This book provides a concrete guide on how to execute strategic pricing to excel in an increasingly dynamic and digitise
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This book provides a concrete guide on how to execute strategic pricing to excel in an increasingly dynamic and digitise
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This is one of the first books to combine the current megatrend of digitalization and pricing as the most effective leve
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Digital Pricing Strategy provides a best-practice overview of how companies design, analyze, and execute digital pricing
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Filling a gap in the current literature, this book addresses the social approach to the design and use of innovative bus
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Innovative digital technologies are forcing companies to rethink how they compete. The focus of digital innovation in bu
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This open access book investigates the role of collective bargaining in the gig economy. Despite the variety of situatio
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Table of contents :
List of Figures
List of Tables
1 A New Perspective on Pricing
Pricing That Attracts Customers
Conclusions Before We Started
The Book’s Background in a First Case—And Then More
PART I Theory and Conceptual Models
2 Business Ecologies—A Way of Understanding Your Environment
Background—Interaction as Directed Collaboration in a Business Ecology
Business Ecologies as Dynamic Interaction Between Enterprise and Environment
Minecraft and the Internet-Based Game Ecology
Skype and the Communication Ecology
Spotify and Developments in the Music Ecology
The Car Industry From a Business-Ecology Perspective
The Dissemination of Business Concepts—The Example Functional Rental
3 Business Models
A Definition of the Business Model Concept
Three Perspectives of Business Models Concept
A Formal Description of Business Models
Business Model Value Creation
Tangible and Intangible Values
The Role of Subcontractors, Partners, Activities and Resources in Value Creation
The Cost of Value Creation
Business Model Value Capture
The Role of Customers, Relations and Distribution Channels in Value Capture
Value Capture and Revenues
Levels of Aggregation in Business Model Analysis
4 Price Models
Background to the Price Model Concept
The Price Model Equaliser
Application of the Price Model Equaliser: Ryanair
Digitisation and Price Models
The Relation Between Inbound, Outbound and Internal Price Models
5 Cost and Its Relation to Pricing
Fundamental Assumptions About Costs
Increased Importance of Cost Information in Analysing Potential Price Models
Cost Dynamics and Pricing
Possibility to Influence
Recognition of Costs in Accounts
Cost Allocation Within Firms
How to Measure Costs: Assessing the Use (Consumption) of Resources
How to Assess What Is a Relevant Cost to Include in the Cost Model
“Inbound” and “Outbound” Pricing—And Internal (Transfer) Pricing
The Degree of Partner Collaboration Determines the Cost, Expressed as Inbound Prices
Profitability: When Costs Meet Revenues—Delivering What We Promise
Cost Assessment Is an Important Input for Price Model Innovation and Selection
PART II Cases and Examples
6 Innovative Price Models and Digitisation
Five Cases of Innovative Price Models
Extending the Scope of the Offering: The Case of Readly
Innovative and Digital Traits of Readly’s Price Model
Switching From Sale to Rent: The Case of Husqvarna
Innovative and Digital Traits of Husqvarna’s New Price Model
Leaving Pricing to the Market: The Case of Google AdWords
Innovative and Digital Traits of Google Ads’ Price Model
Pricing Customer Value Instead of Costs: The Case of Siemens
Innovative and Digital Traits of Siemens’ New Price Model
Assuming Full Risk—Offering Fixed Price on Taxi Rides: The Case of Cabonline
Innovative and Digital Traits of Cabonline’s New Price Model
7 A Motor-Vehicle-Focused Transportation Ecology
Waking Up to Electrification
Growing Use of Small Vehicles
Buy or Rent
Business Ecology and Travelling Ideas Regarding Business and Price Models
8 Strategic and Innovative Pricing in a Born-Digital Company: The Pickit Case
The Business Ecology
The Business Model
Value Creation in the Business Model
Value Capture in the Business Model
Three Different Price Models
9 Conclusion, Discussion and Way Forward
Theoretical Concepts for Strategic and Innovative Pricing
Applications of Concepts for Strategic and Innovative Pricing on Empirical Examples
Beyond: More Pricing Themes to Explore
Division of Labour in Co-Producing Value
Time: Exploring the Benefits of Lock-In
Risk: Predictions and Conjectures
Price Models as Strategy: Impressions vs. Analysis
Matching Out, In and Between—And Cost and Incentives
Controlling Price Offers
A Final Reminder: RITE
Strategic and Innovative Pricing
This book provides a guide on how to execute strategic pricing to excel in an increasingly dynamic and digitised business environment, while developing and deepening relations with contract partners. The secret lies in crafting innovative price models that reward joint value creation in accordance with the business model, rather than engaging in confrontative zero-sum pricing reasoning. The book provides hands-on tools that are applied on three interconnected levels of analysis. First, the book shows how to explore the business ecology to understand its dynamics and how digitisation enables it to prosper. Second, the book demonstrates how to construct a viable business model that enables an organisation to navigate in its vibrant ecology. And fnally, and most importantly, it shows how to use innovative price models to realise and monetise the business model and its value offering, making the organisation and its partnerships sustainable. Models pertaining to the three levels of analysis are applied in rich case studies and examples from different countries. Special attention is paid to digitisation as an underlying theme. The book is grounded in several years of successful research and consultancy with private and public organisations that have benefted from understanding how to strategise through pricing in a digitised business economy. Mathias Cöster is Assistant Professor in Business Studies at Uppsala University, Sweden. Einar Iveroth is Associate Professor in Business Studies at Uppsala University, Sweden. Nils-Göran Olve is Guest Professor with Linköping University and Uppsala University, Sweden. Carl-Johan Petri is Assistant Professor in Economic Information Systems at Linköping University, Sweden. Alf Westelius is Professor of Digitisation and Management at Linköping University, Sweden.
Routledge Research in Strategic Management
This series explores, develops and critiques the numerous models and frameworks designed to assist in strategic decision making in internal and external environments. It publishes scholarly research in all methodologies and perspectives that comprise the discipline, and welcomes diverse multi-disciplinary research methods, including qualitative and quantitative studies, and conceptual and computational models. It also welcomes the practical application of the strategic management process to a business world inspired by new economic paradigms. Strategic Analysis Processes and Tools Andrea Beretta Zanoni Strategic Management and the Circular Economy Marcello Tonelli and Nicoló Cristoni Strategic and Innovative Pricing Price Models for a Digital Economy Mathias Cöster, Einar Iveroth, Nils-Göran Olve, Carl-Johan Petri and Alf Westelius
Strategic and Innovative Pricing Price Models for a Digital Economy
Mathias Cöster, Einar Iveroth, Nils-Göran Olve, Carl-Johan Petri and Alf Westelius
First published 2020 by Routledge 52 Vanderbilt Avenue, New York, NY 10017 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2020 Mathias Cöster, Einar Iveroth, Nils-Göran Olve, Carl-Johan Petri and Alf Westelius The right of Mathias Cöster, Einar Iveroth, Nils-Göran Olve, Carl-Johan Petri and Alf Westelius to be identifed as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identifcation and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data A catalog record has been requested for this book ISBN: 978-0-367-14870-6 (hbk) ISBN: 978-0-429-05369-6 (ebk) Typeset in Sabon by Apex CoVantage, LLC
List of Figures List of Tables
A New Perspective on Pricing
Introduction 1 Pricing That Attracts Customers 3 Conclusions Before We Started 5 The Book’s Background in a First Case—And Then More 7 PART I
Theory and Conceptual Models 2
Business Ecologies—A Way of Understanding Your Environment Introduction 11 Background—Interaction as Directed Collaboration in a Business Ecology 12 Business Ecologies as Dynamic Interaction Between Enterprise and Environment 15 Business-Ecology Examples 18 Minecraft and the Internet-Based Game Ecology 18 Skype and the Communication Ecology 19 Spotify and Developments in the Music Ecology 20 The Car Industry From a Business-Ecology Perspective 22 The Dissemination of Business Concepts—The Example Functional Rental 24 Implications 25
Introduction 29 A Defnition of the Business Model Concept 29 Three Perspectives of Business Models Concept 31 A Formal Description of Business Models 34 Business Model Value Creation 36 Tangible and Intangible Values 36 The Role of Subcontractors, Partners, Activities and Resources in Value Creation 38 The Cost of Value Creation 39 Business Model Value Capture 40 The Role of Customers, Relations and Distribution Channels in Value Capture 40 Value Capture and Revenues 42 Levels of Aggregation in Business Model Analysis 43 Implications 45 4
Introduction 49 Background to the Price Model Concept 50 The Price Model Equaliser 51 Scope 54 Temporal Rights 55 Infuence 56 Price Base 58 Price Formula 60 Application of the Price Model Equaliser: Ryanair 61 Digitisation and Price Models 63 The Relation Between Inbound, Outbound and Internal Price Models 66 Implications 68 5
Cost and Its Relation to Pricing Introduction 74 Fundamental Assumptions About Costs 76 Increased Importance of Cost Information in Analysing Potential Price Models 78 Cost Dynamics and Pricing 81 Possibility to Infuence 81 Timing 81
Recognition of Costs in Accounts 82 Cost Allocation Within Firms 82 How to Measure Costs: Assessing the Use (Consumption) of Resources 83 How to Assess What Is a Relevant Cost to Include in the Cost Model 85 “Inbound” and “Outbound” Pricing—And Internal (Transfer) Pricing 87 The Degree of Partner Collaboration Determines the Cost, Expressed as Inbound Prices 89 Proftability: When Costs Meet Revenues—Delivering What We Promise 90 Cost Assessment Is an Important Input for Price Model Innovation and Selection 92 Implications 93 PART II
Cases and Examples
Innovative Price Models and Digitisation Introduction 99 Five Cases of Innovative Price Models 99 Extending the Scope of the Offering: The Case of Readly 100 Business Ecology 101 Business Model 101 Price Model 102 Innovative and Digital Traits of Readly’s Price Model 103 Switching From Sale to Rent: The Case of Husqvarna 103 Business Ecology 104 Business Model 105 Price Model 105 Innovative and Digital Traits of Husqvarna’s New Price Model 107 Leaving Pricing to the Market: The Case of Google AdWords 107 Business Ecology 108 Business Model 109
viii Contents Price Model 111 Innovative and Digital Traits of Google Ads’ Price Model 112 Pricing Customer Value Instead of Costs: The Case of Siemens 113 Business Ecology 113 Business Model 115 Price Model 116 Innovative and Digital Traits of Siemens’ New Price Model 118 Assuming Full Risk—Offering Fixed Price on Taxi Rides: The Case of Cabonline 118 Business Ecology 119 Business Model 120 Price Model 122 Innovative and Digital Traits of Cabonline’s New Price Model 123 Implications 124 7
A Motor-Vehicle-Focused Transportation Ecology
Introduction 127 Waking Up to Electrifcation 127 Growing Use of Small Vehicles 129 Buy or Rent 130 Business Ecology and Travelling Ideas Regarding Business and Price Models 134 Implications 135 8
Strategic and Innovative Pricing in a Born-Digital Company: The Pickit Case Introduction 136 The Product 137 Initial Product 137 Current Product 137 The Business Ecology 138 Foreground Actors 139 Background Actors 140 The Business Model 141 Value Creation in the Business Model 141 Value Capture in the Business Model 144
Price Models 146 Three Different Price Models 146 Scope 147 Temporal Rights 147 Infuence 148 Price Base 148 Price Formula 148 Implications 149 9
Conclusion, Discussion and Way Forward
Introduction 151 Theoretical Concepts for Strategic and Innovative Pricing 151 The Relevance of Cost Analysis 153 Applications of Concepts for Strategic and Innovative Pricing on Empirical Examples 153 Beyond: More Pricing Themes to Explore 155 Division of Labour in Co-Producing Value 155 Time: Exploring the Benefts of Lock-In 156 Risk: Predictions and Conjectures 156 Price Models as Strategy: Impressions vs. Analysis 157 Matching Out, In and Between—And Cost and Incentives 158 Controlling Price Offers 158 A Final Reminder: RITE 159 Relation 160 Intention 161 Technology 161 Environment 161 Author Biographies Index
3.1 4.1 4.2 5.1 6.1 6.2 6.3 6.4 6.5 8.1
Illustration of business model components The price model equaliser Ryanair’s outbound price model Example of Cost model sheet Readly’s outbound price model Husqvarna’s outbound price model Google AdWords outbound price model Siemens turbo machinery outbound price model Cabonline’s outbound price model Pickit’s outbound price models
35 51 61 75 102 106 112 117 122 147
2.1 Typical actors in a business ecology 4.1 Explanation and examples of the different slider positions 6.1 Summary of the cases presented
26 52 100
A New Perspective on Pricing
Introduction This is a book about strategic pricing in the digital economy, and it provides a guide on how to explore as well as execute strategic pricing to excel in an increasingly dynamic and digitised business environment, while at the same time developing and deepening relations with contract partners. The secret lies in crafting innovative price models1 that reward joint value creation in accordance with the business model, rather than engaging in confrontative zero-sum pricing games. Special attention is paid to digitisation2 as an underlying theme. Several years of successful research and consultancy with private and public organisations were the testbed for our approach, which rests on three interconnected levels of analysis. First, the book shows how to explore the environment, using a business-ecology perspective (Chapter 2) to understand its dynamics and how digitisation enables it to prosper— and poses challenges. Second, the book demonstrates how to construct a viable business model (Chapter 3) that enables an organisation to navigate in its dynamic ecology. And fnally, and most importantly, it shows how to use innovative price models (Chapter 4), an important but often neglected part of business models, to realise and monetise the business model and its value offering, making the organisation and its partnerships economically sustainable. Tools pertaining to the three levels of analyses are applied in rich case studies and examples from different countries, and the book includes guidelines on how to use them. Business ecologies, business models and price models will be used together as a three-step sequence for analysing and articulating relations not only with customers, business partners and between different units within an organisation, but also with trends, ideas and models in the environment that infuence the business models and price models one employs, and their viability. In the frst part of the book (Chapters 2 through 5) we arrive at a new perspective on pricing. We propose an analytical concept called the price model equaliser, to be used as a tool for imagining novel ways of pricing
A New Perspective on Pricing
for the situations that contemporary organisations encounter. From our rich experience of working with consultancy clients and as researchers, we identify how relations nowadays often are long-term and characterised by joint value creation (and where digitisation often is a key enabler). The price model equaliser aids in identifying and discussing such aspects of a deal as the scope of offerings, duration of contracts and the attributes prices should be linked to. There is often unexplored potential for innovations in pricing, better adapted to the needs and preconditions of buyers, sellers and business partners. Pricing thus can serve to realise business models in ways many organisations do not now exploit. Due to differences between buyers and sellers, well-designed price models may be part of win-win contracts that both parties fnd preferable to traditional price models. At the end of Part I, we discuss costs and other fnancial considerations, such as business risk, which obviously will always be important in contracts that regulate payments and how economic values are shared. The business models we fnd most interesting invariably involve joint value creation, where several frms, including buyers, impact value creation over time through their actions. Price models create incentives and infuence risk sharing. We fnd them an under-researched feld of study and regard our proposals as a frst step towards rectifying that defciency. In the second part of this book, we turn to a rich selection of practical cases in order to discuss both the individual parts of our price model equaliser and the joint confguration of its attributes. Most of these come from our own practice, and we have been able to observe how practitioners have been able to absorb and apply the models we propose. By strategic, we mean that pricing will have effects beyond a particular business transaction. Through linking prices to different aspects of the offering, a price model defnes it and infuences how it is conceived by both seller and buyer, and in this way shapes the identity of both and the preconditions for a continued business relation between them. It also provides incentives for exploring joint value creation, for instance in the areas of service and accessory sales. While not new, such insights have proved particularly interesting to practitioners we have met for reasons related to other current debates, such as value capture, risk management, transparency and open-book accounting. By the digital economy, we mean a society based on digital computing technologies, not just shaped by the widespread use of the Internet but increasingly involving embedded computers and sensors that communicate via digital channels to control and monitor physical resources, processes, activities and behaviour, and where people take it for granted that data is recorded and analysed regardless of time and place. This can both pose threats and challenges, enable new business practices and restrict existing ones. For relations between organisations and units within them, digitisation presents previously unimagined opportunities to monitor and
A New Perspective on Pricing
price specifc aspects of a business transaction, making it apparent how prices provide incentives for buyers and sellers. Such exploration of digitisation and pricing can uncover aspects that, in turn, can trigger changes to not only an organisation’s offering as such, but also necessary changes to relations to actors and ideas in the ecology, changes to the business model as well as the overall strategy. In this way, and as we will communicate and explain in more detail throughout the book, digitisation and pricing can be a key-enabler for innovation and a long-term sustainable and fnancially viable organisation. Although this is not a book about organisational control through (internal) transfer pricing or purchasing practices, our three-step perspective of business ecology, business model and price model highlights how prices may determine division of labour and thus co-creation of value among business partners. In this way, pricing can be seen as a skill impacting the sustainability of an organisation and even an economy. Is market effciency through price level competition, with a “survival of the fttest” attitude, always the best path to a sustainable society? Will we see more of multi-year, “obligational” contracts where frms and government organisations use price models to defne joint value creation? Following this brief overview, this initial chapter will now discuss some of the observations and contacts which led us to start on our journey into innovative pricing ten years ago. We highlight what many of us observed in markets and explain briefy how we came to work in this feld.
Pricing That Attracts Customers Probably, mobile-phone contracts introduced many of us to the idea that price models could differ between suppliers and that they were becoming competitive tools. A monthly fee plus variable cost for calls, messages etc.— or a fxed package? Unlimited surfng? A new phone included? How many months before you can exit the contract? Compared to the fee structures for the old fxed-line phone, often provided by a government-run monopoly, many were bewildered. Bewilderment was reinforced as the technology spread quickly—in Western countries there are often more mobile phone contracts than inhabitants—and price-model variations multiplied. There have been reasons for this new price competition. Versatile new generations of phones meant that some were attracted by the phone itself, some saw it as a symbol of modernity and a way to signal success and being an active part of modern trends, while others saw it just as a necessary prerequisite for the services they craved. The range of included functions and services that people are willing to pay for varies widely. Some want streamed video several hours a day, while more traditional customers just want phone calls and messages. Few in a digital-economy environment can get through the day without actively seeking, or being forced to use, apps to perform tasks. Yet most of the services build on
A New Perspective on Pricing
a shared network, which is available for anyone with the right type of mobile phone and operator contract. Capacity and service qualities depend on complex decisions and industry agreements that have little to do with providing individual customers with services—except in extreme cases, like regions with very few inhabitants. Similar trends exist in other industries, and theoretically they are of course not new. Economists have grappled with issues of road fees for close to two hundred years: should they be charged to fnance retroactively the building of a road? The debate has been particularly ferce regarding bridges where no alternative connections exist, and it is socially harmful to discourage the use of an existing facility. In the late 20th century, terms like “up-front costs” became common. Almost-zero variable and marginal costs made it diffcult for new entrants to challenge and compete with frms that had been the frst ones to invest in a new feld. Costs increasingly pertained to the customer relation as such, not to specifc offerings, as electronics were making goods and services more interconnected. In countries like the US, government had long been fghting frms that used their monopoly to require camera buyers to buy a particular brand of flms, or razor buyers to buy their blades. Mobiles created a situation where many of us may have been unsure: • • •
whether we bought a phone and had to promise to buy a particular operator’s services, or bought a phone connection and received a free mobile, whether we understood correctly the cost of the two- or three-year contract we were entering, or would fnd out later about its limitations and extra fees for features we would fnd it hard to resist, and whether service quality—coverage, service disruptions etc.—would prove adequate.
But we also began to realise that some service providers might provide offerings that matched our requirements better than others, for instance, a guaranteed fxed monthly fee for a well-specifed package of services. A problem might be that most of us learnt only through experience how far a specifed number of gigabits would take us. But after some time, we found it natural to choose a service provider for the next few years, rather than buy a phone or a television set. Firms (and even government organisations) increasingly set up “package deals” of goods and services which can be priced in many conceivable ways. In this book we call the fnancial terms in offerings such as the different phone contracts price models. For a seller, a wise choice of price model is an important part of realising a business model. Let us limit ourselves for now to the case of one seller and one buyer. In the mobile phone case, this would normally be an operator and a user (a person or an organisation), although the buyer might think of the transaction as
A New Perspective on Pricing
“buying a new iPhone” (which is not manufactured by the operator), and the seller may buy network services from some other frm. In this situation, the buyer’s choice no longer is just who offers the cheapest identical phone. Offerings may differ in many more dimensions, and especially when phones’ functionality increased rapidly, competitors’ offerings and pricing differed. How to innovate pricing in such situations is what this book is about—and perhaps particularly, how to innovate in situations where a change similar to that in phone services has not yet happened. A price model is about a particular business deal: what is included, and what will determine how much customers pay? But we also use the term somewhat more broadly. What generic types of price models does a frm offer its customers? Often, frms offer different constellations of goods and services that are priced according to fundamentally different models. Each frm has a repertoire of price models. Sometimes, a fundamentally new price model is launched, like when one Swedish mobile phone operator abolished the time factor and gave customers the right to cancel without waiting (like before) for a 24-month period to expire. Price models have become part of competition, and frms have to consider questions like: • • • •
Is there a signifcant group of customers who want a monthly cost they can predict and would be attracted by a fxed fee? Can we handle the increased traffc that is likely to follow? How will it affect our customer-service function if unlimited support is included at no extra cost to customers, who are then likely to use it more? Will our competitors follow us if we change our pricing to attract specifc groups, or will they use dissimilar price models to fnd niche markets of their own? A unitary fee for a bundle of goods and services, including support, will need to be split between the units of our organisation if they shall remain proft centres. Their products and functions will be used to different extents by different customers. How can we organise this inside our frm to provide incentives and enable management evaluation?
Questions like the fnal one also exist for subcontractors and outsourcing partners: how much of our revenues should be passed on to each? Price models for a frm’s relation with those (inbound pricing) may require as much attention as the price models for fnal sales (outbound pricing).
Conclusions Before We Started Casual observation of our own behaviour as consumers, and that of frms we have been observing, yielded several conclusions which motivated our interest in the feld of pricing. They were reinforced by debates in media
A New Perspective on Pricing
and politics over public-sector procurement, where contracts for healthcare and large infrastructure projects were accused of providing wrong incentives, leading to low quality and encouraging cost overruns. Yet we found little research on pricing beyond the established issues of price-level competition between frms offering rather standardised products. So, we drew a number of conclusions early in our own exploration of the feld: Prices are becoming multidimensional. The object that is being priced can no longer be taken for granted. Beyond “bundling” and “versioning”,3 which have been discussed in price literature, offerings are being differentiated through selling something “as a service”, or through limitedtime free access which can be updated, or using a guaranteed “price ceiling” (like public transport in London, which is free once you have reached each day’s maximum fee). Contract duration and payment terms may also be varied. Prices matter. A price agreement will impact the behaviour of both buyer and seller, and it should be seen as an active choice concerning incentives for joint problem solving. Traditional literature regarded cost or customer value as the prime determinants of price. The pricing we could observe often was part of an ongoing relation which aimed to explore co-creation of value. Price models will differ in their impact on the incentives they provide for this and how a shared success is rewarded. Price models infuence costs. What you include, and how prices are linked to various aspects of a deal, has an impact on costs. Especially when agreements are long-term and involve promises of service levels, updates, or data links to improve logistics, both supplier and customer will adapt to the new terms for the collaboration by investing in equipment, increasing or reducing staffng, etc. Pricing is part of the signals that will determine how this is done. For instance, a price formula may include rewards and penalties for uninterrupted service or rapid delivery. A consequence is that seller and buyer need to forecast the impact a deal will have on their activities, in order to evaluate its likely effect on their cash fows and thus how it should be confgured and priced in order to be proftable for both. Customer value provides insuffcient guidance. Marketing literature uses the term customer value as if it can be calculated and used as a price base, implying that a customer’s willingness to pay refects an absolute such value and is possible to identify. For sellers, it is implied that prices lower than customer value will “leave money on the table”, and that they should charge more. But when prices infuence activities and the continued relations between a supplier and a customer, the story is less simple. To gauge willingness to pay for a well-defned good is already hard; to do so when an offering can be designed in different ways, for instance with different levels of service, is even harder. Seller and buyer often predict future use differently, and it may be advantageous for both to work out how their joint co-production of value should take shape for mutual benefts.
A New Perspective on Pricing
Prices articulate an intended relation between business partners and shape their future. A good business deal must be satisfactory to both parties. It should enable value creation that both perceive as suffcient and determine how created values are allocated between them—often with a time dimension, because a longer-lasting relation may create more value through growth over time. Price models can provide incentives for this—or hinder it. Price models infuence risk and risk-sharing. Implicit in the previous paragraphs is that seller and buyer harbour expectations for the future, and that these may differ. A buyer may be attracted by a fxed price, if he believes that his use rate will be high. A seller may also fnd it attractive, if her expectation is that customers will not use the service much. Their experience of extreme outcomes may vary, as will the consequences for them, like service disruptions, costs, etc. A fnancially strong buyer can carry more risk than a weak one. Any long-term deal has an element of insurance policy in it: under what conditions does this price model protect me from consequences we cannot afford? Together, these observations led us to the following conclusion: Success through pricing is not just about fnding the best price levels— there are other aspects of pricing. Ability and will to use price models actively and strategically often determine who gets the business. At least as much as price level!
The Book’s Background in a First Case—And Then More Ten years ago, we were contacted by a company in the global telecom group Ericsson. In one of its markets, a major customer wanted to avoid buying a large system up-front and had suggested that payments should be linked to usage and be paid when the equipment was functional. By itself such a deal would not be new, but our contact rightly felt that a move towards changed pricing required a deeper analysis of how it should be done, what consequences it would have and how such price models should be designed to match the group’s strategies for the target segment of both systems and clients. This turned into a two-year research collaboration where we began to articulate the ideas now contained in this book. With people from Ericsson, we explored the rather meagre literature about price models as tools for realising business models and how customer relations could be defned by price agreements. This activated our interest in the feld, leading us on to other industries and to writing several articles about our fndings. Our work also attracted interest from frms, large and small, that employed us as advisers for their thinking about pricing. We also held seminars where we trained practitioners in performing the kind of analysis we recommend in this book.
A New Perspective on Pricing
As we explained at the start of this chapter, the book consists of a more conceptual and theoretical part (Chapters 2–5) and a part where we apply the concepts and theories on cases we have observed and researched (Chapters 6–9). Together, we believe they provide a ground-map for more extensive research in a feld between strategy, marketing and control. But they also provide practical advice for those who want to explore pricing as a strategic craft in developing relations in accordance with novel business models. Let us now start by exploring the concept of business ecologies in the next chapter.
Notes 1. By innovative price models, we here mean models which, when introduced, are perceived as new ways of competing through pricing. This typically involves changing the relation between the parties to a business deal—for instance making it more long-term. Our focus thus is not necessarily on the general invention of novel ways of specifying price, but rather on the successful application of price models that are perceived as innovative in a particular context. 2. By digitisation, we mean using digital technology as integrated parts of conducting ventures. Increasingly, digitisation not only intertwines use of modern IT and business practices in individual ventures, but it also is important in infrastructure, like the Internet, electricity grids, intermediating platforms (like Amazon and Alibaba, Airbnb and Uber, and YouTube and Facebook). Some want to assign different meanings to the words digitisation and digitalisation; others do not, and use them interchangeably or just the one or the other. Considering that it is common to use them interchangeably, and that trying to make an important distinction between two words that are so similar increases the risk of being misunderstood, we have decided to just use the shorter one, digitisation, throughout the book. It will be clear from the context when we employ digitisation to refer to organisational practices drawing on the use of modern IT and when we refer to a more narrow conversion of something physical or analogue into digital format. 3. Bundling refers to “packaging” of products and services that together have a certain price (the opposite is called de-bundling); versioning refers to making different versions of an offering with different prices that can target different customer groups that have different preferences.
Theory and Conceptual Models
Business Ecologies—A Way of Understanding Your Environment
Introduction There are many reasons why price models have developed and proved crucial to business success. When we introduced our price-model equaliser, mentioned in the previous chapter and presented and discussed in Chapter 4, one reason was prominent: the offering, as it is sought and sold, is increasingly rarely a standard product (a commodity). Hardware priced at a competitive market is precisely what modern enterprises in the Western world attempt to avoid, and consumers high up in the hierarchy of needs rather demand services and experiences. Certainly, standard products still abound, but differentiation is what many strive for. Consumers seeking the particular experience buy a branded product, where the prestige value is more important than the actual functionality, or they subscribe to fullservice contracts to avoid worries and trouble. This also leads to a need to view the specifc transaction in a larger context. The textbooks’ “perfect competition” was an ideal in the classical markets, where the buyer could shop around for carrots and strawberries separately, well aware of what the different stalls could offer. But not even in real markets is the isolated-transaction view an accurate description. You return next Thursday to the merchant whose wares have proven to be of good quality in the past, or who is pleasant to deal with, even if the prices there are somewhat higher. And if you have bought all the vegetables and need some strawberries, perhaps the same merchant will get to supply them too, without you frst inspecting the offers of the neighbouring stalls. Customer relations and customer loyalty are built over time. If the merchant has built a stock of discerning customers, she will in turn see to it to have good suppliers, and perhaps also pay a somewhat higher price to them. The emerging differentiation—the road leading away from the standard goods to goods with more specifc characteristics, or, indeed, to a customised or “bespoke” offering—leads to longer relations between both customer and enterprise, and between more enterprises, who together create the fnal delivery.
Theory and Conceptual Models
For more complex needs, this has been called “supply systems and networks”. Telecom operators, fnance companies and many others that we buy from need to build collaboration with many types of suppliers and distributors to be able to provide us with what we seek. This collaboration starts well in advance because the products require product development and infrastructures. Here, the development of the Internet has had considerable impact, but one that is diffcult to assess. Consumers and enterprises are today customers to businesses in other countries with whom one previously hardly conducted business. This has led to an increase in competition, when more alternatives have become available, and possibly to the dismantling of long-established collaborations. In addition, electronics and the global communication capabilities have made it possible to build increasingly complex services that require collaboration between companies around the globe in order to work. This chapter centres on how to understand this by studying the environment as business ecologies. We briefy introduced the concept already in Chapter 1, but we will explain and develop it further here. The reason for engaging with the business-ecology concept is that the business ecologies in which one intends to participate, and how those ecologies will develop, are among the most important starting points in deciding which price models the business will need (Chapter 3) and possible alterations to other parts of the business model (Chapter 4). Exploring relevant business-ecology views is crucial to the process of establishing strategic and innovative pricing in the organisation. The following sections give a theoretical background by highlighting interaction and collaboration between the organisation and its environment. Before the chapter ends, we present fve illustrations of business ecologies with implications as to how the strategically minded actor can proceed to defne and analyse the environment in terms of business-ecology views.
Background—Interaction as Directed Collaboration in a Business Ecology Towards the end of the 20th century, it became apparent to many, both practitioners and researchers, that the idea of complete, isolated companies that compete with each other needed to be complemented. Certainly, companies have always collaborated. But during the 20th century, it became increasingly rare to be self-suffcient regarding the components and services that one’s production required. The size of the largest companies in the world, measured in number of employees, is supposed to have culminated towards the end of the 1960s. Partly, automation was taking over, but another important explanation is that subcontracting and outsourcing was growing, something that today is also an established practice in the public and non-proft sectors. This, in turn, has its reasons.
