The Empires Strike Back

Business Models at Risk

These essays frequently argue for innovation: product innovation, process innovation and, especially, business model innovation. Innovation affords true differentiation and true differentiation affords sustainable margins. However, Newton’s third law holds that actions spontaneously generate reactions. Innovations work the same way. Innovations often threaten existing business models and entrenched institutions. The threatened and the entrenched react – they strike back!

Here are some examples:

Tesla and the Car Dealers

Tesla Model STesla, The electric car manufacturer, certainly doesn’t think like everybody else. “Everybody else” sells to the public via a network of franchised dealers. The dealers sell new cars, buy and sell used cars, arrange buyer financing, while also providing maintenance and repair services (warranty and otherwise). Dealers also provide a huge capacity for carrying new car inventory.

But Tesla doesn’t think like “everybody else”. Tesla wants to sell to the public directly, rather than through dealers. Tesla wants to run their business on a “pull” system. Tesla wants to make to customer order, rather than building huge inventories.

Tesla is a very small part of the American automobile market. But Tesla’s cars do represent a real threat to the franchised dealer business model. Electric cars can be expected to require little maintenance and to last a long time. Tesla can provide customer financing at least as well as dealers can. So, it’s not just dealer mark-up on new car sales that is threatened: it’s almost all of the dealers’ revenue streams.

The franchised dealers are usually local business people, serving a local clientele. Many are active in state and local politics, individually or through dealer associations. Sufficiently so that the franchised dealer approach to selling new cars often enjoys political “air cover”. In fact, in three states (AZ, TX and CT) it is illegal for manufacturers to sell cars directly to the public. Now that’s striking back!

Solar City and the Power Utilities

Solar City is the national market leader providing distributed photovoltaic solar power systems (meaning solar panels on the roof) to residential and commercial customers. Distributed solar constitutes a tiny fraction of America’s electric power. However, distributed solar is growing fast, and distributed solar is highly visible. Rapid advances in battery technology are providing increasing feasible methods for making distributed solar power last around the clock. [1]

New building construction – residential, commercial and industrial – remains slow. Electric power utilization efficiency is improving rapidly, in new and existing structures, reducing per-square-foot electricity requirements. Accordingly, electric power utilities face a future of declining demand. At the same time, power generation and distribution facilities require capital for meeting environmental and other demands. Capital – usually meaning long-term debt financing.

Facing a weak outlook for future demand coupled with significant capital expenditure requirements, utilities are increasing wary of losing existing customers to distributed solar. So, the utilities are pressing regulators to discourage loss of revenues to distributed solar installations. The electric utilities can see all of the telephone service lines dangling unused from utility poles. Small wonder they strike back.

The Frackers and the Saudis

The widespread use of hydraulic fracturing drilling techniques (“fracking”) has resulted in a major increase in crude oil and natural gas production in the U.S. At the same time, high fuel prices and improvements in energy utilization efficiency have moderated demand. Some time in the autumn of 2014, reduction in U.S. demand – as seen by Saudi Arabia and other petroleum exporting nations – resulted in a sharp break in global crude oil prices.

In recent years, Saudi Arabia moderated global price fluctuations by varying their daily output, such that global supply and demand rebalanced at a level acceptable to them.

AEO 2015 Fig 23Not this time. The Saudis recognized three things: (1) With “fracking”, global supply was increasing too quickly to ignore; (2) In the 1970’s Saudi oil minister Sheikh Yamani commented that “the Stone Age didn’t end because we ran out of stones” (meaning, of course, that the Petroleum Age will likewise end before all of the wells run dry); and (3) the Saudis have by far the lowest cost of producing crude oil.

So, the Saudis struck back by holding crude oil production steady. The “frackers” – with their much higher cost – put the brakes on new drilling. Sharply. Global supply and demand began to rebalance and global crude oil prices began to increase.

For Smaller Manufacturers

For manufacturers, small or large, innovation is a necessary condition for surviving – let alone thriving – in the 21st century. It is a good bet that others, somewhere in the world, will view your innovations as potentially disruptive to their business models. Reaction is all but inevitable. The point here is that potential reactions to your innovations – and how to address them — need be considered when implementing innovations.

Chuck - Mt. HumphriesThoughtful comments and experience reports are always appreciated.

…  Chuck Harrington (Chuck@JeraSustainableDevelopment.com)

P.S: Contact me when your organization is serious about prospering in the globalized 21st century … CH

This blog and associated website (www.JeraSustainableDevelopment.com) are intended as a resource for smaller manufacturers in the pursuit of Sustainability. While editorial focus is on smaller manufacturers, all interested readers are welcome. New blog posts are published weekly.

Image credit: Crude oil net imports chart from U.S. Energy Information Agency, Annual Energy Outlook 2015, Fig. 23.


[1] For more on distributed solar and its implications, see William Pentland, PwC Survey Shines Light on Disruptive Impact of Distributed Generation, Forbes magazine on-line, http://onforb.es/1J5dO2U