light bulbs, the problem of the adopters limited information, the consequent uncertainty about payback time, and the misaligned incentives between the provider and the firm remain, as long as the business model doesn’t evolve, which is something that is frequently the case in numerous examples we describe in our Business Model Innovation blog.