Important components and services demand knowledge or economies of scale that render internal solutions uncompetitive with specialised suppliers. In addition, decreased trade restrictions and communication costs allowed companies to dare to become dependent on others, increasingly located in other countries. There are thus both competence- and costrelated reasons, and institutional ones, for the development of business ecologies—and increasingly complex and geographically dispersed sets of enterprises, institutions and ideas that interact, collaborate, compete, seek new connections and attempt to break established ones. Purchasing from each other, rather than being self-suffcient, increases trade in the world, and thus the use of price models. In this chapter, we direct the attention more at the interactions between the actors than at the specifc price models they employ. (In Chapter 4, we engage in depth with price models.) When products and operations become more complicated and require advanced technology, routines and abilities in the form of knowledge and physical facilities, much of what is purchased will require long-term collaboration. In the late 1900s, there was much talk of networks of companies, and researchers demonstrated that intense collaboration coexisted with stable business relationships that could continue for decades (Håkansson, 1982). A company that employs suppliers for its components does not only purchase standard components in competitive bids on a spot market. During the development of the next product generation, it also collaborates with selected suppliers who, as business partners, spend considerable resources on developing components and production capacity specifcally for the new product generation. Even competitors will collaborate regarding systems standards and new mass-market products and services. Networked and connected products require compatibility with standards and infrastructure, so it is no longer possible to fnd customers for entirely unique stand-alone solutions; market adoption calls for compatibility with standards that will be around for some time. If the offering involves a new standard, the intended customers and users will need to be convinced that this new standard will actually gain traction—whether it be a new mobile telephony standard or a new way of pricing energy. American authors have talked of coopetition (Nalebuff and Brandenburger, 1996), a mix of collaboration and competition, where companies together with their future competitors will frst need to reach an agreement on the foundations of the novelties, so that there will then be a sizable, juicy market to compete for (Shapiro and Varian, 1999). Words like network and virtual organisation emphasise different aspects of this development. Swedish researchers coined the term imaginary organisations to emphasise that the way of acting is not always factually and objectively determinable (Hedberg et al., 1997). It is rather a matter of imagination that business leaders craft regarding how they should infuence their business partners, both those with whom they
Theory and Conceptual Models
have clear relations and perhaps even long-term contracts, and those whom they attempt to infuence in more subtle ways to get them to act in ways that suit their imaginations. When choosing which competences to have in-house and to which organisations one should cultivate relations, it is sensible to base decisions on an idea of the development of the surrounding business landscape. But it is increasingly rare to fnd a welldefned and delimited industry, and our suppliers and customers seldom view themselves as belonging to the same industry as we do. Not even competitors necessarily belong to a stable and unequivocally defnable industry. Industry drift and new solutions require a wider environmental analysis as the basis for cultivation of one’s own capabilities and relations with others. The latter involves what form the relations with others should take. It has become normal to speak of business partners rather than competitors, where the partner concept also includes suppliers, customers, collaborating competitors and so on. Also, companies selling something to our customers that complements what we offer could be included: for example, flm and music that require standard fle formats and software that fts our hardware, or vice versa. Sometimes we may even strive to establish joint ventures with complementing companies or invest in them to indicate our interest. Sometimes we want to license brands, sometimes discuss systems standards or engage in other consultations. If we buy or sell something, we may want long-term contracts, and if this “something” requires development collaboration, the question arises how to fnance the development. This is where price models enter. Our equaliser model (see Chapter 4) can be used to study which agreements are possible in principle and to choose those that refect how we view the strategic importance of our collaboration with other organisations. Not least, the model can be used to explore the fnancial consequences of intended business models. Every price model that is used determines the terms for the payment fows received by the selling party and those handed over by the buying party. My in-prices are someone else’s outprices and vice versa. If some companies plan a product launch, say, where one of them is to serve as the front towards the customers, and the others are to serve as suppliers of parts of the product, and simultaneously offer addon services to the customers, how should the product offering then be designed? And how much of what customers pay should go to each collaborating company? The studies of imaginary organisations and networks demonstrated the value for managers of really considering such issues. But in an increasingly complicated and global world, the diffculty of planning and directing imaginary organisations or networks increases. The importance increases of not being myopic, but also attempting to discern what is happening or is about to start happening outside of the established circle of established collaborations. Therefore,
we now widen the view and study the enterprise’s environment as a business ecology.
Business Ecologies as Dynamic Interaction Between Enterprise and Environment We use the term business ecologies to emphasise the increasing importance of interactions that are not directed and controlled by an overarching actor or “invisible hand”, but by many actors who can of course differ in strength and infuence and who may have diverging interests. The concept of imaginary organisations points at extensive collaboration between different parties. But like the concept enterprise it stands for an image of a controlled business, where someone stands for overarching vision and is responsible for the coordination of the collaboration—an image that is increasingly less realistic. The originators of the concept of imaginary organisation talked of an “imaginator” in a “lead enterprise” who tries to infuence other actors according to his own imagination, but obviously there may be other actors who simultaneously are trying to shape markets in accordance with theirs (Hedberg et al., 1997). Moore (1993) termed such directed constellations (mature) business ecosystems, and claimed that in complex, emerging market situations, leaders orchestrating the undirected interactions will emerge, and that unless they do, the business ecosystem will die. This is in contrast both with our observations and our concept business ecologies. Google is an important actor in the Android ecology, but it does not control Samsung, HTC or other smartphone manufacturers, the hundreds of thousands of app developers, all the large and small entertainment groups whose music and flm contribute to the demand for smartphones, all the network operators and local Wi-Fi owners who are a prerequisite for accessing content and communication, all the advertisers who fnd an interesting market for ads among the Android users, or all the users who through their choices and communication among each other contribute to shape the development of the Android ecology. Also clearly, Google does not control Apple or Microsoft, who through their choices and actions—and their image—act as role models, counter-images, inspiration and threats to the Android ecology. Rather, the ecology as we see it, is a term for a dynamic interaction between a host of small and large actors, who through collaboration and competition, from different motives and goals, give rise to economic activity. Certainly, there are more durable, formalised collaborations and partnerships in an ecology, of the kind that the organisational network theory emphasises, or that many writers employing terms such as business ecosystem, innovation ecosystem or platform ecosystem focus on (see e.g. Adner, 2017; Jacobides et al., 2018), but such more organised and more tightly knit formations only form part of the ecology of dynamic
Theory and Conceptual Models
interactions and possible infuences. That which, as viewed from each actor, seems emerging, changing, opportunity-based and uncontrolled is such an important part of our contemporary economy that we strongly recommend everyone to try to form an idea of what the ecology looks like that is relevant to them. Next, we will provide examples of types of actors and aspects that can be worth identifying and including in the considered ecology view. Business ecologies thus consist of collaborating and competing actors in far more than one step. Only if we take a very narrow view will the business ecology have a certain actor in focus, like the imaginary organisation (Hedberg et al., 1997), the network (Håkansson, 1982) or the value constellation (Normann and Ramírez, 1993). But with such a restricted view, the risk of over-emphasising this central actor and its power is great, and the wider outlook that the ecology view could contribute is lost. The ecology view emphasises the value of looking far beyond the well-known vicinity to be able to understand the larger context of which the organisation or business idea is a part. These contexts consist of far more than just immediate business partners. The ecology view we propose includes existing and potential competitors, existing and potential second- and thirdorder business partners and beyond. It should include other enterprises which in different ways may come to act as role models or counter-images. In addition, other types of actors, such as authorities, standardisation organisations, mass media and special-interest organisations, can play important roles. Such actors and infuences are not typically included in the more narrow, value-proposition-centred business ecosystem concept championed by Adner (2017) and business, innovation and platform ecosystems concepts identifed by Jacobides et al. (2018). And unlike Moore (1993), Adner (2017) and Jacobides et al. (2018), we do not see that the potential of bringing the ecological metaphor into the management and strategy feld is utilised if only restricting it to constellations so close to those captured with alternative, pre-existing terms in the feld, like value chain, value constellation, imaginary organisation and industrial network. Business ecologies are ways of viewing the surroundings; they do not “exist”, “correctly defned”, “out there”. We choose what we want to view as an ecology—with wider or more narrow delimitations. Making meaningful delimitations is a natural part of a strategic grip on an enterprise, but the ecology view that we propose encourages us to consider a wider perspective, at least at some stage of the analysis. If we choose to look at a business ecology just based on a central actor or platform (the Apple ecology, the Walmart ecology, the Android ecology), a number of the actors will simultaneously belong to other ecologies not included in our view. There is then, probably, a useful “higher” systems level to study that can give additional insights (the smartphone ecology, the retail market ecology, the telecom ecology). At the same time, a higher systems level will provide a coarser depiction (given the same amount of descriptive
effort), so it can also be valuable to additionally focus on a lower level such as a product, a business unit or an enterprise in its business-ecology context. In contrast to the value chain, which emphasises the fxed and linear fow from supplier to end customer, the ecology concept emphasises the development over time; business groups grow and shrink, enter and disappear, connections are made and broken, new constellations arise. Snapshots of a business ecology can give a feeling of a value chain or a value star, but we know that the depicted pattern will change in the shorter or longer term. This also goes for the price models in use. The price models we employ should therefore be designed with an awareness of what is happening elsewhere in a somewhat wider ecology, since the price models—and the cost structures they build on and contribute to developing—directly infuence the contracting partners. If customers have become used to a fxed monthly fee for local transportation, it is not unthinkable that they will request the same for telephony or for access to music, and that some supplier will then start to offer this. Or if “pay what you want” (see Chapter 4) seems to work for recorded music, a developer of watches, measuring instruments or computer games could get the idea to test it as a potentially attractive part of their price model, and perhaps even make it a cornerstone of their business model. The view of an industry is unlikely to be constant across an entire ecology, just as the views of the relevant industry will differ when moving along a value chain or in a value system, where different actors normally see themselves as belonging in different industries. This will also make the business ecology we choose to delimit differ in importance to different actors. To some, it may be the central environment; to others, just a peripheral feld of action. By trying to picture a business ecology in which we operate, we can get an idea about which business models seem to exist there, which price models seem to be applied, and if we can have a better chance of playing an important role or be valued higher by others by presenting our efforts in terms that match strong groups of actors (and the price models they seem to prefer). We can, for example, want to take a closer look at what end customers really buy and are willing to pay for, or what a dominant actor actually offers and charges for, and how. We can also try to identify potentially growing niches and subpopulations and assess if they can directly affect what we do, or which alliances we want to build or dismantle. The computer manufacturer Apple came to identify the market for portable, fle-based music as a growth area where their design and computer competence could serve as strengths, but where such an ecology then would naturally encompass the music industry. For that reason, collaboration—or at least compatibility—with the large music companies and their price models (and, because of their price models, a fear of piracy) would be necessary.
Theory and Conceptual Models
Business-Ecology Examples Now, let us move on to examples of how the business-ecology concept can be used to understand ecologies at varying levels, more restricted or lower as well as wider or higher. Three of the examples1 take their starting points in high-profle, newer companies, with different ambitions regarding ruletaking and rule-changing in their environments. These are: • • •
Minecraft and the Internet-based game ecology Skype and the communication ecology Spotify and the music ecology
The following example instead starts at an industry level: •
The car industry and Valeo and Aixam Mega
and investigates two traditional actors following different paths. The fnal example illustrates the spread of business concepts across industries, including traditional ones: •
The dissemination of business concepts—the example functional rental
Digitisation has had an infuence in all the examples. In some, it is the very foundation for the transformations taking place. In others, it infuences the range and nature of value propositions, even when the products offered build on physical goods. The range of examples illustrates how the starting point of a business-ecology analysis can differ depending on the purpose of the analysis. Minecraft and the Internet-Based Game Ecology Markus “Notch” Persson developed a program making it possible for players to build things virtually, based on simple components. He realised that he could launch this as a game, Minecraft, that people would be willing to pay for, and where the users’ ideas could contribute to developing— and marketing—the game. His enterprise Mojang sold tens of millions of copies of the game from the start in 2009 to 2014, when Microsoft bought the enterprise for 2.5 billion USD. Now, in 2019, the game has sold 176 million copies. Notch and Mojang certainly became central actors in the Internet-connected game ecology, where infrastructure such as the Internet, computers and operating systems are prerequisites, and where social media, like YouTube, contribute to develop the use of the game, create communities around it, and connect it to a video ecology. “Let’s play” videos—recordings of someone playing in a Minecraft environment of their own design—can have millions of views. In September 2013, a
year before Microsoft bought the game, a YouTube search provided more than 35 million hits for Minecraft, and a number of these videos had been viewed more than 10 million times. Minecraft as a tool for making music videos—and as a style for music video design—resulted in videos with more than 60 million views in a year, according to YouTube statistics, and top videos would link to sites where the music could be bought for a dollar. Another development was attempts to harness the energy and enthusiasm going into playing and engaging with Minecraft. The Finnish teacher Santeri Koivisto and the company Teachergaming were quick to identify Minecraft as an attractive component in the teaching-material ecology. Mojang was quick to pick this up, creating the brand MinecraftEdu, and now it has a Minecraft Education edition of the game. It would be possible to view a Minecraft ecology, which also includes clothes and other merchandise with Minecraft design—developed by smaller and larger actors (to whom Minecraft plays a larger or smaller role) and sold to customers by the normal retail price model of price per unit and complete rights to the purchased goods. The game has been sold to end users at a fxed price per unit and with full rights to use the copy bought forever. Class sets of the game were available at discount rates. Increasingly, Minecraft, like other software, is becoming a service rented for a certain period of time, and it can even be part of packages. As implied by these examples, there are also license fees to Mojang for the use of the brand on accessories; Google receives ad revenue from the activity that has been generated on YouTube; music and video developers can gain fame and possible sales revenue from entertainment products where Minecraft plays a role; computer manufacturers, Internet operators, etc. beneft from the Minecraft ecology since it contributes to the demand for their products, even when it is not the only and direct reason for their sales of goods and services. As a small actor, Mojang and other Minecraft-related actors have mainly chosen to apply the price models that are current in their environment, but Notch himself has recurrently chosen to contribute to product development of other products out of pure interest, for public recognition of the name of the donor, which can provide status in certain circles, or on a promise of receiving future products or services. The perspective the Minecraft ecology can provide a level of detail that helps interpreting the present, but to be able to discern more of the phenomena that could shape the future of Mojang, it could be valuable to also try perspectives like the Internet-connected game ecology or the education ecology. Skype and the Communication Ecology One example of how ecologies may transform is telephony, which, after having taken over from telegraphy, came to be the dominating form of instant communication at a distance. Actors included operators—often as
Theory and Conceptual Models
government agencies—owning and operating national networks connecting end customers; sea-cable companies tying continents together; equipment manufacturers supplying operators and sea-cable companies with telephony-specifc equipment and individuals and customer companies with telephones and company switchboards; and standardisation organisations contributing to development and application of international standards for telephony. But there were also actors who did not primarily have a telephony focus who contributed with, for example, construction work and electricity production. There were governmental actors who regulated and monitored communication and economic conditions, etc. The general development of computers and computer use in society came to inspire industry actors to computerise telephony, and increasingly, the development of general computer networks and, in due time, the Internet, offering alternative channels for instantaneous communication at a distance. The combination of technical development and deregulation has led to increasingly close connections between the computer-network world and the world of telephony, leading to the use of the term ICT—information and communication technology—where the perspective is that the previously separate telephony- and computer-communication ecologies now fruitfully can be viewed as a global communication ecology. In this ecology, actors like Skype have spurred the convergence, initially by offering an Internet-based telephony alternative for price-sensitive customers, enabling both pure computer-to-computer calls, and from computer to telephone and vice versa, based on a new technical solution and a for the industry revolutionary price model (a service that is free to use in its basic version and where users pay according to a price list only for possible additional services, typically at a volume-dependent rate). With growing success, Skype has itself become an operator with substantial network investments; the company became a direct customer of suppliers of telephony and computer network equipment and collaborated with operators and cable companies to enable a service quality that satisfes the increasing number of customers, who raise increasing demands for service quality—in step with Skype being used as a central communication alternative, and with the alternatives to Skype also developing in technical quality, convenience and pricing. Clearly, Skype came to be an actor that operators and other actors started to watch and act with and against. When in 2011 it was bought by Microsoft, Skype handled a substantial portion of international telephony, and was therefore one of the actors shaping the further development of the ecology, both technically and commercially. Spotify and Developments in the Music Ecology Another actor who has had price models as an important part of its attempts at developing a niche and reshaping an ecology is the music service Spotify. In this ecology, classical and new retailers used a range
of business models, like record stores and iTunes, who sold singles and albums at a fxed list price; classical and Internet-based radio channels, who sent music according to by users unalterable program schedules (linear supply), but fnanced themselves via e.g. ad revenue, and paying license fees according to set price lists to content owners; or fle sharing, where individuals shared the songs they had access to, without charging the recipients or paying originators or content owners for the dissemination. In contrast to all of them, Spotify chose to make a very large music library from a large number of record companies available to the public on a subscription basis, where the users could browse and select from the supply at will. Most of the users chose an ad-fnanced version without user fee, while a smaller portion of the users chose a version with a monthly subscription fee, and therefore no ads. The Spotify management has recurrently changed the terms for the different versions to get users to migrate to the for-pay versions. Spotify also pays license fees to the content owners based on a Spotifydesigned price model with a set share of Spotify’s revenues divided according to the users’ music choices. That which has been listened to a lot gets a larger share. That which has not been listened to at all gets no license money for just being available. Even though the amount per listening is very small, the number of listenings can be very large, and at an aggregate level Spotify and similar actors now provide sizable revenue streams to the content owners. The reactions among the content owners have varied, from viewing the level of the license fees as too low in comparison with other sales channels, to considering it better to get paid a little rather than not at all, as with private fle sharing, and on to seeing this as a viable business model in a digitised world. The desktop-app users also contributed with computer and communication resources by becoming part of the Spotify peer-to-peer network. In 2012, less than 10% of the downloads were estimated to come from Spotify’s own servers. However, with the rise of smartphone use and increased general network capacity, together with the continued growth of Spotify and its server capacity, this practice, which was an important part of a cost-effcient and fast delivery model in the early years, had lost its importance and was discontinued in 2014. Since then, users access music from Spotify’s servers. By now, Spotify and similar music services have demonstrated that the music ecology has room for actors who use the Internet world’s affordances with distributed solutions, individual freedom of choice and the combination of revenue streams (like ads and subscription fees) for commercial distribution of music. For a number of years, the reactions among record companies, song writers and artists were mixed, ranging from the sceptic or even hostile, to the enthusiastically embracing ones. Sweden was the frst country where this business model really became a substantial part of the ecology and accepted as a promising way forward
Theory and Conceptual Models
by a record company. Now, although the debate has by no means disappeared, this type of streaming is clearly established and widely accepted, and the record companies’ international organisation IFPI reports that as of 2018, it accounts for almost half of the recording industry’s 19 billion USD revenues and is expected to continue growing. But what is the role of a mediating actor like Spotify to record companies and originators? Is it a form of advertising, of making one’s songs known and available? Is it a major source of revenue? Is it a threat to previously established business and price models? Is it a powerful blackmailer? Whatever the view of them, these actors are part of a profound change in the ecology. And this change does not only affect record companies and originators. Of course, it affects—and is affected by—music actors like record retailers, radio channels, tour promoters and concert organisers. Among actors outside the traditional music world, Spotify’s business model has offered a type of content delivery that has led to alliances with telecom operators (like Telia, Vodaphone and AT&T, to include Spotify in some mobile packages in hopes of increasing use of their products and offering an additional sales channel to Spotify) and with Facebook, where the social network aspects of both services are expected to be of mutual beneft. To further understand Spotify’s position and possibilities, it is also important to look at other actors, like smartphone and computer manufacturers, to whose customers and users Spotify service can be important. Samsung and Spotify are strategic partners, not only including Spotify as a pre-installed service on devices, but also making certain that Spotify works well on Samsung’s virtual assistant Bixby—important to both companies. Lawmakers and judicial systems work in the feld of tension between record companies and other parties and handle—and modify— the legal side of copyright and intellectual property. It is thus a large and diverse set of actors who could be useful to include in an analysis of the business ecology that Spotify works in, is affected by and affects. The Car Industry From a Business-Ecology Perspective That ecology perspectives can differ between Minecraft, Skype and Spotify is hardly surprising, even if they all have software as a central part of their products and the Internet or telecom as a requirement for reaching their customers. But imagine you had analysed these frms from a classical industry perspective: as software frms. Much of what we brought up in the previous discussion would have been invisible. On the other hand, other observers—for instance management of the frms involved—may well have other perspectives and interpretations of the ecosystems where they are involved. And these will lead to other predictions and actions than those you or we may draw from the last few pages. But the perspectives can also be markedly different between more closely related actors. Let us study examples from a more traditional
manufacturing industry: cars. Economies of scale in development, manufacturing and marketing have led to a constant consolidation of car manufacturers over most of the past hundred years. Even among the suppliers, there has been a demand from the increasingly large car manufacturers for large suppliers, and a striving among suppliers for size that can provide negotiating power. A consortium of car manufacturers created COVISINT at the turn of the millennium as an e-business platform where they, after contract negotiations regarding functionality and contract terms, could place requests for proposals, having suppliers compete on price level. The French Valeo is a supplier with a start in brake linings and clutches almost 100 years ago and then gradual internationalisation and diversifcation into other types of components. In order to keep its manufacturing in France, Valeo developed a specialisation in components leading to energy effciency for cars with combustion engines. That focus, with continuous improvement of the properties of the components, can provide differentiation that reduces the pricing pressure that suppliers in general are subject to but still demands considerable knowledge regarding one’s own development and manufacturing capabilities and the cost structure resulting from them. The business ecology relevant to Valeo would include not only the car industry, with Valeo’s customers, competitors and suppliers. The focus on energy effciency also builds on positions taken by the general public and politicians in energy issues and seeks support from actors like transport agencies and driving schools with fuel-effcient driving on their agenda. In recent years, the trend from combustion engines towards electric vehicles has led Valeo to widen its scope from combustion engines and transmission trains to energy effciency and CO2 reduction also for electric cars, and to build business areas in driver-assisting technology and other growth areas. This has made Valeo face new competition, having software and sensors as increasingly important parts of the products, and to purchase other actors to grow and diversify—and then also become more international in production. The general trend towards larger actors in the car industry is sometimes countered in segments not vigorously pursued by larger actors. The small, French actor Aixam Mega has been producing microcars for more than 40 years with a total production over these years approaching 300,000 units. Aixam Mega especially focuses on microcars so small and with such restricted power and speed that they can be driven without a driving license in many European countries. This segment so far offers less (global) competition and thus better chances for proftable survival for small actors than the classical car segments. The idea is, like in the Valeo case, to reduce the energy consumption of drivers, but here by offering very small cars. The idea is also to reach other segments than the traditional car drivers by offering cars that do not require a driving license. The focus on small cars for short distances makes electrically powered vehicles an increasingly attractive alternative to combustion-engine
Theory and Conceptual Models
versions, and Aixam Mega launched its frst electric microcar in 2013. Electrifcation makes access to charging facilities an important aspect, and complete electrifcation of the range would make collaboration with fuel actors and petroleum-proponents obsolete. For Aixam Mega, just like for Valeo, the general public and the politicians are important to include in the business ecology in which they try to act, and views and values regarding types of energy, environment and climate are important. But these two automotive actors will make different choices, and which actors that appear as important to follow, collaborate with or avoid will therefore also differ between them. So far, the price models towards Aixam customers build on the sale of cars and then of service via dealers and garages. For customers fnding the purchase price diffcult to raise for liquidity reasons, there is collaboration with a fnancial partner offering loans. The trend towards cars-as-service is so far restricted to a collaboration with Rent A Car for short-term rental. However, stringent European CO2emission regulation also affects the large and powerful actors. The French group PSA has bought a controlling share in Aixam Mega, and if the merger between the Italian Fiat Chrysler group and PSA that their boards now champion is completed, the selection and importance of actors in the business-ecology view relevant to Aixam Mega will again change. The Dissemination of Business Concepts—The Example Functional Rental A fnal example of business-ecology dynamics with consequences for price models is the spread of business concepts which can move across industry borders. Let us take a look at functional rental—the move from selling a machine (airplane engine, forklift truck, printer) to retaining the ownership of it but selling its functionality (functioning engine power, specifed access to forklift-truck lifting capacity, ability to print). When a company moves from selling the goods to selling the service the product is designed to supply, risk sharing and responsibilities between buyer and seller change. Life-cycle costs for the equipment tangibly become the supplier’s concern rather than mainly being the buyer’s. The supplier incurs increased service and maintenance costs for heavy wear instead of good demand for servicing of the equipment. At the same time, the supplier can reap effciencies of scale in employing the feet of machines in a manner not obtainable even by large customers. The transition from product sales to functional rental overturns the cashfows of the companies. The customer pays a periodic subscription fee, instead of paying a substantial sum when buying the machine, and thereafter recurrently paying for service. It will therefore be essential to create a price model that provides the supplier with incentives for keeping the promised level of functionality and availability, while simultaneously encouraging the customer to use the machine carefully. Such a price
model can create a need for possibilities to measure the use, for example acceleration and braking, minor collisions, etc., for each driver of each truck, providing the supplier the possibility to determine if it is handling or construction that leads to need for service, and to accurately predict the need for service. In turn, such monitoring can provide the customer with a basis for assessing the need for training among the employees, which can lead to better adaption between supply and demand for driver training. Here, the transition of responsibility for functionality during the product’s life that the move to functional rental brings primarily affects the core of the business ecology: which actors offer what. But there is a wider businessecology aspect here. Certainly, your introduction of functional rental, as supplier, can depend on what your contract partners or your or their competitors do. But the service-rental model can also spread by analogy from an entirely different industry, as it clearly has in many cases of functional rental, just-in-time deliveries, “free” concepts, etc. Googling for “like a Spotify for” and similar googlings provides tens of thousands of hits. They could be “It’s like Spotify for live music”, for coffee, for transportation, for cars, for scientifc texts, etc., referring to a free choice from an aggregated supply at a fat monthly subscription fee. Netfix, with a similar concept in flm and series, is also used as a description of a business concept and extends the list of products to apply it to with Lego, spectacles, stock images, electricity, and more. Also common among the hits are those that specifcally refer to the recommendations feature—to sell the service of creating suggestions for interesting food, plays, travels, books, fashion, relations and so on, based on your previous choices and the knowledge of available alternatives. These types of dependencies—that goods or service structures remind of each other across industry borders and can lead to inspiration and change—can be identifed by creative and wide business-ecology analysis looking far and wide for possibly travelling ideas: a somewhat different type of analysis than the earlier examples in the chapter illustrate.
Implications This chapter illustrates how an ecology is an example of a systems viewpoint: to be of practical use as a tool for strategic thinking and, as we argue in this book, developing business models and price models, its delimitations and granularity have to be chosen according to perceived relevance for the purpose of the analysis. So how may you act in order to establish a useful business-ecology image? Here are some issues to refect on when doing so: •
Defne an appropriate business ecology for the goods, service or organisational unit in question. The core will be the dynamic system of actors who make agreements and deliver goods and services to each other. But do not forget to also try to identify possibly relevant
Theory and Conceptual Models actors who in other ways affect or are affected by the products in question or affect or are affected by the core actors. Which collaborating and competing actors can be discerned in the defned ecology? They could, for example, be customers, suppliers, competitors, suppliers to suppliers, rule makers (for example municipalities or trade associations) and so on. Which price models are we employing in our relations, and which price models are other actors using? • How similar are our price models compared to other actors’? • Do we want to adapt to or differentiate from other existing price models? What ideas do we have regarding business-ecology dynamics over time? • Which actors are growing stronger or weaker? • Are the collaboration patterns changing over time? Are actors changing roles? • Are types of actors appearing or disappearing? How well equipped are we to handle the changes we can foresee, sense or imagine?
As this bullet list highlights and as can be seen from the examples, the snapshot image of a business ecology will contain components that are known from value-chain or value-star views (see Table 2.1). It is natural for those who want to consider a relevant business ecology for their organisation to include suppliers (in many steps) and customers (in all steps on to the end customers). It will also be natural to include existing competitors and to explore whether there are any reasonable substitutes that can give rise to new competitors. Different distributors and Table 2.1 Typical actors in a business ecology Suppliers (in many steps) Customers (in all steps up to the end customers) Distributors and intermediaries Existing competitors Reasonable substitutes that can give rise to competitors Financers and alternative sources of fnancing Standardisation organisations Authorities, agencies and regulating organisations Politicians, opinion leaders The general public Consultants and concept purveyors
intermediaries will also normally be included, as may fnancers and alternative sources of fnancing. But an ecology analysis does not stop there. Inspired by the telecom and music examples, we can also see how standardisation organisations, authorities, agencies and regulating organisations—not least transnational ones—as well as politicians, opinion leaders and the general public, can be relevant to include. Furthermore, consultants and other actors who shape and market ideas that can travel between industries tend to play important roles in the ecology, not just at present, but also for the impulses that may come to change it. Like the functional rental example illustrates, some deliberation regarding types of enterprises and products that in character remind of one’s own, without being competing or substitutes, can also provide inspiration to possible changes or early warnings about pending changes. After having identifed a reasonable set of actors, it is time to chart how they interact. For those who have business relationships, the charting should include which payment streams move between which actors and which price models underlie these streams. If the price models by any chance are similar within a more narrowly defned business ecology—all the way to the end customer—it could be worth adopting a wider view to determine whether there are any interesting business and price models to be inspired by, or business and price models that are becoming popular elsewhere and may therefore come to spread also to the more narrowly defned ecology. If the price models in the business ecology are instead varied—which is more probable—there is reason to ask oneself if the price models one employs towards suppliers and customers are the most appropriate or desirable, or if there is reason to try to adopt other forms that exist in the identifed vicinity. Before analysing how the price models interact with the business ecology in which one operates, it is necessary to also clarify what the real business is. How can value be created through own actions and relations with other actors in the business ecology, and what value can be captured to make the business sustainable? A method for doing this is to identify one’s business models and those of other signifcant actors. This is the topic of the next chapter.
Note 1. The examples are based on publically available material—from websites, news releases, newspaper articles collected over time, on company presentations at conferences and on informal communication with company employees.
References Adner, Ron (2017). Ecosystem as structure: An actionable construct for strategy, Journal of Management, 43(1), pp. 39–58.
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Håkansson, Håkan (1982). International Marketing and Purchasing of Industrial Goods: An Interaction Approach (Chichester: Wiley). Hedberg, Bo; Dahlgren, Göran; Hansson, Jörgen & Olve, Nils-Göran (1997). Virtual Organizations and Beyond: Discover Imaginary Systems (Chichester: Wiley). Jacobides, Michael G.; Cennamo, Carmelo & Gawer, Annabelle (2018). Towards a theory of ecosystems, Strategic Management Journal, 39(8), pp. 2255–2276. Moore, James F. (1993). Predators and prey: A new ecology of competition, Harvard Business Review, 71(3), pp. 75–86. Nalebuff, Barry & Brandenburger, Adam (1996). Co-Opetition: A Revolution Mindset That Combines Competition and Co-Operation: The Game Theory Strategy That’s Changing the Game of Business (New York: Crown Business). Normann, Richard & Ramírez, Rafael (1993). From value chain to value constellation: Designing interactive strategy, Harvard Business Review, 71(4), pp. 65–77. Shapiro, Carl & Varian, Hal R. (1999). Information Rules: A Strategic Guide to the Network Economy (Boston, MA: Harvard Business School Press).
Introduction A fundamental aspect regarding price models is that they are not standalone. As we have highlighted in the previous chapters, they are an integral part of a triad that consists also of business ecologies and business models. The business ecology is a concept for business environment analysis where actors are identifed and their direct and indirect relations analysed. In addition to the frm that is in focus for this analysis (often the frm that undertakes it), other actors to identify are for example, different types of competitors, customers, suppliers and co-creators. The use of the term ecology indicates that it represents a dynamic view of this system, that the borders of the ecology may not be obvious and that the importance and infuence of its actors may change across time. It is in such a business ecology that organisations are to create and capture value. Starting from the focal frm, this may involve interacting with all other actors, suppliers and co-creators as well as customers. The answer to how this is done— currently or in an imagined future—is provided by its business model. This chapter is about the concept of business models. In the next section, we defne the concept and provide background by connecting it to value creation and value capture. We address what may be a relevant formal description of business models. Finally, the chapter also presents how price models can be seen as an extension of business models and why an analysis of price models is essential for the value creation and value capture activities of a business model. Price models are then the subject for the next chapter, Chapter 4.
A Defnition of the Business Model Concept Business model is a concept that has gained increased interest in business and research communities during the last decades (Nielsen et al., 2019; Zott et al., 2011). However, there is still a lack of a mutual agreement on how it can be defned and what it contains or represents (see e.g. Massa et al., 2017). Over the years, there has also been an ongoing debate
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about the relationship between the concepts of business models and business strategy. In this debate, both sceptics and advocates have presented various arguments. Sceptics suggest that the business model concept is just old wine in a new bottle. They believe that the concept adds limited new knowledge to our understanding of business strategy. The business model concept, they claim, does not build on any new theories beyond established ones, such as strategic positioning or the resource-based view. According to the well-recognised strategy researcher Michael Porter (2001), the defnition of a business model refers to a “loose” conception of how a company does business and generates revenue and can even be an invitation for bias and faulty thinking. Advocates of the business model concept admit to an overlap with theories on strategy but at the same time argue that it offers a more holistic perspective compared to stand-alone strategy theories (Gibe and Kalling, 2019). They suggest that business model and strategy are distinct constructs and that the business model concept allows asking (and, let us hope, answering) questions that historically have been overlooked in strategy theories. For example, such theories often focus on sellers facing markets where value-creation opportunities are assumed to be given exogenously. A single actor or a group of actors cannot by themselves infuence or decide what value can be created, as it is given by the equilibrium between supply and demand for goods or services which have already been defned. If value exists, then payment will take place almost automatically, and the size of a market is often already given. In contrast to such a claim, the business model concept acknowledges that it is far from clear what type of value actually is being delivered to customers, how this corresponds to aspects within the organisation and how the customer in the end pays for it. Therefore, and in extension, its advocates argue that the business model concept can help answer questions about how to monetise and capture value from customers through single or multiple revenue streams. It may also enable value creation through re-inventing current markets and creating new ones, especially as economies embrace digitalisation (Casadesus-Masanell and Zhu, 2013). In addition, the concept acknowledges that value is not only created by producers, but also in the relationship with customers and other actors within a business ecology. We concur with such arguments and in this book accordingly view the business model concept as a map or blueprint for how an organisation can create and capture value in a business ecology—and by doing so become successful and sustainable in the long run. A viable business model, we propose, leverages the capabilities of a core actor by building and exploiting relations with other actors in the perceived ecology in such a way that over time all actors experience their joint value creation as benefcial. If instead some of the involved actors feel exploited, the long-term viability of the business model will be threatened.
As noted in the previous chapter, frms may operate within a few narrowly defned ecologies or business areas, and then there may also be synergies between the business models they adopt in doing so. Taking a wider ecology perspective encompassing two or more of such narrowly defned ecologies can be helpful in detecting such synergies—or threats to one or more of the business models. Much of the discussion in this book, like business model discourse in general, starts out from the perspective of some core organisation, although a business model also involves other actors in a perceived business ecology. With those selected as partners in a business model, the core organisation will maintain closer links (exchange of information, shared systems, longer-term contracts) than with, for example, subcontractors and customers with whom contacts are more transitory and casual. This rests upon the requirement that long-run and short-run value capture for everyone is acceptable and meets the long-run goals of key actors (compared to other alternatives that they can engage in). Price models between actors in an ecology thus may be essential for its success, and in later chapters we discuss their role not just when selling to customers— “outbound” pricing—but also between actors who are co-creating value in a joint business model, where price models defne both their revenues and costs. We will refer to the price models used in buying components or services as “inbound” pricing and draw parallels between pricing between partners in a shared business model and how transfer pricing is an important part of management control inside large corporations. Still, in the context of this book, the business model constitutes the conscious choice of how an organisation navigates or intends to navigate within its business ecology. To fully understand not only how value is created but most of all captured, it is essential also to identify the price models. In business model research, this is an often neglected issue (although some researchers tend to address price models as revenue models, see e.g. Wirtz et al., 2015). We will come back to price models in the next chapter. Let us now frst address and discuss three perspectives of the business model concept. Three Perspectives of Business Models Concept What constitutes the content of a business model depends on which perspective we apply. In an extensive review of business model research by Massa et al. (2017), they identify three recurrent perspectives: business models as an attribute of an organisation, business models as a cognitive or lingustic schema and business models as a formal conceptual description. Business models as an attribute of an organisation describes how a frm’s business activities are perceived by others from outside of the organisation. The main focus from this outside-in perspective is on identifying attributes that enable value creation and value capture (Chesbrough, 2010). These attributes can be activities, and the identifcation of them comprises who in the organisation performs the activities, how
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the activities are performed, when they are performed, where they are performed and at what level and the resources necessary to perform them (Dahan et al., 2010). In this perspective, there is a risk that individuals in one organisation who interact with individuals in another organisation hold different images of which attributes are representative for the organisation they interact with. For example, a salesperson interacts with a procurement department at another organisation. This salesperson may experience frst-hand that the other organisation’s business model is dominated by activities performed at the procurement department. Later on, a service technician interacts with the same organisation, as a result of the product sold by the salesperson. The service technician will then probably interact with other departments and individuals than the salesperson did, something that in turn will infuence the service technician’s perception. The latter may then develop a view of the business model that differs from the perception of the salesperson. On an operational level, such differences in perception may or may not prove important. But if management on a strategic level does not share the same idea of the attributes, there is a risk that analysis and decisions regarding e.g. partnership with another organisation is based on misconceptions and incoherent images of it. This will in turn infuence how well this partnership contributes to value creation. When business model has become a popular term in media, it largely is this usage—observers outside an organisation arriving at more or less well-founded ideas about how it operates—which we observe. It may spread and become part of the beliefs also by others in an industry, fnancial markets etc. Business models as a cognitive or linguistic schema describes how organisational members interpret the way their frm does business. In this inside-out perspective, organisational members do not hold real organisational systems in their minds when making decisions regarding business activities. Instead, they hold images of organisational systems that are shaped by their own cognitive frames (Doz and Kosonen, 2010). Depending on the character of the individual image of the system, there is a risk that e.g. managers are less prone to respond quickly to disruptive technologies and market changes (Velu and Stiles, 2013). There are several historical examples of such notions; Nokia is one. It had a dominant position in the business ecology of mobile phones until 2007, when the frst modern smartphone was introduced. Too late it managed to change its business model accordingly, and in 2013 it made an exit from the mobile phone business (although it has continued to develop and deliver radio systems for mobile communication). When the term business model is used inside organisations or by spokespersons of an organisation talking about “our organisation model”, it is therefore important to verify that it is not just wishful thinking but rooted in actual capabilities and investments for the future.
Business models as a formal conceptual description refers to symbolic, mathematical or graphical descriptions of the organisation. The purpose of this third perspective is to visualise and illustrate the attributes from the frst perspective or the cognitive schemas from the second. When doing so, it may enable observers from outside and inside an organisation to conduct an analysis of the business model. Hereby, the formal description also functions as a bridge and boundary object between the outside and inside observers of a business model. There can be differences in the formal representation, depending on the level of abstraction and the content (i.e. what is formally described or represented and what is omitted). Often, business model visualisation includes an organisation’s value proposition, fnancial model, customer interface and relationship, partner network and roles, internal infrastructure and connected activities and target markets (Baden-Fuller and Haefiger, 2013; Casadesus-Masanell and Ricart, 2010; Wirtz et al., 2015). This third perspective has during the last decade become quite dominant in analysis regarding business model content. It should make it possible to inspect and verify. However, the level and character of graphic depiction may vary widely, emphasising rather different aspects of the business (Havemo, 2018). If the business model is articulated in text or graphics, it can also become shared by partners and others who have an impact on its implementation. One of the most popular and wellknown formal conceptual descriptions is the business model canvas (see e.g. Osterwalder et al., 2014, 2010), but there are also others in use. What seems to have attracted several frms we have worked with to Osterwalder et al.’s admittedly highly simplifed representation of a business model is probably that it highlights business models as ideas for collaborating. Outsourcing and “stick to the knitting” have been frequently practiced mantras in many industries in the last few decades, not least linked to digitisation of data and digitisation-dependent business offerings. They lead to a need to clarify joint value creation, capture and sharing among partners who are jointly following a business model relying on a division of functions between partners. Our interest in price models places the focus on the relations between frms and other actors who create value jointly. When price models are used to articulate such relations, business models should provide the strategic ideas behind what kind of relations are desired. We would go so far as to claim that a business model only is practiced in real-life if roles and incentives have been clarifed in this way. We need to add a few words about this fnal point: whether a business model exists or can be just an untried blueprint. According to Massa et al. (2017), whose views we summarised earlier, “business model” may refer to something which an observer believes exists, and it may be real in the sense that processes, agreements and offerings can be verifed. But it may also be an idea for a new venture—the blueprint we already mentioned. In that capacity, it may start as some entrepreneur’s imagination about
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a future business and as yet exist only as a mental construct. This also means that proof of a business model’s viability or lack of success will not be available until later. And, like strategies, business models can be hard to disprove; conditions may have been wrong or the business models could have succeeded with wiser management (for instance, more appropriate price models). Also like when crafting strategies, we believe in evidencebased dialogues among collaborators inside and outside a frm to decide jointly how value creation and value capture are expected to be (Cöster et al., 2016). This is why Massa et al.’s third perspective, business models as conceptual descriptions, will dominate our continued discussion. Further on in this chapter (and the rest of the book) we will therefore discuss and identify fundamental attributes that can constitute a formal description of a business model.
A Formal Description of Business Models Figure 3.1 is a compilation of components that often recur in formal descriptions of generic business models (see e.g. Al-Debi et al., 2008; Casadesus-Masanell and Ricart, 2010; Gibe and Kalling, 2019; Osterwalder et al., 2005) and therefore can be seen as representative of the third perspective, described in the earlier section. Initially in this section, a short description of Figure 3.1 is presented, followed by more extensive explanations of each part with emphasis on how they may be infuenced by digitisation. The core organisation is represented by the square composed of four felds and a circle. The dashed circle that surrounds the square represents the part of the business ecology where the most signifcant foreground actors are active. These are the actors that the organisation tends to interact more directly with, namely customers, partners and subcontractors. The actors outside the dashed circle are considered as background actors; that is, they infuence the core organisation’s ecology, but the core organisation is less prone to interact with them directly. Examples of background actors are rule makers (or legislators), opinion makers, fnanciers, users, industry associations, competitors and fnal customers. Some of the background actors can periodically become foreground players, represented in Figure 3.1 by fnanciers (such as banks and venture capital frms) and industry associations. In the center of Figure 3.1 lies the very core of the business model: the Value proposition. In order to create value, the organisation should carry out certain activities and use certain resources. These activities and resources may be more or less dependent on partners and subcontractors. But partners and subcontractors are not the only ones the organisation may be dependent on when it comes to value creation. For example, in digitised business models it is also common that customers become
Figure 3.1 Illustration of business model components
part of the value creation. This is the case when it comes to the business model of social media platforms such as Youtube and Facebook, where the customer segments are a fundamental component for value creation. If no one posted and commented on updates on such platforms, the value would not be created because these platforms would not have any content to offer customers who want to advertise. As mentioned in the introduction of this chapter, business models should not only address how value is created but also captured. Just as the core organisation’s control over value creation may have its centre of gravity on the left side of Figure 3.1, its value capture may focus on the right side. Value capture happens when different customer segments are offered a value proposition and are willing to make a fnancial sacrifce in order to take part of it. In this context, organisations have to decide what kind of relations they want to have with their different customer
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segments, but also how the value may be distributed to them through various customer channels. For the aforementioned social media platforms, the Internet is the exclusive distribution channel, and it is necessary that customers can access the platforms through various devices (tablets, computers, smartphones, etc.). In turn, the distribution channel infuences how customer relations are constructed and developed. If the Internet is the only distribution channel, one way to design customer relations is to use big-data analysis of customers’ individual preferences. Below the square (composed of activities, customer relations, resources, customer channels and value proposition) we fnd Revenue and Cost illustrated as triangles. Revenue streams tend to come from sales to customers, and therefore the right part of the triangle is the thicker one. However, revenues can also arise if the organisations are part of a value proposition that a partner distributes in the business ecology. Regarding costs, the balance between production and distribution can vary depending on the actual business model and value proposition, but for the sake of graphical symmetry, cost is tapering towards the right. In the following section, we will look more closely at each part of the business model and discuss how it is infuenced by digitisation. We start with value creation activities. Business Model Value Creation Tangible and Intangible Values The value that is created in a business model is often not equal to a certain monetary value, even when the captured value in the end may be expressed in monetary terms (Nagle and Müller, 2017). One reason is that the term value may refer to the (net) benefts each stakeholder experiences from a transaction or relation over time, but also to the revenues (and other benefts) received from customers and available for sharing with other foreground actors. Especially in discussing long-term societal effects that frms have or broadening our business-model discourse to cover also other types of organisations, value may also be either purely fnancial or multi-dimensional. Even for a proft-seeking frm, building a loyal customer base or new partnerships and joint information systems are examples of value-creation which may ultimately have long-term proft as its motivation, but in the short term is more natural to describe as adding intangible assets to an imagined balance sheet. We fnd it useful to think that value is something that satisfes customer needs, depends on the type of organisation and sometimes also depends on other stakeholders’ needs. Crucial to this is that value is aligned to the identity of the organisation and the strategies and goals that the organisation strives to realise. One challenge among others when defning value, is that it may come in many forms, depending on various customer needs.
For example, what is the value to a person of using a social media platform? Is it in communication for commercial purposes (for example, building a personal brand), or is it mainly in keeping track of when friends have their birthdays? Products tend to hold both tangible and intangible values for customers and consumers (Mazzucato, 2018). Equally, for frms supplying such products, in our increasingly digital economy, value goes beyond the subscription fees a core organisation receives, and may include more or less potential intangible future prospects from exploiting data on customer behaviour. For most products, at frst glance, it may seem obvious what the tangible part of a value proposition is. Take for example the value of groceries such as cheese, butter and bread (even those that are lactose-free, gluten-free or made from alternative ingredients). The tangible value of such products can be that they are fuel for our bodies, as they provide us with energy and vital building blocks for muscles, skeleton and more. But if this tangible value would be equal to the total value proposition, why do food producers and grocery stores put so much effort into packaging design and product exposure? One answer is that they want customers to choose their products instead of competitors’ because their offerings include additional intangible values, signalled by packaging and exposure. In terms of food it can be much more than just fuel. For many people at many occasions it holds values such as pleasure, community and an expression of a cultural activity. Therefore, given that a business model creates tangible and intangible values, these values often needs to undergo a thorough analysis before they can be formulated and communicated. Digisation tends to infuence value offerings as it enables servitisation (new or developed service functions in a product) that contributes to greater intangible values. For a car manufacturer, such services can include, for example, a digital Global Positioning System (GPS) that enables a driver to navigate the streets of a city never visited before. Or the feature of having a mobile phone wirelessly connected to the audio system and controlled with a few buttons on the steering wheel. GPS functions can also be used to enable traceability as part of theft protection, and in the event of a robbery or a collision, an alarm to an alarm centre can be automatically triggered. If you are abroad and unsure of which addresses you should set up, a helpdesk function can assist with remote feeding of destinations to the car’s GPS. Or, in the not-toodistant future, the sound system may be controlled by eye movements in relation to a head-up display projected to the driver. All these services are not crucial for delivering the very tangible and bottom-line value of a car: transportation from point A to point B. But it can make it smoother, more comfortable and more secure, thereby being of value to a user and possible for the provider to charge for according to some price model.
Theory and Conceptual Models
The Role of Subcontractors, Partners, Activities and Resources in Value Creation Partners and subcontractors play important roles in business model value creation. They differ in how the core organisation interacts with them. A subcontractor can be replaced relatively easily, although the products they deliver are crucial for the business-model value-creation activities. A relationship with a partner is more long-term and comprehensive. Like a subcontractor, a partner probably sells some product to the organisation, but in addition it has also an active role in the business model activities and perhaps contributes an important and hard-to-replace share of the resources needed for the value proposition. Partnerships can take various forms, such as strategic alliances with non-competitors, partnerships with competitors and joint ventures. Regarding Activities, it is common within organisations to consider these as being part of internal organisational processes, i.e. a network of internal activities that have a specifc start and end activity and are performed in order to create customer value. These activities are in turn intimately associated with the Resources, because without resources, there are no activities. Resources can be physical, intangible, human or fnancial. As with partners and suppliers in the earlier paragraph, a business model should highlight the activities and resources that are necessary to create the value proposition. However, depending on how complex the product is, the delimitation of activities can be quite diffcult to achieve. An important aspect of business models is how activities, resources, customer relations and customer channels are divided and shared between the core organisation (the four felds in the middle of Figure 3.1) and its partners and subcontractors. Digitisation clearly affects all of these parts of a business model. When, for example, a car manufacturer purchases parts such as chairs and airbags from a Subcontractor, it is important that they are delivered in time for Activities related to the assembly of cars. A just-in-time production system can here enable cost reductions (among other things) because the manufacturer can concentrate its Resources and hold as few stocks as possible. In order to manage the logistics of just-in-time, the manufacturer via systems that includes RFID tags, bar codes and similar digital reading techniques can keep track of inventory levels. Here it is also common that Subcontractors and Partners are integrated into the ERP system (a Resource) of the manufacturer, which means that they can access information necessary to optimise their production Activities. In this seamless fow between Subcontractors and Partners and the Core organisation, communication technologies such as 5G and the development of the Internet of Things will play an important role. It enables, for example, each single product in a production chain to carry individual information, which in turn may enable shorter lead times, fewer errors, greater fexibility and less time-consuming programming.
Furthermore, in a business model Activities such as product design, CAD programs (computer aided design) are often used, and 3D immersive renderings can help determine whether components will ft and will be possible to access for service. Testing of e.g. the durability of a product is done with the aid of digital technology where different types of sensors collect measurement data for evaluation. Similarly, computer-controlled industrial robots have long been an important part of industrial production, ensuring quality as well as maintaining time-effcient production, and increasingly, RPA (robotic process automation) is employed to relieve staff of standardised assessments and other repetitive intellectual tasks. However, people are still an important Resource for achieving such value proposition. Digitisation most often involves a combination of man and machine (Brynjolfsson and McAfee, 2014). A common denominator for subcontractors, partners, activities and resources is that they all generate costs and should be the subject of an analysis of cost drivers in the value creation process. The Cost of Value Creation We devote Chapter 5 to costs, especially how costs need to be considered in choosing a business model and articulating its relations through price models. Like value, the term may refer to accounting costs (cash payments which are converted into costs for particular objects, organisational units and time periods) or given the broader meaning of a negative change in tangible and intangible assets which may eventually over time affect payments. It has, for instance, become common to talk of “reputational costs”. A partnership which affects the core frm negatively (for instance through media discussions of environmental or ethical concerns) may have a short-term impact on sales, but its greater “cost” may be its effects on managers, employees, recruitment and future partnerships. In the business model, Costs arise when purchasing products from suppliers and partners, when organising and performing activities and using resources and when maintaining customer Relationships and customer Channels. In the context of the business model, Costs should not only be regarded as a burden on the organisation, which is easily concluded if you study only the income statement. Without the costs generated by certain Resources, Activities, Subcontractors and Suppliers, there will be no value creation. More cost can be useful if these factors lead to even greater value creation. Still, an organisation should constantly strive to use existing resources more effciently. This kind of analysis is enabled through various calculation models. Digitisation often has a major impact on costs. For example, direct costs of production tend to decrease continuously as information technology (IT) enables more effcient processes, including extensive automation and standardisation. But digitisation also tends to shift the cost structure,
Theory and Conceptual Models
from variable costs increasing with volume, to up-front investments in the development of digitised solutions. If great volumes are achieved, this can be advantageous, but this cost structure also puts greater emphasis on strategic bets. If matters develop in a different manner than envisaged, the investments can prove hard to recuperate. In manufacturing industries such as telecom, the car industry and many more, research and development represent an ever-greater cost. Expectations from customers on ever-better digitally enabled functionality, serves to drive cost, both for development itself, and for extensive analyses and tests of the complex digital systems crucial for the customers’ experience of tangible and intangible values. And if competitors move in step, such increased functionality can fail to serve as a differentiator that enables good margins and can instead tend to be competed away, resulting in the benefts mainly accruing to the customers. Business Model Value Capture The Role of Customers, Relations and Distribution Channels in Value Capture Customers, the ones the value proposition is aimed at, are rarely a homogeneous group. In a business model, the organisation therefore needs to categorise them. One way to do so is to divide them into customer groups or customer segments, maybe related to age or lifestyle, or how the value proposition is consumed (immediately or over a time, with other purchases or on its own). Digital streaming services like Netfix and HBO usually address lifestyle as a way to defne their segments, e.g. families with children or young adults without children. A customer segmentation should also assess the willingness and the ability to pay. Such an assessment should preferably include an analysis of possible price models (Chapter 4) that can enable the organisation to address different customer segments. In e.g. the car industry, private leasing (to rent at a fxed monthly cost for a specifed period of time and thereafter return the car) has become popular in some markets as a complement to traditional sale of cars. In urban regions there is also the possibility of customers to join carpools with a specifc car brand, where you pay for the kilometers you drive and the time you use the car (more on this in Chapter 7). Customer Relationships and Customer Channels, just as Activities and Resources, are intimately associated with each other. Customer Relationships can be developed in various ways, such as direct contact between a customer and a seller. This can be established through, for instance, physical meetings, websites and e-mails or via a members’ club that offers discounted purchases. Digitisation has simplifed analysis of customer data, enabling individualised Relations through targeted customer offerings.
You can experience the result of such an analysis when you log on to a digital streaming service or to an e-commerce vendor, as they often communicate the following message: “Because you recently watched/purchased this, you may also be interested in these offerings”. Access to big data sources on customers can also be used for analysing e.g. lifestyle patterns. If you, for instance, become an Uber customer, you have to register personal data, which (combined with your transportation requests) enables Uber to document individuals’ travel patterns over time. Combining a large number of such individual patterns can in turn contribute to Uber’s development of more customised offers and hence their value proposition. But establishing customer relations may be of little value if the value proposition cannot be transferred to the customers. Therefore, the Customer channels are of great importance, and also the infuence they have on Customer relationships. For a car manufacturer, the car dealer has traditionally been an important Partner; many customer relationships arise on their premises, and through them the car is delivered to the customer. Not least, it is through the dealers’ garage services that the original spare parts sales are maintained, something that is of importance for the car manufacturers’ revenue streams. Contrary to this, Uber’s customer channel is concentrated to a single digital one—the app. Uber provides us with an example of a digital business model in which Relations and Channels are non-physical. The company is an intermediary transportation-service provider that links together customers in need of transportation with drivers interested in earning an income. Similar transportation services have existed for centuries and still do in the form of taxi companies, still often with a telephone switchboard as the main Customer channel. (We will come back to and highlight such an example in Chapter 6.) New in Uber’s digital business model is that they do not employ or have long-time contracts with the drivers. And yet they manage to offer customers an increased availability of vacant cars and reduce the time it takes to get hold of a transport—at least in metropolitan areas. This can be considered as the very core of their Value proposition, but they also add value by simplifying payment (deducted from a registered credit card) and provide information on what the trip will cost, where available cars are located and what the ratings of those drivers are before the order is completed. Altogether, the content of this Value proposition distributed through digital-based Relations and Channels may also attract new customer segments. Customers who previously have been hesitant to pick up a regular taxi directly from the street may now consider Uber’s services, as it contains an intangible value of control and security. Altogether, Customer segment, Customer relations and Customer channels must be carefully designed to match and reinforce each other. Otherwise there might be a risk that the value proposition is not successfully distributed and hence that value capture, costs and revenues are infuenced in a negative way.
42 Theory and Conceptual Models Value Capture and Revenues When a customer decides to purchase the product that constitutes the value proposition, an income is generated. The sum of incomes of a certain period of time becomes revenues for that period. The same applies to costs, which are the expenses for that very period. Accounting-based information on costs and revenues can be found in the organisation’s income statement. It provides us with some fnancial information, but the business model can assist with a complementary perspective for understanding the economics of a business and what caused its fnancial results. The major part of the revenues attributable to a business model comes from sales (the wide end of the triangle in Figure 3.1). What characterises the revenue streams depends on the type of product and the price model. How the agreed price is linked to what is delivered, including rights and responsibilities for the product, is discussed more in detail in the next chapter and exemplifed in the second part of the book. Revenues also depend on sales volume and price level. As pointed out in the beginning of this chapter, revenues can also be generated on the left side of Figure 3.1. Partners that the organisation cooperates with in the value creation process can, in turn, in the business ecology offer value propositions to which the organisation contributes. If that is the case, it is possible to defne an actor as both a partner (cost source) and customer (source of revenue). What one chooses depends on how the actor contributes to a comprehensive representation of the organisation’s activities. This is something the formal description of the business model should assist with. Digitisation can infuence revenue streams in several ways. For example, the digital technology can be considered as a necessary infrastructural technology, like an e-commerce vendor’s website or app that enables customers to order products. Without it, the e-commerce vendor has limited possibility to distribute its value proposition, and no revenue will be generated. However, digitisation can also infuence the revenues by adding additional value to a product. If e.g. an electricity-driven heat pump is installed in a house as part of the heating system, the core of the value proposition is probably energy-effcient and reliable heating of the house. But if the heat pump also is connected to a cloud service and can easily be controlled via an app that gives information about current indoor temperature, humidity and the amount of kilowatt hours consumed, this may be of additional value for someone who is planning to invest in a heat pump—especially if it is installed in a summer house that is located a couple of hours’ drive away from where the owner normally resides. Some heating systems may produce excess energy which can be sold to the organisation operating the electricity grid, provided it has effcient systems for handling reverse delivery. Although it may not be the heat pump with the lowest price, such added value can make a potential customer regard it as a very competitive
proposition. The same can also apply to a sound system that is installed in the house. Expanded digital service that adjusts sound quality depending on the music genre (classic, jazz, heavy metal, etc.) may let listeners experience clearer and crisper sound, making it their choice, although it comes with a higher price tag compared to other audio systems. These types of added values can in turn enable new interfaces between a company and its customers in the form of new price models (do we pay for the digital service as a subscription?) that in turn change the value proposition and revenue streams. We return to this in our next chapter, but frst let us discuss some challenges regarding levels of aggregation in business model analysis.
Levels of Aggregation in Business Model Analysis Just as organisational business strategies, particularly in large organisations, can be categorised as group strategy, business strategy and functional strategy, an organisation may also have several business models. When defning the content of a business model (i.e. how the organisation creates and captures value) the organisation should therefore select a level of aggregation. Is it suffcient with only an overall business model that captures the essence of activities, resources, customer relations, etc.? Or should such an overall model serve as a roadmap for development of submodels and therefore be more detailed? Our interest in this book focuses on pricing. Our analysis of ecology and business models is meant to lead us to the understanding of relations— with customers, partners and others in the business model with which a core organisation (in Figure 3.1 illustrated by the four felds in the middle) enters into contracts that specify deliveries and prices for these contracts. Such analysis may be occasioned by a new partnership for a frm which already has an extensive network of business contacts (and contracts) which may be described as its existing business model or several such models. Or we may study a new business venture, where an entrepreneur is establishing initial relationships with the partners who are needed to supply resources and activities or customer channels. The need to articulate division of tasks and suitable incentives for each relation should govern how contracts for these are set up and what price models are used. The relation with a particular partner will, of course, be an entity, but if it includes a number of disparate services, it may sometimes be natural to regard the collaboration as part of more than one business model. In a company group with subdivisions that offer different products to different markets, it is probably a good idea to defne an overall business model that can be divided into subdivision models. The overall model should display e.g. how the different subdivisions and their businesses (resources and activities in the overall model) contribute to the company group value proposition and the possible risks and synergies that may
Theory and Conceptual Models
exist. Regarding risk assessments, one challenge can be to identify relations that the different subdivisions have with different partners and subcontractors in the business ecology. Are some of these also strategically important for the group as a whole? Let us presume that the company group has specifc goals regarding e.g. sustainability that it incorporates in its overall value proposition. If one of the subdivisions then cooperates with subcontractors and partners who allow working conditions that confict with the UN global sustainability goals (United Nations, 2019), this can negatively infuence how actors in the business ecology such as customers, legislators and the general public perceive the overall value proposition. This can in turn temporarily, or in the long run, negatively infuence the image of the company group and the overall demand for its products. When it comes to possible synergies, these can have different forms. For example, procurement of products from a subcontractor to one of the subdivisions may be handled by another subdivision as part of its procurement process and value creation activities. Such synergies can contribute to cost savings at the subdivisions as well as the company group. However, the pure size of an organisation does not necessarily indicate that there is a need for several business models. Organisations whose business emerged in today’s digital economy and is purely based on digital technology can on the one hand be perceived as large when it comes to their number of customers, the value of their assets, etc. But studied more closely, their business model is often very uniform and generic. Take Spotify as an example. It is, similar to Uber, an intermediary actor as its music streaming service connects music producers with music customers. In 2019, it distributed its value proposition in close to 80 markets; it had about 250 million monthly active users, and its fnancial statement showed total assets of around 5 billion euro (Spotify Investors, 2019). Regardless of geographical market, at its website it is possible to interpret its value proposition in 2019 as only one for the whole business (Spotify, 2019): With Spotify, it’s easy to fnd the right music or podcast for every moment—on your phone, your computer, your tablet and more. There are millions of tracks and episodes on Spotify. So whether you’re behind the wheel, working out, partying or relaxing, the right music or podcast is always at your fngertips. Choose what you want to listen to, or let Spotify surprise you. You can also browse through the collections of friends, artists, and celebrities, or create a radio station and just sit back. Soundtrack your life with Spotify. It also has the same partners (the record companies) and same subcontractors (data server services available 24/7) regardless of geographic market. Its main activities are not about music, but rather about optimising algorithms that can be used to enable its promise regarding the
individual-oriented value proposition (“So whether you’re behind the wheel, working out, partying or relaxing, the right music or podcast is always at your fngertips . . . soundtrack your life”). In its business model, its main resources are not geographically located musicians, but instead skilled software developers at a few locations around the world and the systems they have built. Their customer segments are to one part geographically divided (customers in Norway, Belgium and Great Britain may have different music preferences than those in United Arab Emirates, Vietnam and Indonesia—or not!), but they also address music nerds (“the right music . . . is always at your fngertips”) and music omnivores (“let Spotify surprise you. You can also browse through the collections of friends, artists, and celebrities”). Their customer relations are mainly built upon big-data analysis and automated communication, and they use only one single customer channel—the Internet. These two examples indicate that the level of aggregation in a formal description of a business model depends on the character of the organisation. A company group with several subdivisions, offering different value propositions to different markets and customer segments, may beneft from an overall business model that can be divided into subdivision models. But if you are in an organisation with a uniform product and value proposition, it is probably a good idea not to make the business model overly complex. After all, if the formal description becomes too complicated and does not answer important questions regarding how value is created and captured, then it is of little value.
Implications In this chapter, we have discussed the business model concept based on how it can be formally represented. It is important to keep in mind that the very concept itself—a formal representation of a business model—is a social construct of partly abstract ideas of what constitutes a business. When we speak about its “existence”, it is a way to concretise and create a common picture of what we do in an organisation in order to create and capture value. Rather than viewing it as a true depiction of how an organisation and its associates create and deliver value propositions, it should be considered as an aid in creating, refning and assessing ventures, typically in communication between people. Its value is then to be judged by its contribution to the communication. In this book, we present an analytical concept for the establishment of strategic and innovative pricing. The formal representation of the business model is one important step in this. Discussing and analysing the components of the business model (Figure 3.1) enable us to critically review what actual value we and our associates create through our business, how our venture and value proposition relates to our business ecology and how we capture value through price models. Based on the
Theory and Conceptual Models
idea of a specifc value proposition, we can identify the necessary relations that we must have in our business ecology to create that proposition, as well as the relations that are less valuable to us. We may also discover new customer segments and channels and how the relations to them should be managed. We can look for background actors in the ecology that may have great impact on our business model, for example by creating new laws, regulations and standards. Also, no matter what kind of ecology our organisation is a part of, digitisation most certainly has great impact on the business-model aspects necessary to create and capture value. In this context, a concrete way to perform a business model analysis can be to: •
Think of a certain business—in the form of, for example, product, service, business or collaboration, preferably linked to what you analysed in the previous chapter. Describe its business model using the classifcation in Figure 3.1. As the next step, establish how this business model relates to the business ecology that you analysed based on the concept presented in Chapter 2. Can, for example, the organisation expect to continue to make money under the existing business model if the business ecology changes as you have assumed? What relationships to other actors in your description (consumers, suppliers, other partners, etc.) entail payments that may differ depending on the price models applied?
Still, to make value creation and capture happen, this is not enough. Analysis of the business ecology and the business model will indicate essential relations that the organisation needs in its closer and more distant environments. Such relations are based on intentions regarding arms-length deals (for example, effcient subcontractor cooperation) or long-lasting partnership (for example, common product development). Joint activities are likely to be required to provide the value propositions and fulfl orders. This can e.g. require investments leading to a need to assess asset specifcity and create inspectability of price objects (Cöster et al., 2019). Identifying relations, the motivations behind them and the incentives we should provide in order to make the relations fruitful should be the outcome of our analysis. The business ecology and business model concepts do not by themselves offer concrete guidelines for how to mirror and manage these relations, intentions, technology and the environment in the commercial agreement, i.e. in the price models. We therefore in the next chapter arrive at the essence of price models: how they contribute to an analysis of strategic and innovative pricing in a digital economy.
References Al-Debi, Mutaz M.; El-Haddadeh, Ramzi & Avison, David (2008). Defning the Business Model in the New World of Digital Business. In Proceedings of the 14th Americas Conference on Information Systems AMCIS’08 (Toronto, Canada). Baden-Fuller, Charles & Haefiger, Stefan (2013). Business models and technological innovation, Long Range Planning, 46(6), pp. 419–426. Brynjolfsson, Erik & Mcafee, Andrew (2014). The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies (New York: WW Norton & Company). Casadesus-Masanell, Ramon & Ricart, Joan Enric (2010). From strategy to business models and onto tactics, Long Range Planning, 43(2–3), pp. 195–215. Casadesus-Masanell, Ramon & Zhu, Feng (2013). Business model innovation and competitive imitation: The case of sponsor-based business models, Strategic Management Journal, 34(4), pp. 464–482. Chesbrough, Henry (2010). Business model innovation: Opportunities and barriers, Long Range Planning, 43(2–3), pp. 354–363. Cöster, Mathias; Ax, Christian & Iveroth, Einar (2016). Strategic pricing: The relationship between strategy, price models and product cost, in: F. Nilsson, C.-J. Petri and A. Westelius (Eds.) Strategic Management Control, pp. 131–163 (Lund: Studentlitteratur). Cöster, Mathias; Iveroth, Einar; Olve, Nils-Göran; Petri, Carl-Johan & Westelius, Alf (2019). RITE: Meta-model for conceptualising innovative price models, Baltic Journal of Management, 14(4), pp. 540–558. Dahan, Nicolas M.; Doh, Jonathan P.; Oetzel, Jennifer & Yaziji, Michael (2010). Corporate-NGO collaboration: Co-creating new business models for developing markets, Long Range Planning, 43(2–3), pp. 326–342. Doz, Yves L. & Kosonen, Mikko (2010). Embedding strategic agility: A leadership agenda for accelerating business model renewal, Long Range Planning, 43(2–3), pp. 370–382. Gibe, John & Kalling, Thomas (2019). Business Models and Strategy (Lund: Studentlitteratur). Havemo, Emelie (2018). A visual perspective on value creation: Exploring patterns in business model diagrams, European Management Journal, 36(4), pp. 441–452. Massa, Lorenzo; Tucci, Christopher L. & Afuah, Allan (2017). A critical assessment of business model research, Academy of Management Annals, 11(1), pp. 73–104. Mazzucato, Mariana (2018). The Value of Everything: Making and Taking in the Global Economy (London: Allen Lane). Nagle, Thomas T. & Müller, Georg (2017). The Strategy and Tactics of Pricing: A Guide to Growing More Proftably (New York: Taylor & Francis). Nielsen, Christian; Lund, Morten; Montemari, Marco; Paolone, Francesco; Massaro, Maurizio & Dumay, John (2019). Business Models: A Research Overview (London: Routledge). Osterwalder, Alexander; Pigneur, Yves; Bernarda, Greg & Smith, Alan (2014). Value Proposition Design: How to Create Products and Services Customers Want (Hoboken: John Wiley & Sons).
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Osterwalder, Alexander; Pigneur, Yves & Clark, Tim (2010). Business Model Generation: A Handbook for Visionaries, Game Changers (Amsterdam: Alexander Osterwalder & Yves Pigneur). Osterwalder, Alexander; Pigneur, Yves & Tucci, Christopher L. (2005). Clarifying business models: Origins, present, and future of the concept, Communications of the Association for Information Systems, 16(1), pp. 1–25. Porter, Michael E. (2001). Strategy and the Internet, Harvard Business Review, 79(3), pp. 63–78. Spotify (2019). About Us, Available from: www.spotify.com/uk/about-us/contact/ [Accessed 15 November 2019]. Spotify Investors (2019). Quarterly Results, Available from: https://investors.spotify.com/fnancials/default.aspx [Accessed 15 November 2019]. United Nations (2019). Special Edition: Progress Towards the Sustainable Development Goals. E/2019/68, Available from: https://undocs.org/E/2019/68 [Accessed 15 November 2019]. Velu, Chander & Stiles, Philip (2013). Managing decision-making and cannibalization for parallel business models, Long Range Planning, 46(6), pp. 443–458. Wirtz, Bernd W.; Pistoia, Adriano; Ullrich, Sebastian & Göttel, Vincent (2015). Business models: Origin, development and future research perspectives, Long Range Planning, 49(1), pp. 36–54. Zott, Christoph; Amit, Raphael & Massa, Lorenzo (2011). The business model: Recent developments and future research, Journal of Management, 37(4), pp. 1019–1042.
Introduction Strategic pricing raises issues on three levels of analysis. At the frst level—explored in Chapter 2—we explained that the organisation exists in a business ecology, in which various actors collaborate and compete given their interests and goals. The second level of analysis—presented in Chapter 3—concerns how business models enable the organisation to navigate in its ecology. They determine how it can create and capture value within it. Finally, we have the most granular level of analysis: price models, which are the focus of this chapter. More specifcally, we will present a meta-model for price model analysis that we call the price model equaliser. This is both a meta-model for price models to describe different possible confgurations of such models and a method for analysing price models. As meta-model and method, the equaliser aids an organisation to differentiate and re-invent its value propositions in ways that contribute to long-term survival. One of the main defciencies in traditional pricing is the preoccupation with identifying and analysing price levels: whether a price is high or low in relation to competitors’ product offerings and customers’ demands or to internal costs within the organisation. Furthermore, pricing is often considered as a rather uncomplicated and straightforward exercise: to put a price tag on a price object, which is often assumed to be fairly easy to defne. The main challenge then is to determine a price level that is high enough to make money, while being low enough to attract buyers. Instead, we take a strategic approach to pricing (Dutta et al., 2003; Piercy et al., 2010). We suggest that the core issue of pricing has more to do with What and How the organisation actually charges for its goods and services. What is the actual product offering that customers are willing to pay for, and how can its price be expressed in ways that refect the desired relation between a buyer and a supplier? This is the essence of the price model concept. It describes the particular arrangements and agreements between the seller and buyer: what is included in the product offering and what determines the payment.
50 Theory and Conceptual Models We will provide the context for this defnition in the next section, where we will discuss the background to the price model concept. Then we will present and explain the price model equaliser and its fve different dimensions. This is followed by a section dedicated to using and applying the equaliser to the case study of Ryanair. This is followed by two sections devoted to digitisation and price models and the challenge of balancing inbound, outbound and internal price models. Finally, we conclude the chapter by highlighting consequences that may arise when developing and implementing price models.
Background to the Price Model Concept Price models have existed for as long as there has been a transaction between two parties—regardless of whether the currency was cowrie shells, stone axes, beads, metal, bank notes or bitcoin. An organisation rarely applies the same price model for all its service and products. Instead, it often has a repertoire of different price models: for instance “package deals”, subscriptions, licensing, usage fees, etc. Every now and then a new price model is launched where the organisation deliberately tries to adapt to the needs of a particular customer group in order to succeed more than their competitors. The term is frequently used in daily press as well as in everyday speech. A quick search on Google yields 1,710,000 hits for the term price model and 5,150,000 hits for pricing model. However, the concept is not well explored within business studies, and there are very few studies that explore it in depth. In our research we conducted an extensive literature review within 22 highly ranked journals on the concepts of price models in general management, marketing, organisational studies, strategic management and accounting during 42 years (Cöster et al., 2019). More specifcally, we searched for price model1 in abstracts, keywords and titles of articles in these journals during the years 1975–2017. The results were staggering. We only found 54 articles, and among these 37 addressed price model because the words are included in established concepts such as capital asset pricing model, asset pricing models, optimal pricing model, option pricing models or reference to price models. They do not really address the issues of What and How, which are our focus in this book, and they avoid discussion of the philosophical or theoretical roots of price models (or any other type of deeper elaboration connected to price model). We only found seven articles that to some extent explicitly bring up the concept of price model as it is now used in business (see Cöster et al., 2019 for full review of these articles). Therefore, our overall conclusion is that the concept is to a large extent black-boxed within the research community. This can be considered very alarming, given the importance of pricing for the survival of organisations.2
For more than ten years, we have put our energy into opening this black box of price models. We have empirically explored and investigated price models in various industries such as telecom, management consulting, pharmaceutical, law, graphics and printing, banking, university, railroads and gaming. When we have done so, we have detected a stable and recurring pattern across all industries: a price model is composed of fve different dimensions that together constitute the agreement between seller and buyer in a given transaction. For illustrative and pedagogical purposes we have visualised these dimensions in the model named the price model equaliser, which is the subject of the next section (Cöster et al., 2019; Olve et al., 2013).3
The Price Model Equaliser The price model equaliser is displayed visually in Figure 4.1; for defnition and examples see Table 4.1. We display this meta-model for price model analysis through a graphical analogy with a sound equaliser. This is to communicate that a price model needs to be calibrated so that it fts the way the organisation wants to position itself in the market. Or in other words, the price model needs to be confgured in such a way that it aligns with the business model and the ecology in which the organisation is situated. In the same way that an equaliser in a sound system (or audio software) can adjust the sound quality to the style of music, room characteristics and individual preferences, there are a number of “levers” which need to be set at appropriate levels. Our message is that the price model should be confgured in the same way. The price model should be aligned with the identity the organisation
Figure 4.1 The price model equaliser
Table 4.1 Explanation and examples of the different slider positions Dimension Slider position Explanation
Microsoft Offce package; all-inclusive trips Purchase of a single article in a digital magazine; single songs in iTunes
Pay per use Subscription Rent
A complete package of various components for a single price Each part of the offer is priced separately, and the total price is based on customer choice of various attributes Payment each time the product is used Regular deliveries of products not yet produced An offer that is available only for a limited time period
An offer that can be used for a limited time period with the possibility of ownership Perpetual Theoretically, the customer can use the product permanently Exogenous External factors (e.g. price of oil, cost of living index, exchange rates) determine price Auction The price is determined by bidding Pay-what-you- The buyer determines want the price Results-based
Cinema ticket; pay-perview Daily newspaper; virus protection update Rental apartment; hotel room; rental of storage space on iCloud or Dropbox Leasing of computers or cars Clothes; hardware products Public transport
Museums, memorials, churches and cathedrals; donations online e.g. Wikipedia Traditional estate The price is set based on agents; payment observable results from with PayPal; sales of product use products on eBay A bid from a A discussion between carpenter; consultancy seller and buyer support to introduce a new information system Commodities at The customer cannot Sainsbury’s; apps on negotiate because the seller has complete control Google Play and App Store over the price (Continued)
Table 4.1 (Continued) Dimension Slider position Explanation Price base
Per unit Per unit + ceiling
Purchase volume + per unit
Fixed + per unit
Products with strong brands e.g. perfume or alcohol; products without competition, such as Spotify when the service was new Competitors’ price setting Consulting services; products in infuences the price oligopolistic markets decision like streamed movies Summary of costs required Municipal water and to develop, distribute and waste disposal sell the offer The value the customer receives
Gasoline by the gallon; tomatoes by pound; consultants by the hour London Oyster card with capping alternative; Stockholm city congestion charges paid per entry or exit up to an amount of 105 SEK per day per car Printers or copy A fxed price for a machines that offer a basic amount, and then payment for each new unit fxed price for the frst 1,000 copies and then a price for each new copy or print; mobile subscription: fxed price for the frst 200 minutes and then the price of each extra minute Power companies A fxed fee combined with a price linked to the who charge a fxed fee for the ability amount of consumption to deliver electricity by the customer plus a rate per kWh delivered; traditional phone subscription: fxed monthly fee for connection and then per unit for each minute A fxed price regardless of Netfix; Spotify; mobile phone subscriptions the amount of customer with “call as much as use you want” for a fxed monthly charge No ceiling because the price depends on current conditions A moving price with a ceiling
54 Theory and Conceptual Models wants to communicate to the actors within the ecology. It enhances the image the organisation wants to signal to the outside world. For example, a low-cost airline should have a price model that is different from traditional airlines to signify and communicate its low-cost strategy. In this way, the price model articulates and clarifes the value proposition, and through this the identity of the seller. It also expresses the priorities of the buyer, and in a functioning market it will refect willingness to pay for different features of the product offering. Overall, the equaliser consists of fve different dimensions (see Figure 4.1): • • •
The frst dimension of Scope refers to the granularity of the product offering: how many attributes or components are included in what is priced? The second dimension covers the Temporal Rights of the product or service: for how long can the customer use the product offering? The third dimension is Infuence and is concerned with the extent to which either the seller or the buyer (or an external actor) has the ability to infuence the price: who has the strongest negotiating position when the price is determined? The fourth dimension focuses on the Price Base that is the focal point when discussing price: is it information about cost, competitors’ price or customer value that dominates our price discussions and decisions? The fnal and ffth dimension is concerned with the Price Formula used to connect price with volume: what combination of fxed and variable components are used when calculating price?
As we noted earlier, a price model can be seen as an agreement between a seller and a buyer. These dimensions are present in any such agreement. Depending on the specifc price model and situation, some may be more dominant compared to others. Within each dimension the equaliser depicted in Figure 4.1 presents different settings (except for the frst dimension that consists of a sliding scale). Just as for a stereo equaliser, these can be confgured to defne the price model that is used, or proposed to be used, for a particular business deal. Together with other elements of the value proposition, the price model customises the agreement between seller and buyer and aligns it with the ecology and the seller’s business model. Now, let us go through every dimension and control setting in detail. Scope The frst dimension of the equaliser (see also Table 4.1 for examples in each dimension) is the Scope of the product offering, illustrated as a sliding scale.4 At the bottom, each attribute or lowest-level unit of the product offering is priced individually. The product or service is divided into small
components which are priced separately and can be combined depending on the customer’s preferences. For examples, think of the purchase of a single song in iTunes or a single article in a digital magazine. In this way, the customers can, themselves, choose among the attributes of the product offering and infuence the price by deciding what to include. At the top of the scale, we fnd system,5 which is representative of an offering that consists of a complete system of different goods and services. For instance, a Microsoft Offce package or all-inclusive trip often includes a system of offerings (e.g. fight, accommodation, spa, evening entertainment, excursion, etc.), and therefore these would be situated almost at the top of the scale. Here the customer pays for everything included in the offering, regardless of whether she uses all parts of it or not. This frst dimension is connected to the strategic question about what can be considered as the core and peripheral elements of the product (Normann and Ramírez, 1993). A core product is often surrounded by offerings that are perceived as valuable by the customer but that a seller may be less aware of. In this respect, an organisation can change its pricing (or even make alterations to the product offering) if it can identify the value-creating offerings that surround its product or service. The discussion of these issues usually results in an insight that the product offering in practice is more extensive than the physical product or service being sold. Services and supplementary products may even risk being forgotten as an important part of the delivery to the customer. “Servitisation” (see Chapter 3) often involves a shift from a seller’s exclusive focus on hardware as the core of a value proposition to instead realising that customers are relatively uninterested in it as long as a service package functions without problems. In this case, the scope should be redefned, with less attention given to the core hardware, although the seller may think of that as the enabling “real” product. Temporal Rights The second dimension of the equaliser is Temporal Rights. It focuses on how long customers may use the goods and services. This, as well as the remaining dimensions, is composed of a number of discrete steps for how each control can be set, which we will call “slider positions”. At the bottom, we have the slider position perpetual, which is the classical type for goods. Here the customer has the temporal right to use the product offering forever (at least theoretically) and the right to decide what to do with it. Once bought, the customer can choose to resell it or give it away (which is not the case with digital products such as music or e-books which you are allowed to use, but not copy or re-sell). However, the customer may only use the version of the product offering he or she has bought. After the purchase, the consumer will not have the right to any enhancements that the seller makes to the product. It is sold as is.
Theory and Conceptual Models
Clothes or computer hardware components are typically acquired with perpetual ownership. However, in practice the economic life of such products is far shorter than their technical life. Moving up one notch, we have leasing: the buyer has the right to use a particular offer for a certain period of time (usually a couple of years). Such agreements often include that the customer, after the end of the lease term, has the right to purchase the complete (and continued) right to the product or service. Leasing is a very common form of pricing in the automotive industry, and during recent years private leasing of cars has (as mentioned in Chapter 3) become really popular. Leasing of computers is another example. The next slider position is rent, where the customer buys the right to use an offer for a specifed time, after which it must be returned to the seller. The customer is also not entitled to changes or updates of the product. Rental of storage space on iCloud or Dropbox is one illustration of this slider position. Another example is renting an apartment. However, during the rental period, the customer cannot expect any major improvements or updates to the product offering she is renting—except maybe normal maintenance, such as is the case for housing. This is one of the differences compared to the next slider position: subscription. Here the customer pays to get regular deliveries of something that the seller has not yet fully developed and produced—for instance, a virus protection update, or a subscription to Financial Times or the Guardian. The subscription provides the right to the news of tomorrow (Tzuo, 2018). Finally, at the top of the second dimension we fnd pay per use. Compared to the other slider positions, the temporal rights here are the shortest, as the customer has to pay each time she uses the goods and services. Pay per use is a classical form of pricing for selling services and different types of experiences. For example, movie tickets give the right to watch a particular movie at a certain time at a particular cinema. If the visitor wants to see the movie again, she must buy a new ticket (at the same price she bought the frst ticket for). Another example is movie streaming websites that have pay-per-view (PPV) price models where the customer pays every time she chooses to watch a particular movie. Infuence The third dimension, Infuence, is concerned with the power balance between buyers and sellers. The key issue is to what extent the buyers or sellers have infuence over the price level. It is often connected to the situation of a given market and the power play of negotiation between seller and buyer. In the most extreme situation at the bottom of this dimension, the seller has the strongest power to infuence the price level by product offering a
price list on a take it or leave it basis. The customer’s power is limited to the decision whether to accept the price or to purchase the product offering from another seller (or opt out from buying the product altogether). Google Play and the App Store offer price lists which are non-negotiable. Price list is also the usual way to price groceries in grocery stores such as Sainsbury’s or Walmart. Here, the customer has little chance of negotiating the price. The grocery store is completely dominant, and the customer’s only choice is to go to another store that may offer a better price. In the next step, negotiation, the balance is more even between buyers and sellers. The price is now a matter of negotiating between two parties. The starting point may be some form of price list. However, the negotiation can also begin with the buyer, who informs the supplier how much he is prepared to pay for the product or service. If this is the case, then the buyer often has more power to negotiate the price (sometimes called “a buyer’s market”). One common example is the negotiation between a private person and a craftsman that is based on estimates of what time it takes to complete the work and the cost of materials. Another illustration is the pricing of consultancy support when introducing a new information system. The third slider position from the bottom is result based. Here the price is linked to some sort of observable result of the use of the product or service. Both parties need to agree on how the results are to be measured, and normally this will be more within the control of the buyer than of the seller. Traditional estate agents often use this type of pricing. The seller and the agent agree in advance on a percentage of the sales price that constitutes the compensation to the agent. If the agent succeeds in selling the property at a higher price, she gets more money. Two other examples are payments with PayPal or the fee for selling products on eBay. As we will come back to in Chapter 5, this usually has less to do with actual effort or cost than with perceptions of fairness. But for the estate agent, there may be an expectation that incentives are needed to make the agent do a good job and that a split of the resulting extra revenue is satisfactory for both the agent and her client. In the next slider position from the bottom, the power balance has changed somewhat to the advantage of the buyer. Here the customer determines the price based on what she think it is worth: pay-what-youwant (sometimes also referred as “pay-as-you-wish”, see e.g. Chen et al., 2017; Mak et al., 2015). Sometimes the seller can come up with a price recommendation, but the buyer can choose whether to accept it—or pay more or less. This type of pricing has been widely practiced by museums, memorials, churches and cathedrals around Europe for quite some time. Axel Munthe, a high-society physician of European fame a hundred years ago, claimed that pay-what-you-think-this-was-worth was a highly successful pricing strategy when he used it among his patients (Munthe, 1930). More recent examples include shareware or donations to Wikipedia. Students of game theory will recognise that pay-what-you-want is
Theory and Conceptual Models
more likely to be acceptable to both parties if they expect to do business repeatedly, as in the case of Munthe and his patients. We may draw a parallel to recent discussions of open-book relations between important suppliers and their customers. Moving up one more slider position, we fnd auction, where the individual seller and individual customer both relinquish their right to determine price on their own. When a good is auctioned, neither the seller nor the buyer knows what the price of the offer will be in the end. None of them can determine the price of the product on their own. Instead it depends on what other customers are prepared to pay for the same offer. The ability of the seller to infuence revenue consists solely of accepting the bid or not. Art at Sotheby’s or used gadgets on eBay are priced in this way. Last in this dimension we have exogenous, which is the most extreme situation as neither sellers nor buyers have direct infuence over the price. Instead, external factors determine the price, such as indexes connected to the price of oil, GDP or exchange rates. Circumstances beyond the infuence of both the provider and the consumer determine the realised price level. Exogenous pricing is common in long-term contracts of complex goods and services such as public transport. It is then often an add-on to a base price which may derive from an earlier contract, as when a multiyear contract stipulates future “compensation” for salary increases which have not yet been negotiated when the budget is decided. Price Base The fourth dimension refers to what type of Price base the price agreement is grounded in. More specifcally, it refers to what type of information the seller fnds most important for setting prices, which will therefore dominate the pricing decisions. Here we fnd three types: customer value, competitors’ price and cost. For an organisation, all of these three types of pricing information may be of relevance at the same time, but to varying degrees. The most classical alternative here is information about the cost of development, production and distribution of the product offering (often referred to as the price foor). Such cost information is then used as the most important reference point in the price decision. An example of this is the pricing of municipal services, such as water and wastewater charges, whose prices should by regulation be calculated on a cost basis. Many price decisions strongly focus on cost—even today. Reasons include perceived fairness and the idea that competition will ultimately lower prices down to the level of the cost of an effcient producer. As we will come back to in Chapter 5, this implies that all competitors offer comparable quality—that is, all available alternatives are interchangeable and present the same value for buyers. This has led researchers and the marketing profession to direct criticism against standard cost calculations as the basis for pricing. Partly because they do not consider the buyers’ willingness
to pay, and partly because these calculation methods do not capture the “real” cost of a product. Instead of the traditional cost estimates, more activity-based calculation methods should be used. Such a point of departure provides a more accurate picture of the resource consumption connected to a particular product. To base price decision only on cost information is in many cases considered misleading, as the cost is only the “foor” of what is possible. Instead, the price level used by competitors (on comparable products) can be decisive for how an organisation should set its prices. This is often used in markets where large numbers of competitors compete with homogenous goods and where transparency prevails regarding price levels. An industry where information about competitors’ pricing dominates as price base is consulting, especially in public procurement, as suppliers tend to focus their product offerings on being as close to competitors as possible. Digital products like streamed movies are another example. In both of these examples, one might say that competition is working well to reveal what customers are prepared to pay: barriers to entrance are fairly low for competent suppliers, and customers will discover whether the qualities of the goods and services satisfy their needs after a period of use and then switch to other suppliers if they do not. Preferable (at least according to writers on marketing, see e.g. Hinterhuber, 2004; Ingenbleek, 2007; Shipley and Jobber, 2001) is to set price based on customer value—the price ceiling. According to classical economics, this would be revealed in a marketplace where there were many sellers and buyers of similar products. With today’s much more variegated offerings, sometimes few sellers, and buyers who want satisfaction of many kinds from a purchase, markets have become fragmented into niches where it often is diffcult to identify customer value. Yet it becomes central to fnd out what it is in the offer that the customer values, how much she values it and what she is willing to pay for it. Setting the right price level is then seen as fnding the proper balance between customers’ perceptions of what they obtain and what they sacrifce in order to acquire or use the product offering. Although customer value may appear appealing from a theoretical strategic marketing perspective, it is diffcult to determine in practice, while costs and competitors’ prices tend to still fgure prominently in price determination and price negotiations. Products with strong brands and intangible values addressed through senses such as smell or taste, like perfume and alcohol, often base their price decisions on customer value. Other examples include digital products without competition, such as Spotify when the service was frst established. Sometimes it is suggested that the “premium” customers are willing to pay for a specifc brand, over and on top of less glamorous alternatives, can be identifed and added to what competitors charge. Similar reasoning can be applied to professional services, like those offered by corporate advisors.
Theory and Conceptual Models
Price Formula The fnal dimension of the equaliser is the Price Formula used to determine the price, based on fxed and/or volume dependent components. Here it should be understood that depending on the previous equaliser settings, volume may refer to other quantities than the number of units or kilos sold. For digital services, it may be a mixture of technical terms such as the volume of streamed contents and other quantities, such as the number of channels included in a subscription. For books or flms that are made available digitally, remuneration to their authors might be linked to the Temporal rights dimension in the equaliser: payment per view, or a higher fee when the price object is bought with full rights. Or maybe a fee linked to how many minutes it is accessed? At the bottom of this dimension we fnd fxed price regardless of volume used. The seller is guaranteed an income even if the volume turns out to be low, but he or she will not receive anything extra if the volume increases. Digital products like the ones Netfix provides tend to offer a fxed price regardless of how many movies or series the customer watches. Spotify has the same setting in this dimension for its music product. One more example is telecom operators offering subscriptions that allow subscribers to call as much as they want for a fxed monthly charge. The subsequent slider position is fxed + per unit. Here the price is a fxed fee combined with a price linked to the amount of consumption by the customer. The price model is common with telecom companies that offer a fxed price for the subscription and a variable price depending on the number of calls and the length of the call. It is also a popular model for power companies who may charge a fxed fee for the ability to deliver electricity plus a rate per kWh delivered. The succeeding slider position is purchase volume + per unit where a fxed price is given for a basic amount and when this has been consumed, the buyer has to pay for every new unit. The seller is guaranteed contracting for a certain volume of the product offering and will be paid a fxed amount regardless of whether that quantity is used or not; the buyer will have to pay extra for every unit above that quantity. Examples are printers or copy machines that offer a fxed price for the frst 1,000 copies and then a price for each new copy or print. Telecom can also be used as an example here, as some offer a mobile subscription with a fxed price for the frst e.g. gigabyte of data and then the price of each extra megabyte. Per unit + ceiling is located almost at the top of the dimension. This slider position means that the buyer pays for each unit up to a certain limit. When the customer’s total purchases have reached this limit, each additional unit is free. For instance, the Stockholm city congestion charges are paid per entry or exit up to an amount of 105 SEK per day per car. London Oyster card with capping alternative is another example.
Finally, and at the top of the dimension, the customer pays a per unit price. The total price varies depending on volume. Customers buy gasoline by the gallon, tomatoes by pound, and consultants by the hour.
Application of the Price Model Equaliser: Ryanair In the previous subsection, we provided examples for each among the fve dimensions of price model equaliser, one at a time. But the equaliser only comes into full force when a product offering is mapped on the whole equaliser model. Therefore, let us now turn to a simple, illustrative and fairly well-known case example for such an exercise: the Irish airline Ryanair. When it established its business model in the 1990s, it also launched an innovative price model that re-invented its value proposition and in turn enabled Ryanair to differentiate itself from competitors and increase its market share (see Chapter 6 for several more examples of innovative price models). Ryanair was founded in 1985 and is one of Europe’s largest low-fare airlines with a low-cost and high-utilisation strategy (similar to Southwest Airlines in the US) with private persons as their main customer segment. During the 1990s, the airline took advantage of the deregulation of the airline industry that took place within the EU, and in the 2000s it was an early adopter of using online booking to cut costs and selling directly to customers, bypassing traditional travel agencies. Part of its strategy was also a price model that, at that time, was innovative and which we display in Figure 4.2. Ryanair’s price model is mapped and contrasted to
Figure 4.2 Ryanair’s outbound price model
Theory and Conceptual Models
the industry standard of a comparable product offering at that time. Now let us go through every dimension starting from the left. We fnd the biggest difference between the price model of Ryanair and industry standard in the frst dimension of Scope. Here Ryanair has chosen to price each Attribute separately, as there is a single price for the fight ticket, extra baggage, reserved seat, beverages, meals, security fast track, fexible ticket, etc.—in other words an unbundling of the product. The fnal price is the outcome of the customer’s choices of the attributes, and the unbundling of course also affects the Price formula to which we will come back in a moment. This is different from the industry standard (at that time), as airlines traditionally offered a standardised system of several attributes with one single price. Temporal Rights in the second dimension are the same as the industry standard, as payment occurs each time a consumer chooses to travel: pay per use. Ryanair has a strict point-to-point policy and does not take responsibility for connecting fights. However, it could be argued that some traditional airlines offer a (very) slightly longer duration of temporal rights since they take responsibility for transit fights as well as sometimes having a premium offer that includes the right to rebook fights. Also, period passes can be viewed as rental: use the service (fights) for a year (or three weeks) at a predetermined price—but this is not the standard product offering. Moving on, in the dimension of Infuence, there is no room for negotiation, and Ryanair, as well most airlines, offers a price list (where prices may change over time according to availability-based yield management practices). As for the fourth dimension of the equaliser—Price base—Ryanair’s pricing decisions are based mainly on information from competitors’ pricing. Ryanair strategy is to make salient components competitively priced, and non-essential parts of the offer (e.g. priority boarding, luggage allowance and food on board) are then priced according to what a suffcient number of locked-in customers can accept. Since it is the salient attributes of the product offering that are marketed (and indirectly compared to competitors’ product offerings consisting of more attributes), the consumer perceives Ryanair to be a low-fare airline. Finally, in the last dimension of Price formula, Ryanair follows the industry standard and has a volume-variable price: per-unit. Within the product offering, the customer can only buy the service of being transported from point A to point B. If the buyer wants to take a connecting fight, then the buyer has to buy another ticket. It could be argued that some airline product offerings are situated at the slider position of fxed price (regardless of volume) since they offer annual passes or fight packages: “round-the-world-ticket” up to a specifc number of km or based on the number of continents that you visit. However, Ryanair does not offer this, and this is not the industry standard of comparable product offerings for private consumers.
As we can see in Figure 4.2, Ryanair follows the industry standard in four out of fve dimensions. Competitors’ price levels are the starting point for Ryanair’s pricing. Every fight is priced individually, and the customer is only given the right to one departure per priced ticket. The most prominent differentiation in Ryanair’s pricing strategy lies in the frst dimension. By product offering choices of attributes at a high granularity instead of an invariable bundle, Ryanair affords the customer the possibility to compose a customised package from standard components and thus to affect the total price paid. This is by no means a negotiation, as Ryanair has determined which options to offer and the prices at which they are offered. Thus, the customer’s customisation possibilities build on a take-it-or-leave-it basis, not on negotiation. Ryanair’s unbundling approach is one important part of its low-fare image and its low-cost, high-utilisation strategy. However, Ryanair’s price model as such could be considered innovative in the 1990s, and since then this type of price strategy has become a common standard by airlines such as EasyJet. This raises the issue of contagion aspect of innovative price models. Once they are introduced, and if popular, they tend to be copied and become an industry standard.
Digitisation and Price Models Digitisation has made pricing more multifaceted during recent years, and as a result there is a greater repertoire of price models than ever before (Hagberg et al., 2016; Kung et al., 2002; Shapiro and Varian, 1999). Therefore, let us now look at some of the most apparent digitisation effects on price model development through the different dimensions of the equaliser. The greatest infuence on the frst dimension, Scope, refects that the cost of copying digital products is close to zero. Not only is the pace of technological development rapid, with the consequence that the cost and physical size of IT capacity keep falling, but IT also has the potential to make traditional cost-based pricing obsolete, especially for digital products such as software and music and video content. With a copy cost that approaches zero, all the production cost is in the form of initial investments in developing capabilities and contents. These are sometimes called up-front costs. Thus, there is no marginal cost of production to serve as a foor for pricing. This fact can be used to provide free versions of the offering to increase awareness of the product, capture market share and provide a better basis for a customer’s decision to pay for premium versions, Digitisation also makes it easy to divide digital content into separate parts or “versions”. This makes it possible to differentiate several versions or “bundles” through inclusion of different attributes of the core offer (Bakos and Brynjolfsson, 1999; Parker and Van Alstyne, 2017).
Theory and Conceptual Models
We already mentioned the Microsoft Offce package as an illustration here. Another example is different kinds of apps. Toca Boca develops game apps for children and their “Toca Super Bundle” consists of ten of their most popular apps for the price of 19.99 USD (in 2019). If bought individually the apps cost 3.99 USD each. As mentioned in Chapter 3, digitisation has also enabled organisations to collect more detailed data about their customer groups and segments (through the use of big data and data analytics). Such data can then be used to identify particular needs and analyse price sensitivity, sometimes fnding previously unknown customer groups and segments. Based on this, different versions of the product offering can be produced to ft a particular customer segment. An example is reducing the number of functions of a product into a slim version that can be sold to a customer group with a lower willingness to pay—without cannibalising on the proftable sales to customers with a higher willingness to pay. This kind of price strategy is often called “versioning” or de-bundling (Chellappa and Mehra, 2017; Shapiro and Varian, 1999). Apple often uses this strategy (just look up how many versions there are of the iPhone). International book publishers are another example, as they offer physical books to a customer group and digital to another. Also, versioning is common in cloud-based services, where customers can choose which functionality and capacity they are interested in, and the fnal price will depend on these choices. Within the second dimension of the equaliser, Temporal Rights, there has been signifcant change connected to the pricing of software. Earlier it was common to buy software on, for example, cassette tape, foppy disk or CD-ROM and the customer was granted perpetual rights to the product (without any rights for updates). Today one of the most common price models is to subscribe to the software (usually by monthly payment), which is often referred to as SaaS (Software as a Service, see e.g. Guo and Ma, 2018). The customer then has the right to get continuous updates throughout the subscription period—a shift from perpetual to subscription in the Temporal rights dimension. In general, in this second dimension there has been an increase of subscription-based price models. One example is groceries. The most common way of buying groceries is to go to the supermarket, where you pay for each item on every occasion. A new way of paying for groceries is to subscribe to a pre-packed bag with ingredients and pay a fxed price for the bag regardless of the variation of components in it. In many countries there are companies that offer this service and include recipes delivered weekly directly to your door (see e.g. My Food Bag). A similar development is subscription to jewellery (look up e.g. Emma and Chloé, Rent the Runway, Rocksbox) and fashion clothes (see e.g. Stitch Fix, Frank And Oak Style Plan, Menlo Club). Instead of a perpetual right to the jewellery and the latest fashion, you get a monthly delivery of the items and return them in due time. Common to all three examples—groceries, jewellery
and clothes—is that they have taken advantage of digitisation through the way that they use customer data to match their product offerings with customer preferences. And more importantly, they are all based on a new business model whose core idea builds on an innovative price model. Moving on, the most apparent development due to digitisation within the third dimension—Infuence—is the increasing popularity of different Internet auction companies like eBay, Christie’s and Sotheby’s. Such companies capitalise on technology’s ability to reach out to customers and offer a meeting place for goods sold at auctions. Another development is websites that offer free services and rely on advertising or donations, like Wikipedia which we mentioned earlier. Another example are shareware programs. These are computer programs that are often developed and sold by small companies or private individuals and distributed through the Internet. Since the shareware is spread to a great number of people (if successful), and since the manufacturing cost of making another copy of the software is almost zero, the inventor or organisation can make a proft. The fourth dimension, Price base, is connected to a long debate that started in the early days of the Internet. In those days, there were arguments that the Internet would lead to increased focus on its slider positions cost and competition. Information access and the transparency created by the Internet were expected to signifcantly increase price sensitivity (i.e. price elasticity) and drive consumers to continuously seek cheaper options through websites such as Pricerunner.com. Consumer power would increase tremendously, in the long run creating more uniform market and products. Some economists even argued that the Internet could create what economists refer to as “perfect competition” and “perfect markets” (Kung et al., 2002). We now know that such predictions did not come true to any greater extent. And in the pricing literature, the idea of pricing based on customer value is most often argued for. For example, digitisation has led to an increased opportunity to capture customer data, and more active and advanced use of business analytics and big data are then used to increase knowledge about customer value. As explained previously, new and “hidden” segments may then be detected. There are also behavioural issues at work. Digitisation has not automatically translated into price sensitivity; maybe—as explained earlier—customers do not perceive alternative suppliers’ offerings as directly comparable. Instead, they still show brand loyalty and seek out what they interpret as secure websites—as they want to feel “at home” and safe. The ground rules for business and pricing are pretty much the same as earlier, analogue-based value propositions: develop a trustworthy brand and make customers pay a little extra for it. Digital marketplaces may even increase the opportunities for premium brands when you can buy them through the Internet and their status is communicated on global websites.
Theory and Conceptual Models
Another relevant observation within the fourth dimension is the pricing strategies when introducing new digital products. For example, when streamed music and video was completely new, there was no clear market price for such subscriptions. The suppliers (such as Spotify, Netfix, Readly and Storytel) were forced to make an assessment of which price level best matched the value of the product. As more and more suppliers entered the market, price levels seem to have converged, and today the price for a monthly subscription-based streaming of flm and television programs is usually around 9.99 GBP/9.99 USD/9.99 euro per month. Finally, the last equaliser dimension: Price formula. Here the telecom industry is a relevant example. Almost nowhere else can you fnd so many different options where the customer’s total price can be based on such a variety of combinations of fxed and variable price components. Subscriptions to mobile phones in most countries illustrates this aspect very well, where you can fnd a price model for every slider position in the Price formula dimension. One of the most common price models within telecom (especially business subscriptions) is a fxed fee with an unlimited number of calls and text messages. Some argue, however, that such price models are highly unrealistic in the long run. Computer traffc is predicted to grow exponentially in the near future—particularly when the “Internet of things” comes into full force. Some argue that Moore’s law—that computer capacity is doubled roughly every two years—will slow down (Kish, 2002; Waldrop, 2016). In addition and more importantly, a signifcant increase of computer traffc is not sustainable or environmental friendly due to the amount of power needed (Melville, 2010). This may lead to new regulations and policies from governmental agencies. And such future scenarios and discussions about pricing with telecom, and their potential consequences, invite a refreshed analysis of the future of the business ecology—the highest level of aggregation in our triad of business ecology/ business model/price model.
The Relation Between Inbound, Outbound and Internal Price Models In this chapter we have explored the concept of price models and presented the price model equaliser. When we have done so, we have almost entirely focused on price models targeted towards consumers. Such price models are part of what we refer to as outbound pricing. Now if we take a look at business model fgure in Chapter 3 (i.e. Figure 3.1), these price activities are located between the organisation and its customers on the right side of the fgure. However, there are also price models that are concerned with inbound pricing that are located in the relationship between the organisation and sub-contractors (and maybe partners)—the left-hand side of Figure 3.1. In addition, we have internal pricing (also
called transfer pricing): price models used for transactions within the organisation—inside the bigger box in the middle of the Figure 3.1. In most cases, outbound, inbound and internal pricing have within themselves a repertoire of price models. All are, of course, meant to create incentives, and many people in and outside an organisation will be infuenced by them as the payments they lead to end up in the income statements for their organisations or the organisational units they work in. Buyers, salesforces, product managers and management in partner frms are just some examples of decision-makers whose priorities will depend on how price models are formulated. Many considerations will make it natural to use different inbound, outbound and internal such models in the context of a particular value proposition. Components may be purchased and then assembled in several stages before becoming part of a product, which perhaps is sold as a service subscription, and at each stage a price model may be used, which is different from earlier or later stages in this value chain. We will talk more about this in the next chapter. There are risk issues connected to this. Few, if any, organisations have an overall and holistic view of all the different price models that are at play in the outbound, inbound and internal levels, and more importantly how they align. Such aspects are essentially an issue of risk exposure. For example, there is a risk exposure if the inbound price models are mainly concerned with fxed price on resources, at the same time that the outbound price models are focused on a volume-based price. If the customer demands more of the products, there can be problems with the inbound pricing. Sometimes managers are unaware of the risk exposure that such a situation creates, and sometimes it is more of a conscious decision resting on strategic betting. Another aspect of misalignment of price models at outbound, inbound and internal levels is the focus on cost or customer value. For example, people working with procurement connected to inbound price models often have a focus on pure cost of raw materials. However, they often disregard other cost issues connected to internal price models, such as cost of refnement of materials, education and time issues. To make things worse, the outbound price models in many cases focus on customer value. For customers, and for the sales managers who are in close contact with customers, this is a logical expression of what customers are willing to pay for, such as service and image and unique features. Knowledge about these is often much less of a concern for the people working with inbound and internal price models, as the incentives such prices are meant to convey focus on costs and product qualities that only indirectly infuence customer value: durability, low returns or ease of handling in production. Please keep these concepts of inbound, internal and outbound pricing in mind as we will return to this in the next chapter as well as later on in the book!
68 Theory and Conceptual Models
Implications The price model equaliser can be used to map price models of current and future offerings and to compare them to industry standard. For example, the equaliser may be used descriptively to identify patterns among the price models used within an industry. For a frm, maybe one that wants to reconsider its business model, this enables comparison between the price models it uses (sometimes both outbound and inbound pricing) and those of competitors or alternative suppliers, and between existing price model and possible alternatives. The equaliser particularly lends itself to imagining and inventing such alternatives, through investigations of whether other slider positions for one or more of its fve dimensions would be possible. The visualisation aspect of such mapping (i.e. graphically displaying the range of different possible price models) should not be underestimated, as it can result in creative and innovative ideas. Hopefully, such exercises can help to detect price model confgurations that have not yet been offered and that have the potential to increase revenue, re-defne the product offering and differentiate from competitors—in other words, to uncover an innovative price model. One might assume that such a price model would differ from industry standard in most or several among the fve dimensions in the price model equaliser. However, we found in our research that innovative price models only make a (perceived) minor change of how the equaliser is set in only one dimension. For example, Ryanair made a minor change only in the Scope dimension. In Chapter 6 we show fve other examples of this observation. We have referred to the use of the price model equaliser as a suitable exercise for strategic workshops. However, designing a new price model is only half the challenge (at best), as there are usually numerous organisational changes connected to implementing a new price model. For example: • •
Employees: do they have the knowledge, skill and will to apply this new price model? Technology: does our internal digital technology (and maybe software that is embedded in our goods and services) support our new price model? For example, do we need new routines and software in order to collect data that can be trusted if we decide to include usage as a parameter in our price formula? Processes: to what extent are our current activities and resources in the business model aligned with our new price model? Organisational structures: what changes do we need to make to our overarching structures to be able to deploy our price model? For example, if we intend to sell a whole system of attributes, then how
will the revenue and proftability be allocated between the different departments? And, most importantly, will a new model infuence behaviour in the way we want? Alignment with the perceived business ecology and the intended business model hopefully motivated the search for an improved price model. But do the fve dimensions of the equaliser, taken together, signal the priorities and identity of the organisation as desired? Like in all pricing, to answer this question requires deep thinking about who will make decisions where prices are an infuence, and maybe totally determine behaviour. For instance, if a new contract extends over several years, seller and buyer will consider—more or less consciously—when payments will occur. The cash fow from buying an equipment (perpetual) will have an impact on cash fow and accounting proft over the next few years that is different from renting it, and both the two frms involved and the managers in charge of sales and purchasing should be infuenced by this. Switching from perpetual to renting may even be intended to encourage buyers who prefer not to own their equipment. Then obviously an evaluation of price models must include verifying such assumptions. Already in earlier chapters we stressed that we see new, multidimensional price models as suited for joint value creation, where they articulate what is most important for both parties in a deal. These and other organisational change issues often arise past the price model design stage and need close attention. They are natural extensions of developing price models. In specifc cases, there may of course be additional matters that require attention. We do not claim that the fve dimensions of the equaliser are an exhaustive inventory of what matters. For instance, the fnancial consequences we just hinted at may sometimes be a game-changing additional consideration: is a frm willing and able to offer alternative sequences of payments over the lifespan of a multi-year contract? Subscription essentially may require the seller to fnance equipment on a client’s premises. What insurance and other risk concerns does this raise? In summary, the main focus of this chapter has been the price model equaliser, and one way to conclude is to re-phrase every dimension in a list of questions to refect upon: Scope • • •
What is the real core of our offer, and what can be seen as peripheral? Can we achieve competitive advantage if we bundle together components in our offer, or should they be priced separately? Is there a product or service that surrounds our offer that is perceived as valuable by our customers?
Theory and Conceptual Models
Temporal Rights • • •
What temporal rights does the buyer acquire from our current offer? What should be the temporal range of our offer? Can we increase revenue in our product or service by changing how long our customers have the right to use our offering?
Infuence • • •
To what extent do we or the customer have infuence and power over the pricing, and what are the consequences of such a situation? How can we best utilise or change the balance of power between buyers and sellers? Can we beneft from increased involvement from the buyer (through e.g. Internet auctions and pay-what-you-want) or should we in any way try to increase our own infuence (through e.g. price list or negotiation)?
Price Base • • •
What information about pricing do we have access to, what information do we trust and what type of information dominates the decision? Is it cost information, competitors’ pricing or customer value that is the starting point for our price discussions, and what are the consequences of such a departure point? How can we make use of all three information points (Cost, Competitors and Customer value) in our price decisions?
Price Formula • • •
What formula or calculation is the pricing linked to? What combination of fxed and variable components do we want to use when we calculate the price? What are the risks associated with the fxed or variable components of our pricing?
Overall, we have in this chapter discussed the concept of price models as well as presented the price model equaliser. In doing so, we have presented the last part of the triad composed of business ecology, business model and fnally price model. The next chapter—which closes the theoretical part of the book—will be more explorative in connecting our ideas on pricing in Chapters 2–4 to classical concept of costs. Then in Part II we will come back to the equaliser and apply it to several more real-life cases, thereby deepening the discussion we started with the Ryanair case in this chapter.
Notes 1. As well as the equivalent terms pricing model, revenue model and income model. 2. For a broader view of the feld of pricing as such please see Leone et al. (Leone et al., 2012) and Diamantopoulos (1991). As these reviews of pricing research contend, the area of pricing is fragmented and scattered across various disciplines such as marketing (see e.g. Gijsbrechts, 1993; Ingenbleek, 2007; Rao, 1984), management accounting (Balakrishnan and Sivaramakrishnan, 2002; Lucas, 2003), strategy (Anderson, 2009; Dutta et al., 2003), information systems (Bakos and Brynjolfsson, 1999; Breath and Ives, 1986; Kauffman, 2010), economics (Hall and Hitch, 1939; Nagle, 1984; Wilson, 1997) and behavioral science (Kahneman and Tversky, 1979; Özer and Yanchong, 2012). 3. The model was originally developed based on a collaborative research project with the telecom company Ericsson. This specifc project was longitudinal, and the empirical data consisted mainly of 31 interviews with 39 participants and 33 focus group sessions totaling 90 h. Please see Iveroth et al. (2013) for full background and disclosure. Subsequently and over the years, the model has been further developed and validated in research projects with organisation situated in the industries of management consulting, pharmaceutical, law, graphics and printing, banking, university, railroads and gaming. 4. The examples provided in this section (as well as in Table 4.1) are intended as illustrative examples of different positions in the equaliser. Each reference is used to describe a certain position, not to explain the complete confguration of the equaliser for each offering. In Chapter 6, we present fve companies that have launched innovative price models; in this chapter we present the complete confguration of respective price model. 5. Some could argue that the slider position of system within this dimension can, or should, be called bundling or package. However, we have chosen the word System deliberately as a system of products or services should be viewed as a number of offerings (or attributes) that are closely related or connected to each other in some way. Consider a three-course dinner at a Michelin restaurant as an example. In such an offering, the different components are intimately related to each other and carefully thought out: the starter is connected to the taste of the main course, and the main course and the starter ends with a dessert that tie the whole dinner together, and fnally there are different beverages to increase the whole culinary experience. In contrast, a buffet dinner—that can be considered being a package of different attributes instead of a system of different attributes—is often just a collection of different courses without any specifc connection between them.
References Anderson, Chris (2009). Free: The Future of a Radical Price (London: Random House Business). Bakos, Yannis & Brynjolfsson, Erik (1999). Bundling information goods: Pricing, profts, and effciency, Management Science, 45(12), pp. 1613–1630. Balakrishnan, Ramji & Sivaramakrishnan, Konduru (2002). A critical overview of the use of full cost data for planning and pricing, Journal of Management Accounting Research, 14(1), pp. 3–31. Breath, Cynthia Mathis & Ives, Blake (1986). Competitive information systems in support of pricing, MIS Quarterly, 10(1), pp. 85–96.
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Chellappa, Ramnath K. & Mehra, Amit (2017). Cost drivers of versioning: Pricing and product line strategies for information goods, Management Science, 64(5), pp. 2164–2180. Chen, Yuxin; Koenigsberg, Oded & Zhang, Z. John (2017). Pay-as-you-wish pricing, Marketing Science, 36(5), pp. 780–791. Cöster, Mathias; Iveroth, Einar; Olve, Nils-Göran; Petri, Carl-Johan & Westelius, Alf (2019). RITE: Meta-model for conceptualising innovative price models, Baltic Journal of Management, 14(4), pp. 540–558. Diamantopoulos, Adamantios (1991). Pricing: Theory and evidence: A literature review, in: M.J. Baker (Ed.) Perspectives on Marketing Management, pp. 63–192 (London: John Wiley & Sons). Dutta, Shantanu; Zbaracki, Mark J. & Bergen, Mark (2003). Pricing process as a capability: A resource-based perspective, Strategic Management Journal, 24(7), pp. 615–630. Gijsbrechts, Els (1993). Prices and pricing research in consumer marketing: Some recent developments, International Journal of Research in Marketing, 10(2), pp. 115–151. Guo, Zhiling & Ma, Dan (2018). A model of competition between perpetual software and software as a service, MIS Quarterly, 42(1), pp. 101–120. Hagberg, Johan; Sundstrom, Malin & Egels-Zandén, Niklas (2016). The digitalization of retailing: An exploratory framework, International Journal of Retail & Distribution Management, 44(7), pp. 694–712. Hall, Rl & Hitch, Charles J. (1939). Price theory and business behaviour, Oxford Economic Papers, 2(May), pp. 12–45. Hinterhuber, Andreas (2004). Towards value-based pricing: An integrative framework for decision making, Industrial Marketing Management, 33(8), pp. 765–778. Ingenbleek, Paul (2007). Value-informed pricing in its organizational context: Literature review, conceptual framework, and directions for future research, Journal of Product & Brand Management, 16(7), pp. 441–458. Iveroth, Einar; Westelius, Alf; Petri, Carl-Johan; Olve, Nils-Göran; Cöster, Mathias & Nilsson, Fredrik (2013). How to differentiate by price: Proposal for a fve-dimensional model, European Management Journal, 31(2), pp. 109–123. Kahneman, Daniel & Tversky, Amos (1979). Prospect theory: An analysis of decision under risk, Econometrica: Journal of the Econometric Society, 47(2), pp. 263–291. Kauffman, Robert J. (2010). Information technology and pricing: Introduction to the special section, Journal of the Association for Information Systems, 11(6), pp. 298–302. Kish, Laszlo B. (2002). End of Moore’s law: Thermal (noise) death of integration in micro and nano electronics, Physics Letters A, 305(3–4), pp. 144–149. Kung, Mui; Monroe, Kent B. & Cox, Jennifer L. (2002). Pricing on the internet, Journal of Product & Brand Management, 11(5), pp. 274–288. Leone, Robert P.; Robinson, Larry M.; Bragge, Johanna & Somervuori, Outi (2012). A citation and profling analysis of pricing research from 1980 to 2010, Journal of Business Research, 65(7), pp. 1010–1024. Lucas, Mike R. (2003). Pricing decisions and the neoclassical theory of the frm, Management Accounting Research, 14(3), pp. 201–217.
Mak, Vincent; Zwick, Rami; Rao, Akshay R. & Pattaratanakun, Jake A. (2015). “Pay what you want” as threshold public good provision, Organizational Behavior and Human Decision Processes, 127(March), pp. 30–43. Melville, Nigel P. (2010). Information systems innovation for environmental sustainability, MIS Quarterly, 34(1), pp. 1–21. Munthe, Axel (1930). The Story of San Michele (New York: Dutton). Nagle, Thomas (1984). Economic foundations for pricing, Journal of Business, 57(1), pp. 3–26. Normann, Richard & Ramírez, Rafael (1993). From value chain to value constellation: Designing interactive strategy, Harvard Business Review, 71(4), pp. 65–77. Olve, Nils-Göran; Cöster, Mathias; Iveroth, Einar; Petri, Carl-Johan & Westelius, Alf (2013). Prissättning: Affärsekologier, affärsmodeller, prismodeller (Lund: Studentlitteratur). Özer, Özalp & Yanchong, Zheng (2012). Behavioral issues in pricing management, in: Ö. Özer and R. Phillips (Eds.) The Oxford Handbook of Pricing Management, pp. 415–461 (Oxford: Oxford University Press). Parker, Geoffrey & Van Alstyne, Marshall (2017). Innovation, openness, and platform control, Management Science, 64(7), pp. 3015–3032. Piercy, Nigel F.; Cravens, David W. & Lane, Nikala (2010). Thinking strategically about pricing decisions, Journal of Business Strategy, 31(5), pp. 38–48. Rao, Vithala R. (1984). Pricing research in marketing: The state of the art, Journal of Business, 57(1), pp. 39–60. Shapiro, Carl & Varian, Hal R. (1999). Information Rules: A Strategic Guide to the Network Economy (Boston, MA: Harvard Business School Press). Shipley, David & Jobber, David (2001). Integrative pricing via the pricing wheel, Industrial Marketing Management, 30(3), pp. 301–314. Tzuo, Tien (2018). Why the Subscription Model Will Be Your Company’s Futureand What to Do about It (New York: Penguin). Waldrop, M. Mitchell (2016). The chips are down for Moore’s law, Nature News, 530(7589), p. 144. Wilson, Robert B. (1997). Nonlinear Pricing (New York: Oxford University Press).
Cost and Its Relation to Pricing
Introduction In this chapter we will extend our discussion on pricing into the feld of costing. The main contribution of this book is the triplet we have presented in Chapters 2–4: business ecology/business model/price model. Hitherto, the message has been to design the price model according to the customers’ preferences regarding how they would like to pay for the offering. This is in line with the defnition of a business model: i.e. how to monetise and capture the value that is created for the customer. Outbound pricing, however, only captures what the customers are willing to pay for the offering. It does not capture what the focal company, and its partners, have to pay (the inbound prices) to deliver this offering. For their business model to be sustainable, revenues (based on the focal company’s outbound prices) must be suffciently higher over the long run than the costs (materialised by the inbound prices the focal company pays to its suppliers). Otherwise the focal company will not make a proft. In this chapter, we will elaborate on a simple, yet relevant, model to estimate the costs of an offering (see Figure 5.1). The cost model is inspired by the claims, proposed already in the 1980s by Johnson and Kaplan (1987), that many costing models had lost their relevance, as they focused too much on arbitrary allocation of overhead costs instead of on a more detailed assessment of which activities are actually causing them. The model we suggest here aims at relevance by connecting the costs to the core components in the business model. This high-level costing model describes how big the costs are for the four components: resources, activities, relations and channels. Before we start, there is one more fundamental characteristic of costing that we need to address. In the literature on costing, two streams of practices are described: costing as a tool for decision making, and costing as a tool for evaluation and accountability. Typically, costing for decision making is focusing on products, whereas costing for accountability is focusing on organisational units. Both costing types include ex ante and ex post assessments, but generally speaking, greater efforts are put into
Figure 5.1 Example of Cost model sheet
Theory and Conceptual Models
the ex ante efforts for decision making (when assessing whether a certain offering is likely to pay off or not), whereas the accountability processes typically focus on the costs that have been consumed by the departments. The vice versa may also exist but typically not to the same extent, as when assessments are made on whether past products were proftable or not, or allocating costs to different departments during planning and budgeting. However, criticism has been directed towards budgeting by e.g. Hope and Fraser (2003), who argue that budgeting costs is a waste of time. According to them, it is better to evaluate performance ex post and compare the results with peers in a benchmarking group. Following our repeated reference to ecology, and that businesses should rely on partners, the cost model we suggest differentiates between internal and external costs. In many cost models, both are just regarded as “costs”, whereas we fnd it important to show how large a share of the value production is performed by our partners. We call this the cost split (internal costs compared to external costs). As we mentioned earlier, this section will only focus on costing for decision making. The decision we are addressing is not how to set price levels (or cost levels) for a specifc deal or tender. Following the last three chapters, the decision we are focusing on is how to defne an innovative price model (using the equaliser) that boosts the value proposition in the business model and aligns with the customers’ preferences on how they want to pay for the offering. Given the design of the value proposition and the promises operationalised through the price model, the cost structure of the business model will vary. This is what the cost model in Figure 5.1 is showing. Metaphorically, think of the numbers in the cost model as a dynamic response to moving the sliders in the equaliser. If the scope of the offering is extended or the offering is sold as a subscription instead of a pay per use, how will that infuence the distribution of costs and the split between external and internal costs? Think of the cost model as a dynamic window, where the numbers change as soon as the sliders in the equaliser are changed.
Fundamental Assumptions About Costs The cost of something is a calculated value of the resources that are used in producing or achieving it. Organisations have established practices for such calculations but, depending on purpose and situation, cost estimates will vary. “Costs” are also often perceived as subjective: for instance, entrepreneurs and artists may not think of their own labour as a cost. Costs include both resource consumption which can be linked to specifc products (such as materials or the labour spent on it) and a share of other costs (“overhead”). In accounting systems, it is often easier to capture and relate “direct” costs to a particular object than indirect overhead costs of such resources as buildings, equipment or expertise. These may be
Cost and Its Relation to Pricing
equally necessary but are acquired over a long period of time and are not obviously “consumed” by the current production. So even if they are used for a particular product or service, determining how much cost should be allocated to it requires a lot of assumptions. Pricing and costs have long been linked in discussions of how markets function. A central idea in classical economics was that competition is good because it will drive prices down so that they correspond to costs (including the surplus someone needs as reward for risking her capital in a venture). Markets should allow innovation, and buyers and sellers should be able to do business with those partners they fnd give best value for money. In this way a society will be effcient and fair. Among the assumptions behind this is that the goods and services that are traded are well-defned and can be compared. From the start of economics as a science in the 18th century, theorists realised that in practice, businessmen would try to differentiate their offerings in order to satisfy more specialised needs and tastes, and that no markets would ever be effcient in this way. The price models we discussed in Chapter 4 may be seen as examples of this. There may be frms where detailed cost calculations are not meaningful— at least not in connection with pricing. Indeed, the marketing literature often advises against using cost as a basis for prices, claiming that customers’ willingness to pay should guide pricing (see e.g. Krishna, 1991; Nunes and Boatwright, 2004; Wertenbroch and Skiera, 2002). Still sellers need to control costs and their relation to revenues. In the long run and for all sales, costs including indirect costs obviously have to be covered by revenues, and both producers and consumers often expect some relation between them to exist—even for individual products and transactions. Not only classical economists have regarded it as desirable that prices correspond to the cost for each specifc product. It also seems fair and morally just. In some publicly funded or controlled markets, prices are even regulated to be costbased, e.g. many municipal services like waste management and sewage. Also, public defenders, funded by the public system, are remunerated based on an assessment of the cost of running such a business. But take any of the dimensions we highlighted in the equaliser, and the earlier assumption may not hold. A frm that bundles its product differently from its competitors will probably adjust its activities in the business model for a long-term relationship, if they agree on a 24/7 service, and fnd that its costs are not just the sum of specifc production costs. Instead, the amount of costs in the business model component “relations” will increase. Hence, the whole confguration of the business will drive costs over several years, if the intention is to enable this business model. There will be up-front costs in agreeing on business terms and investments in tools and skills that will be used over several years, and often promises of service levels that determine future costs in ways that should be considered before entering into a contracted relationship.
78 Theory and Conceptual Models Firms that use innovative pricing may therefore also have to reconsider their costing practices. This is by no means an established feld yet, except that normal logical reasoning will be useful. The costs we are discussing here are not necessarily the accounting costs used for external or internal proft reports (i.e. accountability reporting). Rather, we are concerned with cost estimates for decision purposes. Such costs are always future-oriented. Past expenses may be necessary to include, because the equipment or capabilities will need to be replaced and renewed. All cost calculations for decision making should assist in comparing different alternative courses of action. Traditionally, many frms make do with simple such estimates (The Economist, 2019): “Menu pricing starts with a simple rule,” says John Buchanan of the consulting arm of Lettuce Entertain You Enterprises, a restaurant group: take the cost of ingredients and multiply by three. Then ask yourself how much customers would expect to pay for a dish of this type, and how much they would expect to pay for it from you. A Pret lobster roll and one from a fancy seafood restaurant are quite different propositions. Lastly, check what the competition charges. “Only a small part of this decision is what I would call scientifc,” says Mr Buchanan. “A lot has to do with a subjective judgment of what the market will bear.” Direct cost plus a “mark-up” may be useful in this situation, and of course many frms’ accounting systems provide more elaborate cost allocations. But what can be done in the new world of collaborative business models and innovative, multidimensional price models?
Increased Importance of Cost Information in Analysing Potential Price Models As mentioned, the costing literature distinguishes between two main uses of cost information. Both are classical parts of management accounting. In choosing between different alternatives, decisions need to take into account costs as well as revenues and often also strategic and other considerations which are not easily converted into fnancial numbers. The other use of information is in accountability reporting. We here use the term to signify how performance, both of an entire organisation and of units within it, is reported and judged. Regardless of whether we are talking about a proft-making frm, a government agency in need of tax money or a proft or cost centre inside an organisation, cost measurements will play a part in how performance will be perceived. Decisions and accountability reporting are, however, often closely linked. Decision-makers will be particularly sensitive to costs that reduce the reported proft of the organisational unit for which they are responsible, even though cost
Cost and Its Relation to Pricing
calculations for decision purposes sometimes defne costs differently from performance reports—for instance including impact outside their own unit or in coming years. And the reported proft will be used by superior levels of management to decide which parts of the organisation are doing well and could attract positive attention. Cost information for both decision making and accountability reporting needs to be designed to provide the right incentives, together with the practices of how it is used. For instance, salespeople and the entire sales unit in a corporation need to have credible information on the costs throughout the frm which will follow if a customer’s desires are met: e.g. “The customer says they want a special design, and they want it next month”. In practice, it is common that non-standard solutions which involve several parts of a corporation may not easily be summarised in one cost model that “tells the whole story”, nor are proft numbers calculated in a way that provides correct directions for local decision-makers. Costing, once thought of as a feld of well-established accounting routines, has been the subject for much discussion in recent decades—trying to keep up with how organisations and their offerings have developed. In later sections of this chapter we will discuss how cost information may (and should) be used in our analysis of business ecologies, business models, and price models. Decisions and accountability reporting have an important role in this. Let’s start with a simplifed overview of how an ideal analysis may run. In Chapter 2 we said that the main actors in a business ecology should be identifed, with some ideas also of the dynamics of the ecology: their ongoing changes in power or size; new entrants, mergers etc; shifts in consumer priorities, etc. Even before thinking of one or more business models you may have perceptions of the main costs of the new value proposition you are considering: who in the ecology has the resources you want to access; what are their current fnancial situation, bargaining-power and loyalties like? Are there different alternatives, like sourcing from a lowcost country or nearby? In cases where your value proposition requires the existence of networks or infrastructures that are provided by other actors, it may also be advisable to think of consumers’ total spending and which share you might gain. When you then start considering your business model, matters of cost become even more concrete. We recommend an extremely rough budgeting exercise, as soon as you have narrowed down your ideas about with whom—suppliers, partners, distributors, customers, facilitators such as network providers—you will need to establish business relations. With some of these you will have arms-length relations, and your deals with those will tend to be traditional and set through competitive bidding. But as we explained in earlier chapters, there will also be a smaller number of partners with whom you attempt to build more long-term relations,
Theory and Conceptual Models
and who may share in your visions—even developing new technologies, systems and processes with your frm as the new value proposition is developed, launched and begins to “scale”. You should be able to do a very rough calculation of the next few years’ fnancial situations: Figure 5.1 tells you a few important things: •
If a large share of the annual costs are spent by your partners rather than by your frm, they need correspondingly more attention. (We call this cost split, and it is shown in the gauge in the bottom.) Remember: these are not just exchangeable suppliers of commodities who should be happy for your business. They are likely to be vital prerequisites for your success, and those who have to invest “upfront costs” in building capabilities ahead of how the business develops. They will need to be convinced it is a good idea. If such up-front costs—also those in your own business—are large relative to the resulting business in coming years, the entire venture needs to be seen as an investment that may require outside sponsors, unless you or your partners can supply the cash needed for several years (as for example regarding activities in the frst year in Figure 5.1). You probably already have started to think about how the fne-tuning of your value proposition will infuence its production and the processes which will have to be developed between you and your partners. For instance: if your prospective customers require a high level of support and rapid service in order to maintain constant functionality, how does that impact not only your but also your partners’ processes and costs (and how that develops over time; the bars to the right in Figure 5.1 show the shift from external to internal resources—per component in the business model and per year in absolute terms).
These concerns lead us on to price models. As we said in Chapter 4, they articulate obligations in relations to the customers. From the table in Figure 5.1, you should be able to “double-click” on each “external” cell to fnd more detailed info on the company’s main relations: who are the high-value contributors who supply components that are uniquely developed for this business model, or who are the distributors who have invested extensively in skills and processes for it? The costs we discuss now are mainly estimations, based on how the value proposition is designed—grounded in an understanding of how its various features require work also among your partners. For several decades now, “target costing” and similar ideas have been attempted in industry to reverse the old tendency to frst design a product, then cost it, and fnally set a price to cover those costs (Cooper, 2017). Instead frms try to guess, or research, customers’ willingness to pay for some features in the offering, and only if they can produce these—at this cost
Cost and Its Relation to Pricing
level—should those features be added to the product. Next, we will turn to the dynamics of pricing.
Cost Dynamics and Pricing When addressing costs, there are typically four aspects of their “behaviour” that are particularly important for pricing. These are closely related, but still possible to discuss one by one. There is of course a large literature on this, so let us just remind us of some considerations. Possibility to Infuence Economists discuss how well available production methods refect how stable and long-term the demand is expected to be. To invest in costly equipment makes sense only if you expect to continue production for a longer time. If you expect sudden disruption of your sales, you will prefer a more fexible method—often with lower fxed costs but higher variable costs. Especially the Scope dimension in our equaliser will infuence what we may call how “pliant” costs will be. An appropriate price model would defne Temporal rights and Price formula in a way that targets the probability for a long-term relation. In turn, this would impact how the frm contracts with its suppliers and outsourcing partners. Are there irreversible links, where the suppliers are expected to invest in equipment that is diffcult for them to sell or repurpose? Or is it desirable to maintain fexibility by using several partners in less close relations? Joint analyses of life cycle costs may be valuable in agreeing on price models that split the consequences for all partners in a way that is considered fair and functional for the scenarios envisioned: higher and lower demand than expected; new technologies or political upheavals suddenly becoming important, causing a need to rethink the partnership; etc. Timing Price models determine when payments are due, as defned in the business model: is the deal a partnership where several frms will make necessary investments, or are there some partners who will fnance a joint venture? Price formulas will determine the balance between fxed and variable payments, which will show up in the “external” columns in Figure 5.1. If—based on the issues of fexibility we just discussed—partners will decide to risk investing in a long-term and extensive collaboration, there may be equally extensive “up-front” costs in their frms as in the focal frm. This has become more common with the general trend of “dematerialisation”. This is because digital services on the Internet require preparations, but when they have been successfully launched, the maintenance
82 Theory and Conceptual Models and continuous renewal can be rather inexpensive. In designing a price model, it becomes important to have a realistic idea of the likely multiyear trajectory of revenues (the upper row in Figure 5.1) and who should carry economic risks (indicated in the cost split in the fgure). Such calculations will resemble capital budgeting calculations, testing how different price models under different scenarios (for volumes etc.) will impact each partner. Recognition of Costs in Accounts Price models do not just infuence expected payments (i.e. cash fow); they may also impact how costs are reported. Timing of payment streams with identical net present value can differ in attractiveness, based on when profts will be reported. Either this may concern external fnancial reports, of obvious interest to board members and executive teams, or it may be important for unit managers whose success is evaluated using internal transfer prices. Often this is closely related to the fexibility issues already discussed. But there may also be links to external rules and taxation. Buy-or-lease decisions (which typically convert external to internal costs in Figure 5.1) are a well-known example, and price models may have a direct impact on these through the dimensions of Scope and Temporal rights. Selling a system (high Scope) may have different balance sheet consequences if it is defned as expensive physical equipment, with installation and service as low-priced enticements thrown in, or buying services where the same equipment is an incidental part, maybe even still owned by the seller for the duration of the contract period. Cost Allocation Within Firms Sometimes price models can infuence the internal management accounting, both for buyers and in frms collaborating with partners. This may infuence how they act and the perceived attractiveness of a deal. Management accounting is meant to provide incentives for good business decisions. For instance, which role has been assigned to an IT department in a large frm: to provide services within the frm, based on a pre-set budget, or to sell services at transfer prices in order to cover its expenses without any pre-set budget from group management? What discretion does the IT department have in deciding what to sell? Most likely, the IT unit will behave differently if it has received a budget or if it is a proft centre that invests in systems that it is expected to “sell” internally, to recover the outlays. In practice, it is not unusual to fnd managers who devote considerable effort to making their own unit “look good” by avoiding costs in their
Cost and Its Relation to Pricing
own internal proft reports. Sometimes this will determine reactions to proposed price models. A simple example: if an external consultant is preparing and delivering a large training programme to a client and the price model defnes this as a temporary employment cost, it may turn up as overhead at some high-level department in the buying organisation. But if the price formula instead defnes a cost for each trained person, the consequences may be different, not only in terms of volume risk for the consultant and for the buyer, but also how the inbound price (i.e. the cost) is treated internally. It is likely that the charge will be allocated to those units in the buying frm that actually send their staff to the training programme. This may lead to lower usage of the training opportunity. Maybe a compromise is called for, where a central department pays for the consultant’s development of the training programme, and there is a low additional fee for each participant attending? Our message is that it may be worthwhile to discuss the incidence of costs in order for seller and buyer to arrive jointly at a price model—in this case a price formula—that will have the desired effects.
How to Measure Costs: Assessing the Use (Consumption) of Resources It is practical, but often misleading, to use conventional accounting systems to determine costs in the situations we have discussed this far. If a unit is entirely dedicated to the offering that is to be priced, it may seem easy to decide which costs have to be covered. But often a major point of innovative pricing is “versioning”, where a frm may enter into different relations with different customers who should pay differently, depending on the “bespoke” treatment given to them. To identify the resources needed for this, the costs associated with this and what share of that cost customers should rightly pay is not something a standardised reporting system can handle. Mark-ups like in the Economist quote earlier in this chapter are no fx for this, especially not if a seller wants to price its offering according to “what the market will bear”. But also, when a company is charging its customers based on value, cost estimates are necessary in order to fnd a rational and effective way of working and to predict fnancial proftability (as indicated in Figure 5.1). In classical cost accounting, concepts such as fxed and variable costs (linked to produced volume) and “learning curves” reduce cost over time as cumulative volume increases. This usually builds on assumptions of homogeneous products which can be counted. In the 1990s, “activitybased costing” taught frms that costs may be driven by order or batch volume, rather than product volume. Customers requiring short delivery time may require increased inventories, and high-precision quality may necessitate expensive tools and processes for some demanding customers (but
Theory and Conceptual Models
not all). These are also “cost drivers” to take into consideration. In a similar way, we believe that changing the value proposition and the price model will result in a need to reconsider the cost structure to see how it will change due to this. We will here frst discuss cost as a basis for price and relevant cost analysis. But, as we mentioned earlier, costs are themselves a consequence of how the price model is defned. Hence, we also discuss “inbound” and “internal” price models, and how they become costs for the buyer. All business model components that involve relations with suppliers and business partners will infuence cost calculations. In a recent article we identifed how changes in markets motivate new price models. Two such changes are: 1) direct costs have come to constitute a smaller, and sometimes negligible, part of all costs; and 2) business relations are often long-lasting and involve dedicated investments in “asset specifcity” (Cöster et al., 2019, pp. 542–543): Many activities require high “up-front” costs and investments (Arthur, 1996), which then must be recuperated through charging customers for a range of goods and services which were enabled by the “upfront” outlays. As a result, accounting cost information often provides unreliable guidance in arriving at “fair” prices. Rather, both popular and academic literature on marketing suggests that customers’ valuation of their benefts from their purchases should be the yardstick (McNair-Connolly et al., 2013; McNair et al., 2001). . . . When contracting parties strive to become “partners”, “loyal customers”, etc., they may want to bind each other through contracted terms that promise a pattern of payments for a long time period. Such deals often require investment in capabilities that are meaningful only if partnerships evolve as expected; for instance, manufacturers of customised components are hostage to the success of their customers’ business. Costing of such business deals may be regarded more as capital budgeting than product costing, in its emphasis to understand the new initiative’s fnancial consequences over time. Commitments to maintain rapid service and spare parts for the duration of product life may bind resources for many years (see for example external costs in the “resource row” in Figure 5.1). Discussions regarding temporal rights in the equaliser may require input about how costs will occur over time. If a contract can be terminated, there will be less incentive to invest in long-lasting solutions like dedicated data links to a customer, even though this may be more economical and would be the chosen solution if a long-term contract could be agreed on. Mirroring the timing of a supplier’s costs in pricing and asking the customers to share the investment up-front may signal the intention of a long-term, loyal relation. A shorter contract moves the risk to the supplier, who then may choose to change the production setup
Cost and Its Relation to Pricing
to make it more fexible—even if the resulting higher variable costs may make the joint economic outcome less advantageous. Similar analyses should occur with suppliers and business partners in general. Who will pay for development, equipment and tools—which price models will induce component manufacturers to invest in accordance with maximum long-term economy? Cost consequences, risks from commitments that are made in the face of uncertainty, and alternative price models have to be discussed in parallel. “Life-cycle costing” is an approach that the literature suggests to integrate uncertainty and fexibility in choosing between designs with different future adaptability (Korpi and Ala-Risku, 2008; Woodward, 1997). Cost incidence through the choice of price models is as yet a little-explored topic.
How to Assess What Is a Relevant Cost to Include in the Cost Model Organisations always have costs that differ in how closely linked they are to a specifc object of analysis. The term direct costs implies a close, observable relationship, but there has always been a recognition that the distinction between direct and indirect costs was not very strict. For one thing, there is a time relation: given suffcient time, all activities and possessions that cause costs can be reconsidered, except possibly those relating to basic legal requirements which have to be fulflled in order to remain in business. On the other hand, in the short run, few costs may be possible to avoid. Indirect costs are mostly associated with capabilities and capacities which can be used for different purposes over a longer period of time: a production line, a computer system or skilled employees who are seen as key to future survival. By observing how such resources are utilised, we often allocate their cost (to some extent, arbitrarily) to specifc cost objects; either we call these costs “direct” and use classical “absorption costing” techniques, or we analyse and allocate them more closely with “activity-based costing” techniques. Regardless of how we do it, the relevance for decision making can be questioned. If there is spare capacity that we cannot use, or are not willing to terminate, why not regard it as a free resource? Costing always entails comparisons. For reporting purposes, full allocations may be useful. However, these reports are designed to answer questions about “what difference does it make?”. What are the relevant costs in deciding between different production alternatives, customers or designs of a contract? We need to assess, more clearly, how our choice drives costs: does it force us to acquire additional resources or change the use of our existing resources (as indicated in the rows “resources” and “activities” in Figure 5.1). The fve dimensions of the equaliser summarise how an organisation designs and contracts an offering, causing it—and business partners who may be involved in fulflling the order—to use
86 Theory and Conceptual Models resources differently from other possible price models. Let’s look at the fve equaliser dimensions in turn: •
Scope. Differences in scope may have consequences for cost beyond just adding the components of a “bundled” package. When products or services are sold separately, each transaction will require analysis of needs and requirements, administrative activities, contracting and delivery which do not have to be repeated if they are combined into a larger-scope deal. (This should result in lower costs in the “relations row” in Figure 5.1.) Such economies of scale may also extend over time—cf. subscription (Temporal rights). To be aware of such cost differences is obviously key to arriving at a deal which will beneft both parties, as the economies of scale and scope can be split between seller and buyer. Temporal rights. By extending a contract from a specifc point in time to a continuing relation, this could lower the cost per transaction, and the beneft could be possible to share with the buyer. This will obviously differ between products which are manufactured and delivered separately, such as a newspaper or a theatre performance, and those that involve complex and dedicated installations and training of customers, such as a specialised computer system. In the former case, costs will mainly be affected as the seller is guaranteed future sales; in the latter case, all costs may relate to the up-front installations. Infuence is about the power over pricing. For instance, a price list will often be changed because of changes in costs, negotiations will be infuenced by how costs are impacted by changes in agreements and proft sharing with customers requires agreement on how costs are calculated. Prise base. Earlier, we discussed briefy how even a deal, based on customer value, normally will involve a comparison with cost. There are several reasons for this, most obviously that a seller needs to make a proft by identifying customer needs that the seller is able to meet at a long-term cost which is lower than what the customer pays. Matching customer value and cost involve scrutinising each attribute in the offering and its costs and perceived value. How highly do customers value 24/7 service or rapid response time if a product fails? How much are they willing to pay for fossil-free production? Such questions require both studies of customer taste and cost analysis. In the costing literature, there has long been a method called “target costing” that can provide guidance, but it may be more useful here to negotiate product features and qualities against “open-book” estimates of how much the cost will differ for different setups and sharing the consequences between seller and buyer depending on what the two contracting parties believe is the best balance between cost and value (Kajüter and Kulmala, 2005).
Cost and Its Relation to Pricing •
Price formula. This dimension is mainly about what attributes are used as the visible basis for differentiating price between different deals and to what extent price varies with such attributes or is fxed. In the same way that classical economics predicts that price for uniform products, commodities, will be competed down to a level where costs are covered, it could be expected that Price formulas under “perfect competition” would refect the costs of providing each individual attribute: a highly specifed Price formula where, for instance, the cost of providing 24-hour or 12-hour service is refected in the price differential between these options. Although the total deal might be a bundle (and scope large), prices would then refect the cost of each attribute. This would, however, not take into account that the attributes used in pricing may not correspond to how qualities are produced. For instance, expert technicians or service facilities can be allocated in different ways, and attribute costs in the Price formula may refect willingness to pay rather than cost. Costs rarely occur as a direct consequence of agreed attributes, but rather refect long-term dimensioning of facilities and agreements with business partners about qualities and cooperation.
“Inbound” and “Outbound” Pricing—And Internal (Transfer) Pricing Pricing is usually discussed mainly from the seller’s point of view. We call these “outbound” prices. But obviously the prices a buyer pays—which we may call “inbound” prices—are equally important for the fnancial results of the company. It should be clear from previous chapters that many business models require cooperation between economic actors where prices should not necessarily be regarded as a result of competitive negotiations, but rather as expressions of sharing the value that the frms create jointly. With a long-term perspective, it may be important to defne formulas for sharing the value that is created to be fair, through linking prices to various characteristics of both parties’ contributions to their joint value creation. An important aspect of this is risk-sharing. In many business models, one partner handles marketing and has the main infuence on sales, while it outsources major functions to other participating frms. These may deliver components, but also handle logistics and after-sale service (as can be seen in Figure 5.1, where the cost split is equal also in the two business model components relations and channels). It will often then be considered fair to let the marketing partner bear the risk that sales are more or less successful, while providing the “upstream” partners some guarantee that they will cover their costs for maintaining readiness to deliver even if sales are low. On the other hand, there will be expectations
Theory and Conceptual Models
that exceptionally successful sales should be rewarding for all partners— but perhaps especially for the marketing unit which is the one closest to the customers. If one partner invented the business model and has the greatest fnancial strength, that partner may be in the best position to bear the risk of uncertain sales volumes. But before entering into the collaboration and determining the price models that best will realise the intended business model, all partners will have to consider the fnancial consequences of different scenarios. A good price model should provide incentives for handling one’s role in the collaboration, while at the same time taking into account the “levers” of value creation that each party can infuence. Often such discussions need to take a multi-year perspective, as for instance a provider of components may have to invest in production facilities ahead of time (“on speculation”) and may need up-front payments to do so. The cost model in Figure 5.1 can be used to show the fnancial outcome, given different designs of the outbound price model. Each price model should be assessed both from its “outbound” and “inbound” effects on behaviour and expected fnancial outcomes. At least this is the case between frms within a collaboration, such as those we discussed in the previous chapter. But even when selling to external customers or buying from suppliers outside the circle of collaborating partners, it may be useful to consider how innovative price models can be expected to affect their actions. Essentially such discussions are similar to what scholars and practitioners have been arguing about, for at least half a century, concerning internal or transfer pricing in large organisations (Eccles, 1983). Units are operated as “proft centres” or “cost centres”, and the relationship between them is structured as an internal market, where price models are used as the basis for internal coordination. The price models defne what the internal supplier is delivering and how the internal customer is going to pay for it. A producing unit will e.g. supply goods to a sales department; an internal service unit exists to support other units and may in such circumstances be expected to cover its costs through internal sales. Whether such prices should be based on costs or include profts, whether costs should be direct or full costs and how such costs should be calculated has long been argued over. With the discussion of activity-based costing during the last thirty years, it has been increasingly recognised how internal prices may be linked to so-called cost drivers and the need for a discussion of which organisational units control such drivers (Bjørnenak and Mitchell, 2002; Gosselin, 2006). In today’s frms, following several decades of outsourcing, the organisational units that still remain should be those that are regarded as the most essential to the frm’s strategy, and the collaboration between them as a long-term partnership. (These units constitute the grey bars in the chart to the right in Figure 5.1.) This should be a good basis for the kind
Cost and Its Relation to Pricing
of innovative pricing discussed in previous chapters, which can be applied also in internal supplier relationships where, for instance, service levels, agreed delivery times and the level of fxed costs associated with these, may be what an internal buyer pays for—rather than only the volumes that have actually been utilised. Internal prices then introduce yet another complication in judging the incentives and consequences from price models. When marketing confgures a large frm’s offerings with prospective customers and initiates a debate on how scope, service levels, etc. should impact the price formula, people in marketing should be aware of how scope and service promises impact other units in the organisation. Financial targets for the marketing unit should also refect this. The “recipes” for delivering the promises are not always apparent: for instance, must the organisation build a new service team close to a major customer in order to manage 24/7 service, and can the team then be used for other customers as well? The deeper reason for this is our desire to make it possible for a proft centre—or one frm collaborating closely with others in a complex partnership—to focus on its own success, while at the same time achieving long-term, multidimensional joint value creation. It is neither pure arms-length market competition nor top-down hierarchical authority. By using innovative pricing in the sense of Chapter 4, we hope to achieve coordination, which will let each unit act in the joint interest of the business model shared by both buyers and sellers.
The Degree of Partner Collaboration Determines the Cost, Expressed as Inbound Prices Organisations sometimes claim that their costs are largely variable and fexible, in a sense avoidable, because they consist of purchases from suppliers to whom they have not committed themselves long-term (cf. cost split in Figure 5.1). Costs thus can be related to business models (Chapter 3) in several ways. In a production chain, there will be purchased components and services that obviously constitute costs for the buyer who needs them for his offerings. Still, it is the supplier who is in the best position to develop effcient production methods to keep his cost low. How activities are shared in the business model will infuence where among partners costs occur and whose decisions determine costs. It is common practice that the components which make up a product have been bought and sold several times as intermediate goods and services. The price models that structure the relationship between the actors in the business model therefore determine how costs are perceived. The price models used for inbound pricing thus provide the incentives for joint efforts among the actors to match value and cost in a way that satisfes the fnal customer. When large organisations are involved in such business models, the actors we just talked about may be different units within a corporation or
Theory and Conceptual Models
a public authority. Management control in such organisations routinely uses proft incentives, meaning that the transfer prices should be regarded as valid cost estimates by purchasing units of the larger organisation. This opens up yet another need to keep track of costs in a way that can be linked to the price models in use. Literature on transfer pricing has long discussed the merits and demerits of basing such prices on cost or some estimate of produced value. It may seem attractive to let, for instance, an internal component-maker gain recognition for part of the proft made in the fnal sale of the completed product. On the other hand, internal buyers could then get an exaggerated impression of how much components cost. So, in many cases, cost-based internal transfer prices are preferred. When autonomous frms, or semi-autonomous units within the same organisation, use innovative price models as part of their collaboration in a business model, it will create interesting questions about the relation between cost and pricing. For instance, a well-designed price model may highlight, for two parties in a business model (e.g. a component maker and another frm selling the assembled product), how economies can be achieved by taking a long-term perspective and investing in tools and machinery based on a conviction that the collaboration is not fckle, but intended to last for several years. Such an intention may be best depicted in a price model that is cost-based (with a realistic idea of capital return for both parties), where the Price formula may contain both fxed and variable parts. There may even be some explicit sharing of risks, such that investments in equipment by the component-maker are partly fnanced by the buyer. Such practices have existed for a long time, where the large and fnancially strong frm identifes and helps a smaller frm, for whom it is unrealistic to make the long-term investments that are economically called for. The business model that both agree on may then be translated into several price models—one for their relation, another for external sales of the complete product—which are consciously designed to refect how costs will be impacted by different attributes as the hoped-for expansion of the joint business occurs.
Proftability: When Costs Meet Revenues—Delivering What We Promise Until now, we have assumed that the offerings that are sold to external customers and consumers can be “decomposed” in a meaningful way into components and services. In many of the cases we have encountered this is hardly true. Increasingly, it seems that the fnal sales depend on capabilities and activities that are very different from what the consumer wants. This is partly a consequence of “dematerialisation”: frms and households have needs that only indirectly are met through physical products; and if they purchase products, it is rather for their ability to give the customers the services or experiences they want. Often, they don’t care at all about
Cost and Its Relation to Pricing
the “recipe” used by the selling frm and its partners to deliver the services or experiences. So, the attributes in a Price formula will probably refect use, rather than the products enabling it: for instance, access time or speed for a data connection, rather than computer memory or technical quality of the router. Another example: few of us can describe the activities of our typical suppliers, such as our bank or insurance company, whose services we pay for. Those suppliers have costs both for their own activities (resource use) and for the constituent services they buy from others—from partners which are actors in their business model to suppliers of commodities at “arms-length” distance. The “recipe” can be regarded as a switch between the components needed and the offerings that are presented to us. In traditional costing, components are specifed in a cost calculation: materials, labour, overhead. For a frm to be able to trace how costs increase or decrease with changes in service level, like in Figure 5.1, more complex calculations are needed. For instance: if a frm identifes that customers are anxious about rapid service and exhibit high willingness to pay for it, it obviously becomes important to research what it will cost to cut response times. Is the best option to 1) make products that need service less often, 2) to have service teams that can reach customers more quickly, or 3) use the Internet to assist customers in restoring service even more quickly for a large part of breakdowns? What will it cost, and how can the worries of customers be converted into pricing where improved service guarantees are matched by higher prices? Three factors enter into this price-model design: cost, risk and expected revenues. Imagine a case where a seller is convinced it will be able to avoid breakdowns at an acceptable cost. Customers have the experience that breakdowns are frequent yet want the product and are willing to pay for guaranteed service. That seller and buyer have different estimates of risk. There is also a gap between the seller’s estimate of costs and the buyer’s estimation of how much the breakdowns will cost the operation. It should be quite easy in this situation to create a mutually attractive price model because the seller’s expertise provides a solution to the buyer’s needs. Such deals also seem commercially attractive because both sides can focus on their situations without being distracted by issues of “fairness”. Over time the gap between willingness to pay and predicted cost of promising uninterrupted service may diminish, making this a less commercially attractive business. The buyer will learn that breakdowns are no longer frequent, and there may be competitors who offer even better terms. The latter depends on how unique and diffcult it is to imitate the “recipe” for providing dependable services. This is a good example of how dematerialisation and increased consumption of what some call “experience goods” are changing market competition in ways that also impact cost calculations.
92 Theory and Conceptual Models
Cost Assessment Is an Important Input for Price Model Innovation and Selection In Cöster et al. (2019), we suggested a framework we call RITE—Relation, Intention, Technology, Environment—to study how innovative price models may be applied in situations that differ strategically. Which costs are relevant to a business decision is often, like we said earlier, a matter of which alternatives we are willing to consider. For instance: if a frm intends to retain a certain capability and environmental-friendly materials are part of its image, there are certain immutable “givens” for the alternatives it may consider, and thus for its costs. If so, the company has to have a way to recover those costs by introducing a suitable price model. For a more developed discussion of RITE, readers are referred to Cöster et al. (2019). Here we will briefy discuss the acronym’s four parts, focussing on how they relate to costs. Combining them, we arrive at a number of categories which could be of use when thinking about how cost information is needed under different strategic conditions. •
Relations, both with customers and partners, will differ in duration and resources. For simplicity, we may contrast them as arms-length and partnerships. Investing in relationships will obviously require that it is attractive as a long-term proposition. When a relationship is seen as arms-length, all outlays are likely to be viewed as costs that should be remunerated by customers immediately. Intention. We have identifed how intentions in relations may differ in terms of strategic benefts and degree of differentiation. A simple dualism could here be to distinguish deals where both parties are guided exclusively by short-term commercial success (proft) or to take multidimensional benefts like learning, preparing for future collaboration or establishing reputation through the reference-value of a sale into account. In the latter case, some of the outlays may not be viewed as costs for the immediate commercial deal, but investments in future opportunities: learning and development of new capabilities. Technology. Salient differences in technology may impact pricing, for example the degree of asset specifcity and inspectability. Traditional physical sales often concern goods that are well-defned and where a successful fulflment of an order can easily be agreed on, while for instance an innovative computer system’s success may depend on many factors, be diffcult to agree on until after years of use and even then be diffcult to evaluate due to changing circumstances. Such differences infuence to what extent costs can be traced to a specifc purpose, making them logical as a basis for pricing. Environment. We would especially like to highlight institutional factors and uncertainty as the main contingent factors of importance to pricing. In highly regulated felds, with low levels of change,
Cost and Its Relation to Pricing
agreements may be very different from situations where future market conditions are unpredictable. Broadening the concept of environment to sustainability issues, it becomes even harder to trace costs to a specifc business deal. Rather, there may be extra costs that relate to overarching and future-related aims like making one’s entire business operations “future-safe” in terms of their impact on conditions that are sensitive in the eyes of regulators or stakeholders. Among the needs for costing in connection with pricing, and especially design of price models, it is obvious that these conditions together should infuence cost calculations. A relation which both partners identify as a long-term partnership, with the intention of developing joint capabilities, is likely to involve resource commitments up-front, joint risk-sharing and more openness about costs and the proftability of fnal external sales. If it happens in a situation where the solution to a customer’s problem, rather than an established product, is the external offerings—and where market conditions are hard to predict—loyalty and a sense of shared destiny may be needed. Also making joint investments and sharing of information may be a natural way to develop trust and deepening collaboration.
Implications This marks the end of this chapter, and the end of the frst part of the book. The main message we have delivered so far is that pricing must be understood in its context. In this book, we offer a broad recommendation: do not only consider the characteristics of the business model. Also put the business model into its contexts. We have argued that the space surrounding the business model is best understood as an ecology. This metaphor highlights the volatility of the system, acknowledging that new entrants may step in and disrupt the ideas about how the company is working. The metaphor also makes it easier to see how ideas diffuse and potentially “infect” the unwritten rules of the game. For example, the way companies set up their price models—how they charge the customers for their offering—is a highly concrete example of how ideas fy. After a quick search on the web, we got 350,000 hits on the exact phrase a Netfix for. When looking at the hits, the idea of subscription-based price models has been discussed in as diverse felds as transportation, travel, restaurants, games, electricity, eyewear and so on. But, by using the price model equaliser, we have demonstrated that there are far more alternatives to compete with innovative price models than just introducing subscriptions (like Netfix). In the next section of the book, we will show almost a dozen companies who have developed their business models by using innovative price models. After the three chapters on our triplet of business ecology/business model/price model, we concluded the frst section of this book with this
94 Theory and Conceptual Models chapter’s summary of how to address costs in light of business and price models. The take-away from it is that any analysis of a new, or changed business model, should also address the cost consequences. We suggest a high-level cost model that is based on the four building blocks of the business model. It summarises the costs of resources, activities, relations and channels. In addition to this, it also reports explicitly on the cost split, for each of these components, based on the idea that any business model—in today’s society—is dependent on partners. Hence, costs are reported as external and internal. This creates a notion of who the business model relies on and also allows for more thorough analyses on what to do internally and what to source externally. This cost model should be used for decision purposes. And its intended use is to assess the robustness of the business model and price model. Given how the value proposition is operationalised in the price model, what revenues could we expect, and how big are the potential costs? The cost model should be updated, as the sliders in the price model equaliser are changed, e.g. if the company extends the scope of the offering or moves from perpetual sale to subscription, how is that likely to affect activities, resource consumption, channels and relations? How much of this is going to be kept internally and what will be sourced from external partners? And what are these partners’ attitudes to risk? Some might want to get paid upfront for everything they deliver, regardless of the success of the business model, while others may want to bet together with the company facing the customers, assuming risk and potentially getting much higher revenues if (and when) the complete offering gains momentum in the market. The cost model is compatible with contemporary activity-based costing methods. Activities, relations and channels in the business model mainly consist of processes. Hence, summarising costs is about assessing the resources spent on activities underlying these processes and making sure that they connect to the right process. Likewise, inbound prices need to be split up to make sure that the costs in the partnering companies are connected to the right component in the business model. In summary, this is what we have dealt with in this frst section of the book. We are now ready to turn to a handful of illustrative examples. In Chapter 6 we will present fve different innovative price models. We have chosen them to illustrate how a simple shift in any of the fve dimensions in the price model can result in fundamental changes in how the offering is perceived. In the subsequent two chapters we will present a somewhat deeper description of two different situations. In Chapter 7 we will address the transportation ecology, based on an outside-in approach. We will cover different actors in the ecology, how they interact with each other and give examples of price models in play. In Chapter 8, on the other hand, we will take the reverse approach. We embark on a story within a specifc company that a newspaper described as “a Netfix for images”. We present the company’s business model and why the company’s founders are certain it will be successful in the business ecology where the company operates.
Cost and Its Relation to Pricing
References Arthur, W. Brian (1996). Increasing returns and the new world of business, Harvard Business Review, 74(4), pp. 100–109. Bjørnenak, Trond & Mitchell, Falconer (2002). The development of activitybased costing journal literature, 1987–2000, European Accounting Review, 11(3), pp. 481–508. Cooper, Robin (2017). Target Costing and Value Engineering (London: Taylor and Francis). Cöster, Mathias; Iveroth, Einar; Olve, Nils-Göran; Petri, Carl-Johan & Westelius, Alf (2019). RITE: Meta-model for conceptualising innovative price models, Baltic Journal of Management, 14(4), pp. 540–558. Eccles, Robert G. (1983). Control with fairness in transfer pricing, Harvard Business Review, 61(6), pp. 149–161. The Economist (2019). Why Americans pay more for lunch than Britons do: Even when they are buying the same sandwich, 7th September, Available from: www. economist.com/fnance-and-economics/2019/09/07/why-americans-pay-morefor-lunch-than-britons-do [Accessed 5 November 2019]. Gosselin, Maurice (2006). A review of activity-based costing: Technique, implementation, and consequences, Handbooks of Management Accounting Research, 2, pp. 641–671. Hope, Jeremy & Fraser, Robin (2003). Who needs budgets?, Harvard Business Review, 81(2), pp. 108–115. Johnson, H. Thomas & Kaplan, Robert S. (1987). Relevance Lost: The Rise and Fall of Management Accounting (Boston, MA: Harvard Business School Press). Kajüter, Peter & Kulmala, Harri I. (2005). Open-book accounting in networks: Potential achievements and reasons for failures, Management Accounting Research, 16(2), pp. 179–204. Korpi, Eric & Ala-Risku, Timo (2008). Life cycle costing: A review of published case studies, Managerial Auditing Journal, 23(3), pp. 240–261. Krishna, Aradhna (1991). Effect of dealing patterns on consumer perceptions of deal frequency and willingness to pay, Journal of Marketing Research, 28(4), pp. 441–451. McNair, Carol J., Polutnik, Lidija & Silvi, Riccardo (2001). Cost management and value creation: The missing link, European Accounting Review, 10(1), pp. 33–50. McNair-Connolly, Carol J.; Polutnik, Lidija; Silvi, Riccardo & Watts, Ted (2013). Value Creation in Management Accounting: Using Information to Capture Customer Value (New York: Business Expert Press). Nunes, Joseph C. & Boatwright, Peter (2004). Incidental prices and their effect on willingness to pay, Journal of Marketing Research, 41(4), pp. 457–466. Wertenbroch, Klaus & Skiera, Bernd (2002). Measuring consumers’ willingness to pay at the point of purchase, Journal of Marketing Research, 39(2), pp. 228–241. Woodward, David G. (1997). Life cycle costing: Theory, information acquisition and application, International Journal of Project Management, 15(6), pp. 335–344.
Cases and Examples
Innovative Price Models and Digitisation
Introduction Welcome to the second part of this book, where we apply the theoretical concepts presented in Chapters 2–5 to a number of empirical examples. The main purpose is to illustrate and explore how organisations can act in order to develop strategic and innovative pricing in a digital economy. In this chapter, we will focus on fve cases of innovative price models— one for each of the fve dimensions of the equaliser that was presented in Chapter 4. We will also include a short description of each company’s business ecology and business model. The subsequent Chapter 7 uncovers actors and relations in the transportation ecology. Here we apply an outside-in perspective and observe various actors and relations in the ecology and highlight examples of several business models and price models. In Chapter 8, we take the opposite approach and apply an inside-out perspective. This chapter presents an analysis of a business model and its price models based on observations made within a single “born-digital”company that is active in a global business ecology: the company Pickit. Finally, in Chapter 9 we summarise the content of the book by presenting conclusions and a way forward. Let us now start this second part of the book by looking closer at fve samples of innovative price models enabled by digitisation. Five Cases of Innovative Price Models Each case will start with a short introduction of the company and a description of the business ecology where we found it. Then we highlight what are the most important parts in their business models. The illustration of the ecology and the business model are broad and high-level investigations in order to fnd the most important determinants for the price model. Each case ends with short discussion about the innovative and digital traits of the price model. Table 6.1 provides an overview of the selected cases.1 As partly illustrated by the frst column, the cases represent a wide variety of businesses.
Cases and Examples
Table 6.1 Summary of the cases presented Case
Price model innovation
Dimension in the equaliser in focus
Expanding the scope of the offering Switching from sale to rent Leaving pricing to the market Pricing customer value instead of cost Offering fxed price on taxi rides
Husqvarna Google AdWords Siemens Cabonline
Temporal rights Infuence Price base Price formula
All cases focus on presenting and discussing outbound price models (but of course all of them also have inbound price models from subcontractors and partners). The middle column provides information about the actual innovation, and the third column shows which dimension in the equaliser is of biggest interest. The cases were selected mainly based on two criteria: 1) that they have introduced some innovative feature in their price model, and 2) that they rely heavily on digitisation. Readly and Google Ads were born digital (i.e. they could not have existed without the Internet and digital technology). The other three operate in traditional industries and have used digital technology to develop innovative price models.
Extending the Scope of the Offering: The Case of Readly Readly is an aggregator of traditional physical magazines, distributed in a digital platform. The company was founded in 2013 and has been widely referred to as a Spotify of magazines, with the potential to disrupt parts of the publishing ecology. The offering is sold as a fat-fee subscription that gives the customer access to over 4,000 magazine titles (both current and earlier issues) and functionality to search for topics and articles across all available issues. The magazines can be read on the IOS and Android platforms (phone or tablet) or on the computer. Readly is a global service and it cooperates with more than 700 publishers in the UK, the US, Ireland, Germany, Switzerland, Austria, the Netherlands and Sweden. Readly is for the magazine industry (all-you-can-read) what Spotify is for the music industry (all-you-can-hear) and Netfix for the movie industry (all-you-can-watch). According to Readly, part of its value proposition is a smooth and easy-to-use service of an abundance of titles, and at the same time an opportunity for publishers to reach a wider
Innovative Price Models and Digitisation
(and often unknown) audience that goes beyond those who the publishers already reach in their respective ecologies. Business Ecology There are a number of competitors within Readly’s ecology, e.g. Apple News+, Blendle and daily news directly from publishers like Financial Times, the Economist, and the Wall Street Journal. For example, Apple News+ offers a subscription service in the US market to users of iOS devices, for 9.99 USD per month, where the customers can access more than 300 newspapers and magazines. The service is only available to US customers using Apple products (iOS platform). In the European market, the biggest competitor is most likely Blendle from the Netherlands. Blendle offers articles from newspapers and magazines but with a completely different price model, as it relies on micropayments and charges the customers about 0.2 euro for each individual article they read instead of a monthly fat fee as Readly does. However, there are also other actors, besides direct competitors, in the ecology. These are for example Netfix (movie and TV series), Spotify (music) and Audible (audiobooks). They offer another kind of content but compete for the user’s time. It is not likely that a consumer will watch a movie and listen to an audio book at the same time. Business Model Readly’s main customer type is what it refers to as “entertainment junkies” who also subscribe to other similar services, such as Spotify, Netfix and Audible. The users are evenly divided between men and women. About 40% of the customers use the service every day, and they read approximately 33 articles per month. According to the CCO of Readly UK, Ranj Begley, many publishers were afraid that Readly would cannibalise on their existing revenues in the beginning. However, only 2% of Readly’s customers also subscribe to the paper magazines. Readly’s customers also read the magazines in a different way than how paper magazines are typically read. The readers browse the titles in higher pace and explore new magazines and topics more frequently. This is the reason why Readly claims that publishers can fnd new customers—in new market segments—by allowing their content to be read through Readly. Seventy percent of Readly’s revenue is paid to the publishers, based on the time readers spend on the articles. In addition to the money the publishers get, they also get real-time data about the readers’ behaviour and how articles and magazines are consumed. The data is recorded on a very granular level so the publishers can see, for example, how many minutes readers spend on specifc items such as articles and advertising (combined with demographic data) in real time. Another selling point,
Cases and Examples
when attracting publishers, is that there is no set-up cost for the digital distribution and there are minimal risks. Readly can show it has already aggregated an interested audience, which the publisher can tap into. If, for example, the publisher would try to implement a similar technical solution, it would require signifcant marketing and technology development costs. Price Model The core of the value propositions is to offer customers the world’s biggest digital compilation of physical magazines. Hence we categorise the offering fairly close to the top in the Scope dimension (see Figure 6.1). Competitors, like Blendle, would on the other hand be categorised at the other end of the spectrum since they have chosen a price model where they sell single articles—much like buying a single song in iTunes. Apple News+ would be placed somewhere in the middle of the scale, as it does not yet have the same amount of agreements with publishers, is only available in the US and can only be accessed via iOS devices. The temporal right is categorised as a subscription, as the customer subscribes to the service. Subscription is different from rent in the respect that rent will only give access to the same content during the contracted period (e.g. renting a movie from Google Play will only give access to that particular movie), whereas a subscription is a promise from the suppliers to add new content during the subscription period. Signing up for a subscription hence entails some risk, since the customer has to trust the supplier that the catalogue of available material will grow, not shrink.
Figure 6.1 Readly’s outbound price model
Innovative Price Models and Digitisation
In the third dimension, Infuence, Readly’s price model is located at the bottom of the lever. The price is 9.99 euro/9.99 USD/7.99 GPD per month, with no room for negotiation. In the fourth dimension, we categorise the price model as competitor-based, since it seems closely aligned with what other entertainment streaming services, such as Netfix, Spotify and Audible, charge for their offerings. As more and more streaming services have been launched, in various entertainment markets, the price levels seem to have gravitated towards a price of around ten euro. In other words, Readly offers a price level that seems well aligned with the general opinion regarding what an entertainment subscription costs. Finally, the Price formula is fxed as the price is a fat fee, in the same way as many other popular entertainment streaming services. Innovative and Digital Traits of Readly’s Price Model Overall, Readly has taken a frst-mover advantage within the ecology of magazine distribution in a digital environment. There are few competitors offering a similar value proposition with a similar price model within the industry. Readly has also been at the forefront of digital media technology and succeeded in signing up publishers to join its platform. It also seems to beneft from having customers that are accustomed to a subscription-based price model, as the majority of the users also subscribe to Spotify and Netfix. A potential threat to Readly is that it may get lost in the “media noise” in the entertainment ecology. However, the CEO of the company claims that its service has a high degree of “stickiness”, as the users who have signed up tend to stay for a long time. Forty percent of the customers who tried the service fve years ago are still using it. Readly’s revenues seem promising. In 2018 (Readly, 2019), the turnover was almost 20 million euro—an increase of 54% compared to the year before. Still, the losses are substantial: almost 50% of their turnover. The reason for this is most likely increasing marketing costs in newly established markets, continuous product development and the revenue split with publishers. In this way, Readly is presently pursuing growth over proft (similar to Spotify’s strategy). Overall, Readly is both an interesting and relevant example of a streaming service that has the potential to change some of the rules in the publishing ecology, completely relying on digital technology; and an example of a new and innovative price model compared to its competitors.
Switching From Sale to Rent: The Case of Husqvarna Husqvarna Group is one of the leading producers of outdoor power products for forest, park and garden care in the world. They develop, produce and sell chainsaws, trimmers, robotic lawnmowers, ride-on lawnmowers and garden watering products.
Cases and Examples
Husqvarna’s market position is strong, and it is considered to head the market for robotic lawn mowers, watering systems and garden tractors. It comes in at a fattering second place in the segments of chainsaws and trimmers. In total Husqvarna has more than 13,000 employees worldwide, turns over more than 4 billion euro and has an operating proft of 5–10% over the last years. In the given market situation, Husqvarna is in a good position. Business Ecology However, the market is changing. At Husqvarna this has been spotted; and true to its mission of being an innovative company that aims at solving its customers’ problems, it is not sentimental about its existing product portfolio. In studying the business environment, it has identifed fve important trends that gradually will hit its offerings and how it operates. This may have signifcant impact on its business ecology. The following trends are of greatest importance: electrifcation, digitisation, urbanisation, new buying behaviours and increasing attention to environmental concerns. Husqvarna has a long tradition. It was founded in 1689, and its people pride themselves in their passion for innovation, development and precision. This has led to a long line of successful products and solutions in very different areas—from weapons, sewing machines and motorcycles to garden equipment. Its core competence has, for many years, been combustion engines, which have been an integral part in its products since the early 1900s (when it started to produce motorcycles). Switching from combustion engines to electric motors is an important switch, both to employees who have a background in combustion technology, and to customers who may not trust that battery-driven equipment is as powerful as combustion machinery. In an effort to turn the opinion in favor of electric engines, Husqvarna has taken initiatives to demonstrate that such equipment offers as good performance as petrol-driven equipment does. Digitisation has made it possible to embed intelligence in products, e.g. enabling new innovations like the robotic lawn mower. Such equipment carries onboard computational capacity to monitor and control the cutting process (computational decision making on where, when and how to cut the lawn). An additional, and important, trend is urbanisation. Following from more urban living, garden sizes are diminishing, reducing the need for more powerful garden tools. It can be assumed that when gardens get smaller, some customers will be less interested in buying advanced garden tools. This latter trend has both resulted in increased competition from low-price suppliers (whose equipment will not last for long, but still be “good enough” for some “casual users”) and fueled the parallel trend of new buying behaviours. Over the last decade, the idea of “owning” has been challenged, with the introduction of concepts like circular economy and subscription-based models.
Innovative Price Models and Digitisation
Business Model Central to the business model is the company’s vision and purpose. Husqvarna states that their core purpose is “Turning technology into opportunity—With a passion for innovation we create performance, pride and improved results for our customers”. In line with this credo, the company decided to challenge its existing operating model, even though it still is highly successful. The existing business model is based on selling high-end garden machinery through highly specialised re-sellers who are often located at places far away from where household customers typically go. Husqvarna wanted to extend the business model also to target urban customers, who need high-quality equipment, but do not necessarily want to own it. According to Husqvarna’s calculations, there are customers who only use some of their garden equipment for as little as 0.3% of the time (over the year). To some homeowners, renting would be a more attractive alternative for some products (than buying them). Hence, in 2017 Husqvarna initiated the development of a completely new offering which was launched and tested that same year. The results were promising, so the test has now (2019) been extended and released in fve more markets. The offering is based on a branded and computerised storage box that contains 30 lockers. The container can easily be put in places where potential customers frequently go—like shopping centers or outside big grocery stores. The lockers contain various high-end electric garden machines from Husqvarna, including batteries and even protection wear, like gloves. The container is controlled by a computerised surveillance system. Each locker is individually controlled by an app that can be downloaded for free. Through the app, the customer books and pays for the machine she needs. The app is used to open the correct locker door. In the app, the customer can also get instructions on how to use the specifc machine. The location of Husqvarna’s traditional resellers was one of the issues being addressed when extending the business model with this new offering. The frst box was placed in the middle of a parking lot outside a big mall, in the outskirts of Stockholm. From a business model perspective, renting instead of selling introduced new internal processes that needed attention. The products are rented per day and must be returned before 8 p.m. at night. The customer returns the machine in the locker by opening the door through the app. “Returning” is thus handled by the customers themselves, but Husqvarna needs a dedicated process to check, clean and recharge the products so that they can be rented again the next morning at 8 a.m. Price Model The offering focuses on a slightly bigger bundle than just the machine. In the locker, the customer will not only fnd the machine and the battery
Cases and Examples
box, but also some protection wear and maintenance equipment like lubrication oil. The offering is also extended into the app, where the user can watch video instructions on how to use the product. The offering is still rather narrow, so we position the Scope closer to attributes than system; see Figure 6.2. The core of the pricing innovation lies in Temporal Rights. Husqvarna’s belief is that customers in the given ecology are increasingly becoming used to renting products on a demand-basis, rather than owning them. Sometimes, this offering (and others) has been referred to as a subscription model, but we categorise it as rent because the functionality of the offering does not change during the contracted period. Neither would we call it pay per use, since the fee is set for the full day (regardless if it is used much or little during that day). The price is set by Husqvarna. The price was approximately 35 euro per day (during the frst proof-of-concept phase). All types of machines in the box were offered at the same price. The price was also the same, regardless of weekday or when during the season the rent took place. Even though the offering is new, there are some competitors in the wider ecology. Firms in other locations (e.g. construction rental companies, typically addressing the professional market) offer similar machines for day rental. When Husqvarna set the price of its offering, it acquainted itself with the prices in that corner of the ecology and used that as a Price base when deciding the price level. Hence, pricing started off with a reference to the remote competitors’ price levels. Finally, the rent is set per machine and day. If the customer wants to rent two machines, the price will double. Hence, we categorise the price formula as per unit.
Figure 6.2 Husqvarna’s outbound price model
Innovative Price Models and Digitisation
Innovative and Digital Traits of Husqvarna’s New Price Model To summarise, Husqvarna’s Battery Box is now released in fve additional markets around the world. It is an example of an innovative price model. In this case, Husqvarna actually challenges the existing business model (selling machines). For several reasons, Husqvarna believes it to be important to add new offerings—based on a new price model—to the market. The shift from combustion engines to electric motors still meets some resistance among customers due to battery anxiety. Renting, instead of owning, releases the customer from that risk. Also, urbanisation, with less need for machinery due to smaller gardens, reduces the need for the type of high-quality equipment Husqvarna produces and sells (as mentioned earlier, Husqvarna estimates that some customers only use their equipment as little as 0.3% of its availability—if bought). And, fnally, in the wider business ecology, attention to environmental concerns is becoming more and more important, both among suppliers and customers. Hence the idea of the circular economy and “subscription-based” models have grown in popularity. Husqvarna is an early mover in addressing these trends and catering for these needs. Even though the core component in the new value proposition is very physical (a chain saw, a trimmer, a hedge cutter, etc.), digitisation is completely fundamental in introducing the offering as such. Without apps and mobile phones (including security and robust identifcation mechanisms) it would be less feasible to operate the container automatically. Also, the container as such includes advanced security and surveillance functionality to assure that the lockers are not opened by unauthorised persons. The system also keeps track of the inventories. At present, the price is the same, regardless what and when the customer rents, but in the coming versions there will be better opportunities to shift pricing dynamically (through the app) based on contingent factors like demand and weather conditions.
Leaving Pricing to the Market: The Case of Google AdWords We don’t believe Google needs any extensive introduction anymore. Its name has even grown into a verb, like Rollerblade and Yo-yo. To google something is to search for it on the Internet. The frst time the name was used this way was in 2002 in an October 15 episode of the TV series Buffy the Vampire Slayer. Since then, the Google corporation has become one of the world’s highest-valued companies, and it has diversifed into many different business areas. In August 2015, it changed its name to Alphabet Inc. to separate the corporation from the search engine offering. In this nugget, we will focus on the original search engine (Google, or BackRub as it was originally called). The
Cases and Examples
name “BackRub” referred to Larry Page and Sergey Brin’s idea that links leading to a website (so-called “backlinks”) could be used to judge its credibility and relevance, in the same way as researchers use citations as a proxy for academic quality. Business Ecology Internet, in the application domain, seems to be in a constant state of fux. Most apps and services are, so to speak, not more than a mouse click away. To switch from one search engine to another is not more diffcult than instructing the web browser to use a different web page. Still, for the last decade, Google has maintained a “market share” of around an astonishing 90%. This might be an indication of the perceived quality of the search results generated by Google or successful creation of lock-ins, where actors in the business ecology fnd it too diffcult to switch platforms (since Google also offers functionality other than Internet search, e.g. communication, storage and productivity applications). Contrary to what could have happened (given diminishing transaction costs, where users can easily move around between different providers in the business ecology), many seem to prefer a limited set of platforms where they spend most of their time. Rather than transaction cost economics, network externalities may seem to be a better perspective to understand why, at least up until now, the winners almost take it all in these types of business ecologies. If all friends are, for example, connected to Snapchat, it is more likely that a new user would go there rather than to a competing app with fewer users, even if the cost of entering, or switching from one to another, is fairly low. In Google’s business ecology, value creation is about simultaneously providing relevant information to users and offering advertising space to companies. Marketing in digital channels is growing rapidly, whereas advertising in traditional channels (like newspapers, broadcast television, billboards and physical mail) is shrinking. In many countries there are mainly three platforms where users fnd information and advertisers go to fnd potential customers. All of these operate on the global market. People who are looking for products typically ask Amazon frst, customers who are searching for a topic use Google and people who want to keep up to date browse their Facebook feed. Successful presence on these three platforms will connect most advertisers to potential customers all over the Western world. We will now turn to Google’s value proposition, which is about allowing advertisers to display ads for potential customers, attracting them to click on a link and drive traffc to the advertiser’s website. We will not describe Google’s, or Alphabet’s, complete business model, only the set-up and design of Google Ads.
Innovative Price Models and Digitisation
Business Model The core of Google Ads’ value proposition is the opportunity for advertisers to reach potential customers in the exact moment when they are interested in the topic the advertiser is marketing. This is argued to be the biggest difference between general marketing and online marketing: the ability to reach exactly the audience who is looking for something that the advertiser has to offer. Over the years, Google in the role as an intermediator between advertisers and potential customers, has refned the possibility to target audiences, not only based on what users are interested in (as demonstrated by what they search for), but also on very detailed geographic, demographic and temporal conditions (e.g. only show the ad to people in a specifc city, to users in a certain age interval, who has certain interests, and only during a particular time of day). To be able to segment the market with such granularity, high search volumes are required. With Google’s 90% market share, and the volume of intentional searches made every day, each such specifc quota is typically big enough. In total, Google performs 5,5 billion searches per day, and some 15% of them have never been searched before. Almost regardless of how narrow the advertiser defnes the target audience, it will be big enough, counted as number of individuals, to be attractive to address. Google’s value proposition is of course completely dependent on digital technology. (Google is digital technology.) Also, the customer relationships and customer channels are completely digitised. Google has made it very easy for anyone, without much prior knowledge of marketing, to create ads and tailor the target audiences. The complete process from becoming a customer, producing and managing advertisements and customer segmentation, to customer service and billing is automated. Google Ads’ monitoring system also allows every customer to evaluate the effects of its marketing campaigns, i.e. which ads and which audiences generate the expected number of clicks. In Google Ads’ interface, the customers can see detailed reports on the payback of the money spent on ads. If the company is advertising to sell something, customers can even see exactly how many purchases the ad has resulted in, allowing them to adjust how much they are prepared to pay. This brings us to the core of Google Ads’ business model—the set-up of the pricing mechanism. Given the enormous search volumes and Google’s ability to segment the searches in a variety of dimensions, it has been able to monetise the “golden moment”, when a user asks Google for the most relevant information on a specifc topic. In the early beginning of Internet advertising, the ad space was rented (banners were placed on websites, similar to billboards along roads). As traffc to the websites could be measured more precisely, site owners could charge the customers for the number of times an ad had been shown (selling impressions, rather than display time). Compared to newspapers and broadcast media (that also
Cases and Examples
measure audience, and claim impression), digital marketing could even measure if the desired action had been taken. Instead of just measuring the number of times an ad had been displayed, the site owner could assume more risk (and thereby raise the price) by only charging the customers when the users clicked on the ad to get to the advertiser’s site. In many such setups, the price was negotiated or set per each click. Google, on the other hand, realised that if at least two customers were interested in showing up on top of a specifc search (in connection to a user’s explicitly stated interest, i.e. the search term used on Google), the price level could be determined in an auction. The more narrowly Google could defne the searches (including all relevant information regarding the search: words, location, personal characteristics, time of day, etc.), the greater the number of available auctions to run. As long as at least two buyers competed to get the most prominent position on the SERP, a market-based price level could be established automatically—by letting the competitors bid against each other. Google does not have to assess the relevant price levels for a click on a certain search term; the customers will tell Google how much they are willing to pay for it. The users must trust and like the search engine to return to it. Without search engine users, Google would not have any value proposition to offer the advertisers. Therefore, it is in the interest of Google not to jeopardise its position as the preferred search engine among users. That is one of the reasons why Google never allows traditional fashing banners on its site, since it believed this would affect the user experience negatively. Instead, ads were displayed very discreetly, as text messages at the side of the organic search results. No images, no colourful fonts. Just plain text displaying a title, a link and a short message. Also, the paid links on Google must be relevant to the user’s interest. Since the visual design of the ads is not very different from the organic search result, it is important that they lead to sites that are relevant to the user (given the search question). Hence, Google analyses the quality of the site the link refers to and takes that into account when awarding the winner in each auction. Google multiplies the advertiser’s bid with the site’s quality (measured by Google in the so called QualityScore, QS). The prime space in the SERP is awarded to the company with the highest ad rank (bid x QS). By assuring that the page is relevant to the specifc search term, an advertiser can win an auction on a lower price per click than a competitor who is bidding higher but is referring to a page that is not as relevant. As a rule of thumb, a page with QS 10 will win an auction at half the price of a competitor with QS 5. A bidder with a very low QS (1) would have to pay four times as much to win the auction as a bidder with QS 5. Given this combination of bid and quality, and that the prices are set for every search that is made on Google, it is impossible to know the price levels of advertising on Google in advance. However, it has been reported that the price window is very wide. In
Innovative Price Models and Digitisation
auctions with few participants, advertisers with high QS can buy clicks for almost nothing (0.1 cent), while there is no theoretical price roof in competitive auctions. (In 2018, “Business Services” cost 58.64 USD per click on average, “Bail Bonds” 58.48 USD per click, “Casino” 55.48 USD, and “Lawyer” 54.86 USD.) Some sources even report much higher prices in very specifc searches: e.g. the price for “Car accident attorney Long Beach” was 590 USD, and “personal injury lawyer in Colorado” sold for 585 USD (Mondovo, 2019). Price Model When search engines began to make their way into the public’s eye, they were typically monetised in the same way as ads in broadcast media. Advertisers could buy “banners” on the sites, and either pay a monthly fee to be featured on the site or sign up for a more performance-based fee where they paid for ad space based on the number of times the ad was viewed, or even the number of clicks it generated. In 2000, Google launched the AdWords program where it sold and displayed ads on a “cost-per-thousand impressions” price model. The price levels were preset: “The AdWords program provides low-cost exposure on one of the industry’s leading search engines with CPMs from $15 or 1.5 cents an impression, $12 or 1.2 cents an impression, and $10 or 1 cent an impression, for the top, middle, and bottom ad unit positions, respectively” (Google, 2000). In 2002, Google left the impression-based price model and replaced it with a more results-oriented alternative: pay-per-click. What Google realised was that if at least two customers are interested in showing up on top in a specifc search (in connection to a user’s explicitly stated interest, i.e. the search term used on Google), the price level could be determined in an auction. When buying ad space on Google’s search results page, it is not only the actual display of the ad that is included in the package. When signing up for Google Ads, the customer also gets access to a complete System that supports her in the creation, management, analysis and billing of Internet marketing activities on the Google platform. All these services are available to the customer without having to pay extra (or qualify) for the more advanced features. Clicks are sold per piece (i.e. pay per use), and Google displays the ad for as many times as is needed to reach the goal (number of clicks and budget). Neither the customer, nor Google, are participating in the price establishing process (see Figure 6.3). Google lets the market mechanism play out for every search that is performed. Sometimes the highest bid is close to zero; sometimes it reaches the stratosphere. The customer can control the cost of advertising on Google by setting the maximum price she is prepared to pay for a click, and the maximum budget for the day. If a bid
Cases and Examples
Figure 6.3 Google AdWords outbound price model
is too low the ad will not be displayed, and no clicks will be generated. If the advertiser raises the bid and/or improves the quality of the site, the likelihood of winning the auctions will increase. We argue that Google’s pricing is a good example of customer value-based pricing. No customer pays more for an advertisement than he is prepared to. And, fnally, there is no fxed fee associated with buying ad space on Google. The customers only pay for the clicks they receive (i.e. per unit). Innovative and Digital Traits of Google Ads’ Price Model The importance of digitisation to Google goes without saying. Google was born digital and global. Its core offering is to use digital technology to organise the world’s information and make it universally accessible and useful. In every activity Google performs, technology is at the core. At the same time, we argue that Google’s decision to charge the customers based on clicks and to allocate the price-establishing process to the market may be one of the prime reasons for its monumental success. By being able to monetise on its initial innovation, the ranking algorithm, Google has secured funding for the continued development of the various components of its platform. If such funding had not been available, it is less certain that Google would have been able to keep up with the competition and innovation. By being at the front, continuing to attract users who search for information, it has a steady infow of users who come to them with a deliberate intention to fnd an answer. By being somewhat selective and
Innovative Price Models and Digitisation
only selling visibility to “the right” advertisers (those who offer relevant commercial answers to the questions asked), in specifc auctions, it has been able to grow the market and to entice the customers to pay even more (by using auctions) to get the prime position in each of these micro markets. No human could have ever managed a pricing process of this magnitude; hence Google is a good example of how pricing can be used to innovate in digital markets.
Pricing Customer Value Instead of Costs: The Case of Siemens Siemens is one of the biggest industrial conglomerates in the world. It has close to 3385,000 employees and turns over more than 86 billion euro (2019). Siemens is a publicly traded company and operates in numerous industries, such as energy technology, health care technology, industrial automation, drive technology and consumer products. In this example we will focus on Siemens’ small- and mid-sized gas turbine machinery. Siemens offers a wide range of turbines in different sizes (from almost 600 MW down to 4 MW) for various applications. The biggest turbines are typically used for electrical power production. The smaller the turbines get, the broader the application domain. In addition to producing electricity, they can be used for drilling and pumping oil or powering compressors to produce pressure that can be used in many application areas (from running machinery to maintaining chemical processes). The gas turbine machinery offering is truly global. The customers are spread all over the globe, as is Siemens’ feld service organisation and spare-part distribution network. The small- and mid-sized gas turbines are developed in two main locations, one in England and one in Sweden. This gives the business ecology certain characteristics. Business Ecology The main business ecology, where Siemens’ gas turbine unit operates, is facing radical change. To begin with, producing electricity for a power grid is a complicated task. The power producers’ direct “market” is the grid. The grid must be centrally controlled, so it is never over- or underpowered. Too little power will lead to power shortage among the users. Too much power may damage equipment in the grid. Hence, all power grids are run under some kind of centralised regulation, since someone needs to keep the momentaneous balance between production and consumption of electricity. The actual generation of power used to be a public responsibility (via state or municipally owned production units), but over the last 20 years, privately funded producers have also been established. These can either be contracted by the state or by a grid operator (if the energy market is
Cases and Examples
still considered a monopoly) or operated on a more “traditional” (deregulated) market where end-customers select which individual producer and distributer they want to source their power from. Regardless of how the actual power market is structured, there has emerged a variety of different power producers in most regions of the world—with different aims and goals. As the market grows more heterogeneous, so do the requirements on subcontractors and partners (like Siemens). Some customers may seek advanced technology, whereas others may ask for assistance to reach business, or other, goals. In addition to the fundamental physical structures in this business ecology, concepts and ideas from other domains have entered the scene. Most important, of course, is the attention to climate change. There is a major shift in the power generation industry, away from fossil-based fuel to renewable energy sources. In the total production mix, and the physical confguration of electricity grids, this can serve both as a threat and opportunity for mid-sized gas turbines. On the one hand, fossil-based fuel (like gas) is phased out; on the other hand, there might be a growing need for smaller turbines that can operate as balance power when there is momentary shortage of renewable energy (like wind and sun). Also, high-level “business concepts” are popping up; digitisation, big data and machine learning are promising great rewards also in this feld. And there are new fnancial actors that have entered the industry to look for resources they can invest in—as with any other type of capital investment. These players typically lack an in-depth industrial knowledge but have great fnancial capacity. Relying on their fnancial resources they can buy both development services (establish, construct and deploy power production facilities) and continuous operation of it. When a power plant is up and running, it can deliver secure fnancial returns at fairly low risk. To these players, “black-boxing” the development and operation is not a problem, as long as the investments generate the expected fnancial results. This boosts the opportunity for collaboration and partnership in the business ecology. Previously, organisations in this industry were monoliths and self-containing entities (they were one unit, with one shared goal). Nowadays, many “organisations” are created as networks of separate units (that may pursue slightly different goals) that collaborate on certain specifc endeavours (like setting up and running a power plant). In the construction phase of a power plant, it is not uncommon that a consortium of many different suppliers cooperate. Sometimes, some of them will even stay during the operation of the plant to make sure that it operates optimally. In such settings, there may even be an expectation that the ones who have developed and built the power plant (who are experts on the technology) are actually better than the customer (who has funded the investment) running it. Establishing such partnerships offers completely new contractual set-ups between the supplier of the technology and those who are buying it. All of these business ecology conditions infuence Siemens’ turbo machinery business model in several ways.
Innovative Price Models and Digitisation
Business Model Siemens has a long tradition of being considered one of the best suppliers of gas turbines in the world. Its competence and experience (for more than 100 years) has been appreciated by both industrial and fnancial actors, in both the power and oil and gas industries. Over the years Siemens has been delivering machines of outstanding technical quality as well as best-in-class service. The service offering covers both regular maintenance and repair activities, as well as capacity-enhancing modifcations and upgrades. The service offering has traditionally been offered according to pre-defned service plans (approximately every third year), with smaller or bigger overhauls (not very different from how cars are serviced). Following two fundamental and simultaneous trends in the business ecology, Siemens has started to redesign the service offering: these trends are digitisation and the ambition to become an even more important business partner to all sorts of customers. First, digitisation has made it possible for Siemens to capture and process data about the operation of its installed base of gas turbines. Extensive data capturing on-site allows Siemens to know exactly how each plant is running. Not only running hours are important to keep track of in order to know when it is time for each type of service intervention. Also, exogenous factors such as temperature, humidity and the air’s salt level (depending on e.g. how close to the ocean the plant is situated) affect the expected life span of the components in the plant. When using advanced statistical tools, new forecast models on degradation can be calculated, allowing Siemens to tailor the service plan to each plant, rather than to each model in general. This will not only allow many customers to run their plants longer (reducing waste by not exchanging parts before they are worn out, contributing to a smaller environmental footprint). It will also reduce the number of days the plants are stopped for service (increasing utilisation) and will allow customers to run their plants in manners that are tailored to their demands (allowing different patterns; e.g. running continuous base load, reducing the cost per kWh or allowing many starts and stops, optimising on selling kWh at high spot prices). With deep knowhow of the machine integrity, as the OEM of the machine, together with the intelligence of each specifc machine’s realtime operation data, Siemens can shift its focus towards supporting each customer to optimise its operation, based on what creates value for each specifc customer. Maintenance will not just be a consequence of the technical operation, but will be an integrated part of the scope for optimised business operations. Second, Siemens wants to become a close business partner to its customers. The ability to tailor service plans to specifc plants is one big step towards creating true customer value. With generic plans, the offering is similar to Henry Ford’s famous quote. In this setting it would sound like this: You can service your plant according to any plan, as long as you
Cases and Examples
choose the one we have defned. As noted earlier, Siemens is now able to align the service and operation of each plant to its specifc circumstances. To some customers, who have extensive technical knowledge, the traditional plans might do. On-site, these customers have employees with extensive knowledge and experience about the plant, and they might want to buy service and repairs on a piece-by-piece basis. These customers will know more about the plant than Siemens does. Simultaneously, other customers may consider their plant a purely fnancial investment, and they may not have any expertise on the technical details regarding the plant. Instead, they would like to buy maximal production or even maximal proft (i.e. only running the plant when the gap between price and cost is the highest). These latter service and operation plans are completely different from the service plan that is offered to customers with high technical competence. In order to launch this type of customer-centric service offering, all the resources mentioned are necessary to operate the extended business model. To be able to create reliable, tailored service plans, Siemens both needs to capture detailed data about each site’s operation and have the analytical and computational skills to calculate each site’s operation pattern to know the degradation of each component. In addition, Siemens needs to develop its sales skills to engage with its customers on what it considers business value. To some customers “realised proft” may be more important than anticipated operating costs. If so, the sales representative from Siemens needs to convince the customer that Siemens can help him generate such proft by implementing a tailored service and operations plan. Price Model Traditionally, suppliers in the power industry have sold service and overhauls based on the resources consumed in such efforts. The number of hours spent in the service intervention and the cost of the components being changed have been the typical base for the price. In addition to that, the generic service plans have regulated when certain components should be switched, regardless of whether the operation patterns and the location of the site have affected when each component needs to be changed. Most likely, some parts may be replaced before they are completely worn out. Siemens’ innovative new price model, which will co-exist with its traditional price model, addresses these two issues, only replacing components when needed and charging for the service based on the value for the customer (rather than the costs associated with it). The Scope of the offering (as described in Figure 6.4) is fairly wide. Instead of detailed and pre-defned service steps, the offering focuses on the plant as a whole. If the contracted variable is production volume, revenue or even proft, there are many various initiatives that can be taken
Innovative Price Models and Digitisation
Figure 6.4 Siemens turbo machinery outbound price model
in the plant to maximise this. The interventions will not only focus on switching blades in the turbine but can as well focus on using the digital control system to run the turbine according to a better scheme. They can also include an upgrade of a component without having to seek acceptance from the customer. Siemens can decide to install it, if it contributes to delivering bigger output (which Siemens will get paid for). The Temporal right is defned as a subscription. Neither Siemens nor the customer knows what the most rewarding initiatives during the contracted period will be. Instead, the interventions are black-boxed, since it is the realised outcome that is contracted. Depending on how much risk Siemens is willing to take, the Infuence dimension could vary; either the price could be negotiated for the contract period or Siemens could get paid according to the production results. In the latter case, the customer would not have to worry that Siemens wouldn’t put in the extra effort to help him in reaching his goals. If production volume is the customer’s main objective, Siemens would get paid based on the amount of power produced, i.e. based on the results. The whole idea underlying the new service offering, and its price model, is that Siemens’ revenue should depend on the customer value they create. Finally, the price formula is still volumedependent (i.e. per unit). The more customer value Siemens contributes to (defned as production volume, revenues or proft), the more money it will earn.
Cases and Examples
Innovative and Digital Traits of Siemens’ New Price Model Siemens’ new customer-centric price model marks a big change in what is contracted. The norm in the industry is to bill the customer for the work and the components that have been changed in the service interventions. The new price model shifts the focus, as the core component is the value created (defned as production volume, revenue or proft). Hence, the change is mainly made in one dimension: price base. The Scope is fairly much the same. The agreement is still a subscription, as is the case in traditional service agreements: the supplier and the customer agree that the supplier will maintain the plant according to a generic service plan. In these types of big deals, the price is typically established in negotiations. This may also be the case in the new price model. But if the customer wants to emphasise the mutual attention to customer value—which is the main change in the price model—it can be embedded as a results-based set-up in the contract. Finally, the price base is still volume-dependent, as was the case in the traditional price model. But instead of paying per hour or per component, the new price model can be defned as a price per kWh or per euro. The development would not, as aforementioned, have been possible without digitisation. Thanks to massive computing capacity and advanced statistical programs, researchers at Siemens have been able to develop detailed forecasting methods to know when different parts in a plant need to be changed given certain contingencies. Through new sensor technology, each plant is measured in high granularity (both over time and in detail), which generates plant-specifc data that can be fed into the forecasting models, allowing Siemens to create tailored service plans for individual plants. This has enabled Siemens to launch new service offerings that revolve around what is considered value by the customers—and price them accordingly.
Assuming Full Risk—Offering Fixed Price on Taxi Rides: The Case of Cabonline The transportation sector is argued by many to be one of the ecologies that will face the most dramatic changes in the coming years due to digitisation. Therefore, we will devote a full chapter (Chapter 7) to the potential macro changes that may happen in this ecology. In this section, however, we will focus on one particular actor in one corner of the transportation sector—the Swedish taxi service provider Cabonline. Several trends led up to Cabonline’s decision to implement a new price model: the introduction of binding fxed prices between two addresses, offered to the customer before the trip starts. The deregulation of the Swedish taxi market, competition from new players (like Uber), customer dissatisfaction with how taxi trips are charged and the unforeseeable
Innovative Price Models and Digitisation
challenges from profound digitisation of the transportation sector all contributed. This made Cabonline—the biggest Scandinavian taxi operator, which operates several taxi labels like Taxi Kurir, Sverige Taxi, Taxi Skåne, Topcab, Norges Taxi, Covanen and FixuTaxi—reconsider the way it priced their offering. In combination, the trends described earlier and the owner’s conviction to listen to the customers resulted in a unique price model—true fxed-fee between any two given places in the country. No other taxi company offered that at the time. This nugget tells the story of how Cabonline introduced a new customer-initiated price model. Business Ecology The Swedish taxi market is dominated by three interconnected types of actors: the taxi brands, the taxi owners and the taxi drivers. The “brand” is mainly the administrative hub that the taxi customers interact with when they book transportation. Customers can either contact the brand over phone or online, whereas corporate customers and travel agents can interact with them through dedicated booking systems and application programming interfaces (API). The taxi cars serve as an extension of the brand since they are striped with the brand’s name and colours. However, the cars are not owned by the brand. Instead, they are owned by independent taxi owners, who can select either to belong to a brand (a long-term relationship) or operate as an independent taxi (still with specifc identifcation marks, like a special license plate and a sign on the roof to show that it is a taxi). Different brands are set up in different ways. In the Swedish deregulated taxi market, anyone can set up a taxi brand. But the cost of establishing a brand seems to be a barrier to entry. In Stockholm, e.g. there are only a handful of brands. They have developed out of two very different origins. The oldest brand, Taxi Stockholm, was established in 1899 and originally offered horse cabs. It is a member association and consists of almost 1,000 taxi owners. The brand is, so to speak, created and controlled by the taxi owners. Cabonline, on the other hand, does not have any such formal connections to the taxi owners. On the contrary. The brand is run more like a franchise business. It offers a concept, administrative processes, and aggregation of customer demand via long-term contracts with companies and public tenders (for transportation of elderly, disabled persons and school kids). The publicly funded transportation accounts for approximately 50% of the taxi market. By aggregating demand and developing competitive concepts, Cabonline attracts taxi owners to the brand. The brand was founded in 1989 (under another name) by a former taxi driver, and it was sold to an American venture capital frm (HIG Capital) in 2015, for between 200 and 300 million euro. The taxi owners (typically small companies who own one or two cars; 66% of all taxi companies only own one car, and 14% own two cars) carry the capital cost of the vehicles, as well as the labour costs of operating them.
Cases and Examples
The owners spend a lot of time in their car. But to make it pay, the car needs to be in circulation almost 24 hours a day. To achieve such a utilisation, the taxi owner must rely on employed drivers. Remuneration in the industry is typically variable; the taxi owners get paid when there is a customer in the car, and the same pay structure is used between owner and driver. The drivers’ salaries are based on the amount of money they generate. In 1990, Sweden deregulated its taxi market. Anyone can start a taxi company or a taxi brand. There is no limits to the number of taxis that are allowed to operate in a city, and there is no price regulation. All agreements are bilateral between the taxi owner and the customer. However, the price must be explicitly stated on an offcial sticker in the rear side window of the car. Prices can vary during the day and week (typically, the prices are higher on Saturday nights than on Tuesday afternoons). The deregulation of the taxi market resulted in an increase in independent taxi cars. Being independent allows them to set any price they want. Typically, their prices are higher than the taxis belonging to a brand. The independent taxis’ prices can be between 50% and 100% higher than the brand’s prices (the “comparison price” for a trip with a Cabonline taxi is approximately 32 euro, and a normal price level for an independent taxi is 50–80 euro, some even above 100 euro).2 When deregulating the market, each supplier was given the sovereign right to offer its services at whatever price level it wanted. The underlying assumption, by the lawmaker, must have been a trust in the market mechanisms; taxis that offered their services at a too high price would not be selected by the customers and eventually have to lower their price levels or go out of business. However, it seemed like this assumption was not completely correct. Business Model The Swedish taxi market can, roughly, be divided into three broad segments: commissioned trips (e.g. transportation of elderly, disabled or school kids, funded by the welfare system), company trips (where big companies or travel agencies have special deals with taxi brands) and ad hoc trips (where the traveller picks a taxi on the street). Even though commissioned trips and company trips account for the majority of the market (where buyers are educated and scrutinise their suppliers), the development in the smallest segment of the market affected the general view of taxi companies. As the price levels for ad hoc trips, when picking a random taxi on the street could vary as much as 100 percent, the public opinion regarding the deregulation and the taxi market gradually became very negative. In newspaper articles and television interviews, travellers who “had been fooled” to pay excessive amounts for a ride (even though the price had been publicly displayed on the window) raved about the state of the taxi industry. Not only did the high price levels
Innovative Price Models and Digitisation
among some independent taxi operators attract severe criticism, but the fundamental characteristics of the price model that is frequently used in the industry—where customers pay a variable price for a service they cannot control; where they have to assume the full risk of the driver’s driving pattern—was criticised. In a large commissioned survey, an astonishing 92% of the respondents explicitly stated that they would like to know the fnal price of the trip before it started, and 81% of the customers said they didn’t even understand how the price for a trip was calculated. Given Cabonline’s value proposition, running a double-sided business model, it pays equal attention to both the travellers and the taxi operators. The simultaneous focus on these two stakeholders made it possible to challenge the established price model in the industry, where taxi operators and drivers do not have to assume any risk for the actual delivery of the service. If a driver gets stuck in a traffc jam or decides to choose a less optimal route, it does not hit the driver or the operator. The taximeter is running, and the customer has to pay regardless of the circumstances. According to the founder of Cabonline, this was not a sustainable business set-up. Eventually, some transportation operator would launch an offering that would be more aligned with the vocal and (according to the founder of Cabonline) reasonable claim among the customers to know the price of the offering before they actually consume it. The founder was also confdent that Cabonline was in a good position to implement such a new offering—better than any of its competitors, given that Cabonline operated as a traditional company with one owner instead of being a member association (as the biggest competitor is) where all strategic decisions needed to be accepted by the members (in this case the taxi operators who would have to assume the new risk, compared to the traditional model). Cabonline’s business model is, as mentioned, double-sided. On the one hand, it aggregates customer demand, and on the other it aggregates transportation supply. Taxi owners are recruited to the brand and are compensated based on how much they drive. The inbound price model hence matches the outbound price model (volume-dependent revenues and mainly volume-dependent costs). Even though taxi owners can leave the brand, there is a switching cost associated with entering and leaving it following from the striping of the car and the installed technology that connects it to the brand’s dispatch system. Hence, taxi owners can be considered more of partners to Cabonline than pure suppliers. The main resource within Cabonline, to be able to deliver the new offering, resides in digital solutions. In order to offer a fxed price for a ride between any two given positions in Sweden, an advanced digital map and routing system needed to be developed. The system creates momentaneous quotes for any trip. Trips that are not possible to anticipate in advance (different from the competing taxi brands who offer fxed price trips between a limited number of origins and destinations, like from the vicinity of the city centre to the airport). In addition to maps and routing, the system also must
Cases and Examples
integrate traffc predictions, so a reasonable price level can be calculated and quoted. If the quote is too low, it will be diffcult to attract drivers to the trips that are sold at a fxed price, since all drivers are remunerated based on their earnings. Selling a trip at a fxed fee, without knowing how long it will take to deliver, increases the risk of the driver. Many drivers would rather choose to pick another booking that they know would be fully compensated regardless of the driving circumstances. In addition to the back-end system for routing and calculating prices, a front-end booking system is needed. Bookings can be made in various interfaces; initially the new price model was released to corporate customers, through the legacy booking module that is integrated with most travel agency systems and through the internal interface that is used by Cabonline’s telephone operators. Later, the new price model could also be accessed through a dedicated app that was launched when the offering was introduced to the consumer market. Price Model When Cabonline launched the new value proposition, it did not make any changes to the Scope of the actual service (see Figure 6.5). In some segments of the market, more “advanced” services have been launched e.g. by offering more exclusive cars, making it more limousine-like, and offering extra treatment during the trip (like fresh water in a bottle and a daily magazine). No such changes were made in Cabonline’s new offering. The cars and the service were the same.
Figure 6.5 Cabonline’s outbound price model
Innovative Price Models and Digitisation
The Temporal right is also unchanged. Each trip is sold as a separate entity (i.e. pay per use). “Fixed price” in this respect does not imply that the price is fxed regardless of the number of trips the customer books or the distance of the trips. The fxed price is offered for each specifc occasion, which means that Cabonline will offer different price levels for the same trip, depending on what time of day and year it is. Also, the price level is based on a price list. Cabonline’s system produces a quote, and the customer’s only option is to accept or decline it. There is no room for negotiating the price (as is the case in many other taxi markets). The price engine in the system uses the same price components as when the trip is charged based on taximeter: expected travel time and distance, and the time of day, results in the binding quote. The price band among the big taxi brands in Sweden is fairly narrow, which makes us classify the price being based on what the main competitors are charging. Finally, we fnd that the only shift in the price model is in the Price formula dimension. The typical price model in the industry (which is also offered by new entrants, like Uber) is to charge a combination of a fxed and a variable price. It is the variable component (price per minute plus price per mile) that pushes the fnancial risk to the customer. Cabonline, of course, takes time and distance into account when calculating the quote, but in the price model it does not separate the two. Instead, it relies on the estimate and offers the customer the trip for a Fixed amount. Innovative and Digital Traits of Cabonline’s New Price Model With only a small shift in the price model, Cabonline has changed the characteristics of its offering completely. When the taxi industry faced hard criticism connected both to its established price model and to some actors’ questionable price levels, Cabonline took this opportunity to launch a new price model that targeted the customers’ preferences. The shift from Fixed + per unit to a binding fxed ex ante price released the customer from the risk of not knowing how much the service would cost until it had already been consumed. Digitisation is completely essential in realising this new offering. To begin with, booking is mainly made directly by the customer in any of Cabonline’s digital interfaces. But that is not the core of the offering; the digital routing and pricing engine is what enables Cabonline to offer fxed prices on unique trips, of which many have never been quoted before. To be able to automate such a pricing process, Cabonline needed a detailed and up-to-date map system which could calculate the optimal route between any two places in Sweden. Not only does the system take general traffc patterns into account, but it also integrates live traffc data to predict the shortest and fastest possible route between two locations, in each unique situation.
Cases and Examples
To our knowledge, Cabonline’s new price model is one of the few in the world that offer a binding fxed ex ante price, offered to the customer before the trip starts. We can see three main reasons why Cabonline was able to release this new offering and price model: 1) the deregulation of the Swedish taxi market in 1990, which allowed any company to start a taxi business and to set any price it liked; 2) a strong reaction among customers against the industry’s pricing scheme (and shameful pricing among some operators); and fnally 3) the ownership structure of Cabonline that made it possible to innovate on the offering that created value to the customer by shifting the fnancial risk from the customer to the supplier (the taxi operator and driver). Still, the higher risk in the back end of the business model could lead to improvements and better returns to the drivers. When the price is fxed, there is an incentive for the driver to fnd a shorter route to the destination, because this will increase proft. For drivers to leverage this opportunity, they needed to enhance their capability, for example, learning more about the traffc situation and how to use technology more frequently to avoid roadblocks and congestions.
Implications In this chapter we have described fve companies that have launched price models that are different from the norm in each respective industry. Newspapers are typically sold as individual subscriptions, while Readly offers a large bundle of titles in one subscription. Husqvarna mainly sells high-quality garden equipment but decided to experiment with short-term rental as well. Google has built an automated pricing engine, so it won’t have to spend intellectual capacity on estimating the correct price for specifc search terms. Siemens has launched a new offering where it stopped selling parts and labour hours and instead contracts on what creates value for the customer. And, fnally, Cabonline introduced a fxed-price model, which completely shifted the risk from the buyer to the seller. In all the cases we have shown, none of these innovations would have been possible without access to digital technology. Readly and Google were born digital—so in their cases it is obvious. But also in the traditional industries of garden equipment, maintenance of large industrial systems and more simple transportation services, the traits of digital opportunities were obvious. Another pattern, that is equally important, is that we can see that a company does not need to make many changes in the price model, to set it apart, and make it different from the competitors’ price models. In the case of Cabonline, just pulling the slider one step down from fxed + per unit to fxed completely changed the character of the agreement. The driver could take any way he wanted, and it would not affect the price for the trip between two addresses. Similarly, changing the Temporal rights,
Innovative Price Models and Digitisation
in the case of Husqvarna, from perpetual to rent both aligned the offering with contemporary ideas on circular economies and environmental concerns and became a remedy to fght battery anxiety. In this chapter, we have also honoured the conceptual model we argue for in this book: that the relevance of a price model is defned by how well it aligns with the business model, and that the business model, in turn, cannot be assessed without taking the greater business ecology into account. However, we have had to be brief to be able to cover all these cases. In the following two chapters we will move from broad to deep and dive into two different settings. First, we will continue from the taxi ecology, into the wider motor-vehicle-focused transportation ecology. After that, we will explore the price and business model of a specifc company that strives to become a “Spotify for images” in an ecology that consists of more than a billion knowledge workers who are using Microsoft products in their daily working life.
Notes 1. Readly, Google Ads and Cabonline have been explored by us as customers (i.e. buying and using their products). Altogether we have spent hundreds of hours using these respective services. This frst-hand experience was combined with publicly available information composed of mainly annual reports, articles in newspapers and information from websites. Empirical data about Cabonline has been collected through interviews and archival material. This has been reported on in a separate article (Petri, 2014). Opinions about the taxi market have been collected through interviews with interviewees from the Swedish Taxi Association, the Swedish Transport Agency, the Swedish Tax Authority and the Swedish Police. Also, data and information about the industry has been compiled from governmental reports and investigations about the industry, the Taxi Association’s trends and future outlooks, as well as earlier research on the taxi market. Information about the background, development and implementation of Taxi Kurir’s (part of Cabonline) new price model has been captured through interviews with two representatives from Taxi Kurir and interviews with taxi drivers. The cases of Husqvarna and Siemens are mainly based on publicly available sources but have also been complemented by interviews with representatives on the inside. The data was collected in 2013 (Cabonline) and during 2018 and 2019 (Husqvarna and Siemens) and entailed interviews with several managers (all three cases) and internal documents (all three cases). This primary data was also combined and triangulated with secondary data composed of annual reports, news articles and website information. The interviews focused mainly on the discussion connected to each dimension of the equaliser and more explorative questions connected to business ecology and business models. 2. The most expensive taxi in Stockholm, at the time of the study, offered its services at the whopping comparison price 1,000 euro, which meant that a customer who would happen to take that taxi from Stockholm to the airport would have to pay approximately 3,500 euro for that one-way trip. The typical market price is 60 euro if you go with a taxi from one of the big brands. Nota bene: this taxi was not a luxurious limousine service. The taxi was an ordinary car, and from what we would guess, maybe not with the most service-minded driver.
Cases and Examples
References Google (2000). Google Launches Self-Service Advertising Program, Available from: http://googlepress.blogspot.com/2000/10/google-launches-self-service. html [Accessed 26 November 2019]. Mondovo (2019). World’s 1000 Most Expensive Google Keywords in 2019, Available from: www.mondovo.com/keywords/worlds-1000-most-expensivegoogle-keywords [Accessed 11 November 2019]. Petri, Carl-Johan (2014). Using an innovative price model to leverage the business model: The case of price model innovation in the largest Swedish taxi company, Journal of Business Models, 2(1), pp. 56–70. Readly (2019). Årsredovisning för Readly International AB 2018, Available from: https://s3-eu-west-1.amazonaws.com/public.readly.com/web/shared/ar_readly_ international_ab_556912-9553.pdf [Accessed 12 September 2019].
A Motor-Vehicle-Focused Transportation Ecology
Introduction In Chapter 2, we looked at the car-related actors Valeo and Aixam Mega from a car-centric ecology perspective. There, non-car-specifc trends, like energy-awareness, CO2-emission regulation, servitisation, diversifcation and economies of scale, impacted the relevant ecologies in important ways. Here, we will widen the scope and look at a transportation ecology, still with ground-based vehicles driven by the general public as a starting point. This ecology analysis displays dynamic reconfguration and a wide and developing fora of business and price models.
Waking Up to Electrifcation Electrifcation is an obvious answer to calls for CO2-emission reduction and a move away from petroleum-based transportation. Although electric cars have a history of over a century, entirely electric cars were not a major factor until championed by Elon Musk and Tesla and the launch of Model S in 2012. The Musk and Tesla ambition and subsequent realisation of large-scale production and sales of all-electric, high-performance, high-profle cars, demonstrating that complete electrifcation was both technically feasible and attractive on a market, set in motion a rapid move towards electrifcation among Western and Chinese car manufacturers. In addition to implications for the petroleum industry and mining (to enable large-scale battery production), and changes for companies such as Valeo, it has led industrial groups, such as Siemens, into ventures aimed at the growing electrically-powered-vehicle market. In Siemens’ case, it took the shape of a joint venture with Valeo in electrical powertrains in 2016, a venture that three years down the road is still struggling with establishing economic viability, and the strain it puts on Valeo’s proftability has led a French government-owned bank to start investing in Valeo stock to protect the company from foreign corporate raiders. The intended range of products will face competition from many quarters, and the intended products are to some extent a move into unknown territory. The joint
Cases and Examples
venture is a sign of long-term commitment to mutual investments and collaboration in a strategic bet on a mutually benefcial growth opportunity; but apart from that, price models appear to be traditional and the intended novelty lies in developing new, valuable electric powertrain solutions by combining the complementary resources of the two partners. In addition to existing industrial players like Valeo and Siemens, niched start-ups also see international possibilities, entering the feld from, for example, backgrounds in electrical engineering or digital systems. One example is Charge Amps, producing high-capacity charging cables to keep in the car to facilitate interfacing with publicly available charging stations, and a car-brand-independent charging station for companies with employee and guest parking places, and for people who want an optimised ability to charge their, or others’, cars at home. Its business model involves considerable interaction with other parties. It has sourced the exterior design from a designer working for a high-profle sportscar manufacturer, received investments from, among others, an owner of a petrol-station chain and a municipal energy company, and partnered with an international electricity company to reach customers and to promote the reverse-charging functionality, vehicle-to-grid, allowing the car to work as part of the grid to help balance the grid and to reduce the customers’ electricity bills by charging at low-cost hours and relying on the car-battery electricity for consumption during high-cost hours. The value propositions thus involve more actors than Charge Amps. The usefulness of the charging cables will depend on what public charging stations and connector standards other actors offer—and on future development of de facto and de jure standards. And not only will Charge Amps view its own charging stations as a product where the value offer depends on charging and reverse-charging capabilities of car manufacturers’ batteries, but also on the price models offered by electricity companies. It is also possible that car companies and electricity companies will come to view reversecharging-enabled charging stations as part of their value propositions. The niche entered by Charge Amps is far from uncontested. Musk, entering the electric-car business from a background in international digital platforms aiming at consumers (for city-guides on the web and for online payments), also is pursuing electricity-related ventures, for example in solar power and in battery packs for private or grid use, but on a large and innovative scale. Another, smaller but well-connected, player is Anton Piëch, great-grandson of Ferdinand Porsche, who, with a background in Asian studies and having run a media agency in China, is launching an electric sports car with extremely fast charging—80% in less than fve minutes. The battery technology relies on collaboration with the Chinese-German actor Desten for developing batteries and related products, and the charging infrastructure relies on collaboration with Hong Kong-based Qingdao TGOOD, a major actor in power transformation and distribution in general and both selling and operating charging
A Motor-Vehicle-Focused Ecology
infrastructure for cars. Piëch’s sports car is not aimed at the mass market, but the fast-charging and discharging batteries in it would constitute an excellent resource for grid-balancing if they would become wide-spread. Tesla, expected to have sold one million vehicles by mid-2020, is more of a potential grid asset due to quantity, despite the batteries not being as fast in charging and discharging. Actors like Charge Amps, potentially providing reverse-charging capacity to millions of owners of electric and hybrid cars, could also become an interesting resource to grid managers, if electricity companies develop price models that would enable households and small-scale parking-lot operators to become not just customers, but also temporary electricity suppliers. Batteries and charging infrastructure is thus not a standardised area yet, and the development of battery and charging technology and the proliferation of electric vehicles thus starts to go hand-in-hand with the development of electricity infrastructure in general, with cars potentially serving as balancing parts of the electric grid, and with battery-pack technology for cars going hand-in-hand with larger, stationary battery packs for individual houses or larger units. Who sells what to whom then also becomes a more complex issue. Wider ecology perspectives are needed to detect developments that enable and force business-model changes and revision of price models.
Growing Use of Small Vehicles Let us return to small vehicles. Along the path followed by Aixam Mega— the development of smaller vehicles—others have taken further steps in many respects. In China, e-bikes have been a growing alternative to combustion-engine motorcycles for over two decades, and by now, different sizes of e-bikes and electric scooters are as common as cars—a quarter of a billion of each. The growth has been a response to restrictions on vehicle emissions, with e-bikes not producing exhaust fumes and, even if the electricity is produced with fossil fuel, having CO2 footprints of only a few percent of that of combustion-engine cars and motorbikes. The growth was also fuelled by fear of contagion in public transportation during the SARS epidemic in 2005, when the total stock of e-bikes was around 10 million. But none of those drivers would have prompted the spread of e-bikes, had e-bikes not also been a very inexpensive alternative to other motor vehicles. The Western world lags far behind in e-bike sales and e-bike use, but increasingly companies like Lime, WeTrott, CIRC and Voi are deploying feets of small rental e-scooters, bought from companies like Fortune-500 Xiaomi and start-up Ninebot, complementing the existing urban transportation options. For shorter distances, convenient access to small scooters that can travel at 20 kilometres an hour has made them a popular alternative in cities where they are available.
Cases and Examples
Companies offering free-foating feets take extensive use of existing digital infrastructure. Using available digital mobile networks, the scooters are kept track of. Their battery status, whether they are currently rented or not and their location (based on GPS, the US Air Force-operated global positioning system) are monitored online, so users can leave them wherever it is not forbidden, fnd and access them (unlocking them via a smartphone app, which also handles payment), and the feet operators can collect, recharge and service them when needed. Some operators use independent collectors, who are paid per vehicle they collect, recharge and place back in circulation according to instructions in the map-based app. The rates can vary according to time of day, location and status of the vehicle. Payment from scooter users can be by the minute, possibly with a fxed amount for unlocking and starting to use a vehicle, and at a fxed per-minute rate or one that varies depending on the current demand at that time and in that location. The GPS tracking can also allow the feet management system to reduce maximum speed in pedestrian areas and shut off the power if the vehicle reaches the border for allowed use. The shared scooters are each used far more than the individually owned ones, which could be good from resource-footprint perspective, but currently, that also presents a problem because of wear and damages. Many of the scooters in the feets are built for private use and do not last long under the high-use, low-care conditions that unmonitored driving and parking by casual non-owners create. Business models that do not encourage careful use and parking will be diffcult to maintain. A high turnover of the feet causes doubt both about life-cycle resource effciency and footprint and about economic viability from a more narrow operator perspective. Some feet operators, like WeTrott in Paris, require check-in and checkout of vehicles in docking stations, rather than employing the free-foat model, to prolong the life of the scooters. But that comes at reduced convenience to users in terms of fexibility of access and drop-off location. Fixed parking-space feets do not serve a last-mile transportation need as well as free-foating feets do. Balancing retrieval costs and investment costs with rental revenues is diffcult, and the sustainability of the business models is still uncertain, so business model redesign and experimentation continues.
Buy or Rent If the rather new vehicle-type e-scooter is popularised in the West through fexible rental arrangements, cars are in a different situation. Having typically been widespread in the Western world as consumer durables, purchased and used by an individual or a small group, like a family, the attitude among the general public has started to shift. In urban areas with good public transportation and limited and costly parking, owning a car is becoming less common. This creates a reason for car companies
A Motor-Vehicle-Focused Ecology
to explore other ways of selling cars—and other potential sources of revenue. Also, the general trend in society towards servitisation infuences car companies to consider how they can create servitised offerings. Thirdly, digitisation, and not least the widespread use of smartphones, provides an infrastructure where new services become possible and demand-side scale economies can be powerful and valuable. To incumbents, these ideas can be worth exploring, both because they offer interesting potential for future business, and because others are exploring them and could start posing a threat to existing business models. At the same time, a start-up mainly only ventures the capital of venture capitalists, not the fnancial resources and historical legacy of an existing business. For established frms, in contrast, unsuccessful new ventures or just heavy investment in such uncertain strategic bets will strike at their current proftability and possibly threaten their existence or at least ownership status, like in the case of Valeo and its joint venture with Siemens. Car rental, by the hour or day, with fxed pickup and drop-off locations, has been around for a long time, with or without car companies as owners, but the basic service offer has been largely unaltered since its inception a century ago. Leasing for longer periods has an equally long history, although private leasing has not been a preferred option in most countries. In its basic form, leasing differs from sale of cars mainly in a move from perpetual to leasing in the Temporal rights dimension of the price model. Now, private leasing appears to be on the rise, possibly in bundles with insurance, service and tyres included (moving towards system in the Scope dimension). Many leasing operations are owned by car companies, others by banks and investment companies. Differences in ownership will shift the composition of the business model, but not necessarily the value proposition towards customers. Typically, leasing operators offer new cars for leasing according to a pricelist, but some focus on older cars, then pricing the leases according to the age and condition of the car, or even tender the leases on an auction or bidding basis, like for the sale of used cars. Organised car sharing has also existed for many decades, but it has recently started to be tested in larger scale by a number of car manufacturers. The carpools reside in parking lots rather than at rental offces, and can be booked and accessed via smartphone apps by carpool members. The return of the car to the carpool’s parking spaces is also signalled via the app—and can be verifed by the GPS in the car. The difference to traditional rental is mainly that the checking of the renter and driver by the feet operator is done on a subscription basis, rather than at each individual rental, and that booking, access and return of the cars is done on a selfservice basis, enabled by app-controlled locks. Charges tend to be built on a combination of subscription fee, rental time and possibly distance. Like in the case of e-scooters, some operators, like the BMW Daimler collaboration ShareNow, offer free-foating carpools, where pick-up and
Cases and Examples
parking is possible in any parking space in large, designated areas in cities, and charges for the rental are by the minute. This allows for short, one-way trips, not just longer return trips, making the cars a more fexible complement to the urban transportation system while reducing the need for parking in relation to the traditional alternative of individually owned cars. To offer this solution, carpools need a contract with the municipality that allows parking without individual parking tickets, thus including yet another actor in the business model. To be economically and functionally viable, free-foating carpool solutions require a certain scale, both in terms of density of cars available and density of potential users. It is thus so far mainly an alternative for larger cities, and the economic viability is not yet generally demonstrated. Daimler’s mobility-app venture Moovel, aiming to offer point-topoint travel planning and ticketing, builds on having transportation providers join the platform, show their offers—including timetables, vehicle location and fares—in real time and accept payment via the app. This ambitious goal thus requires large-scale collaboration between a majority of the transportation providers in an area. So far, it has been used as a convenient solution for municipal transportation organisations wanting to offer online travel planning and ticketing, and under the brand Reach Now it also powers the ShareNow car pools, where it extends the carpool offer by including some other urban-transport alternatives, making mixed-means travel a convenient option both in terms of planning and payment. If carpools so far are mainly alternatives for private membership clubs or publicly available, but still membership-based, ventures offered by, for example, car companies, the brokering of privately owned means of transportation also exists. The Finnish venture Skipperi, in addition to offering boat pools with a feet owned by Skipperi, offers a matching-service similar to Airbnb, where boat owners can let their boats, and those wanting to use a boat can rent one. Like other such matching services, Skipperi provides a trust-building platform where the boat owners describe their offers, the renters describe their boating credentials, and users from both sides write reviews of the other party as part of each completed rental. The boat owners decide on their prices and terms, and Skipperi receives a percentage of the rent—the economic side of the rentals is handled via the platform. In ridesharing, similar matching services have been available since the advent of the modern smartphone, with Uber, Lyft, Meituan and DiDi being well-known brands. The value proposition is that the rider can, based on a map, see the availability of cars and the ratings of the drivers, and the drivers can see the rating of the riders prior to ordering. Also, payment of the ride is secured via the app. While some ride-hailing companies only have cabdrivers as drivers, others offer opportunity also for
A Motor-Vehicle-Focused Ecology
non-professional drivers to accept riders on a ride-sharing basis. Now, with autonomous vehicles being an increasingly realistic possibility in certain environments, Musk has announced plans to launch the Tesla network, where owners of Tesla cars with self-driving capability will be able to offer their cars as ride-providers, instead of leaving them idle when not using them. This, being a potentially one-million-strong community at the suggested launch in 2020, would offer an all-electric feet that would take free-foat car-sharing to a new level and provide both a non-petroleum-based and high-comfort transportation alternative in highly monitored cars, contributing to the safety of both car owners and riders. It would also add a potential source of income to the Tesla value proposition to potential car buyers, just like the letting and grid-balancing alternatives do to charging-station and battery-pack buyers. However, if it becomes widespread, it will decrease the availability of Tesla cars for grid balancing and possibly increase the need for charging also at times when the grid capacity utilisation is not low. A less technically advanced brokering service is proposed by the Volvo- and Geely-owned Lynk & Co, which has a somewhat different idea for dealing with less car-interested people who still want access to cars. The cars come in six versions, rather than providing a long list of extras to choose from—to simplify for customers and reduce the complexity in production (a concept used by Japanese car manufacturers in the 1970s when trying to gain market share in Europe—then including much of what would be extras for other brands and fnding production economy in having large volumes of the same setup). In China, they still sell the cars in the traditional manner, but in Europe, they believe that leasing will be a preferred option. Leasing a car, and especially for short durations, could make the sense of ownership—and the emotional attraction to “my car”—insignifcant enough to make subletting the car an interesting proposition. So Lynk & Co intends to offer leasing durations of down to one month, and to offer its leasing customers the possibility to offer their car for hire when they are not using it—similar to Tesla’s ambitions, but without the self-driving feature, so picking up and returning the car will be an issue to handle. But the concept of (partly) fnancing your car costs through letting it to (previously unknown) others via an app is the same. The app provides the means of contact between individuals with cars to let and people wanting the temporary use of a car. It will also provide ability to locate, unlock and lock the car, and handle payments. If such subletting becomes popular and those letting cars do not want to be an active part in the Lynk & Co business model, handling cleaning, washing and flling or charging the cars, it is probable that some actor offering those services will appear. Lynk & Co could then either partner with such an actor in offering the service to leasees, or leave it to the leasee to fnd and contract such services if they require them.
Cases and Examples
Business Ecology and Travelling Ideas Regarding Business and Price Models What appears in this account of a motor-vehicle-focused transportation ecology is, certainly, a number of traditionally car-related actors. But it also shows the travel of ideas across traditional sectors. Servitisation, the concept of manufacturers moving from selling goods to selling services the goods can help produce, is gradually introduced into the transport area. On the one hand, the selling of transportation to individuals is almost as old as civilisation, and we are used to airlines, train and bus operators, cab services, etc., but we do not think of them as vehicle manufacturers selling transportation. There, Volvo and Geely, Mercedes and BMW operating carpools seem like examples of an infuence from the current servitisation trend—and the sharing idea—rather than a traditional forward integration along the value chain to start competing with existing customers, the transportation operators. At an overarching level, the climate crisis and environmental concern, with electrifcation as a currently popular remedy, also play into the current appearance of carpools, as does the idea of smartphone apps for mobile access and control. Tesla has demonstrated that large-scale, high-performance, all-electric vehicles are technically and economically possible. Assa Abloy and other lock manufacturers have demonstrated that smart locks are possible, and Ericsson’s Bluetooth has become a standard for smartphone-based near-feld control of gear. Google has demonstrated the power of combining data from numerous sources in a map-based user interface and that smartphone-based maps are powerful for locating resources and navigating. The low-CO2 transportation need not only supported ventures like Aixam Mega’s microcars, but has also given rise to a host of e-bike and mini-scooter manufacturers. Along the servitisation and sharing ideas demonstrated as a possible large-scale business model by, for example, Uber, it has unlocked the coffers of venture capitalists to fund e-scooter pools, which, like Uber, still are to prove their economical sustainability. There, the allure of “scale fast, reap later” business models, frst established in other business sectors, continues to be an important factor in making start-ups quickly become large players in ever more felds. In turn, the idea of riches to innovators and disruptors makes actors rush to focused areas—to capture ground, to not be left behind, to observe (and perhaps stall), to learn . . . for long engagement or to proft from quick entry—and quick exit (playing the hype curve). Thus, we see a mix of new and old players. Companies like Tesla, Charge Amps, Xiaomi and Desten face—or collaborate with—Toyota, BMW, Siemens, Valeo, Vattenfall, etc. Existing technical solutions and business models are challenged by new—or migrating—ones. Can the expensive goods be offered for rent or packaged as a service? Can longer contract periods be broken down into shorter ones, or can the buyer’s fnancing partly be solved by revenue streams
A Motor-Vehicle-Focused Ecology
from subletting or cost reductions from novel types of use? Can demand for new goods and services be created through large-scale, low-threshold offers? Often, it turns out that the rapid expansion of a new service either requires collaboration between numerous parties to be possible to offer, collaboration in order to scale or risks becoming a nuisance to someone, attracting regulation or the need to collaborate with offended parties. The world is certainly connected—services requiring an existing infrastructure, ventures involving numerous parties, traditional sectors converging and clashing, concepts and business ideas travelling between areas of application. The dynamics of this changing, connected world that we need to learn to navigate in, are made more visible by analysing the business models and their associated price models with a business ecology lens.
Implications This business-ecology analysis demonstrates how business models are infuenced by travelling ideas from near and far in the wider ecology. Examples include free-foat, digital-platform-enabled sharing, electrifcation and servitisation. Business models increasingly involve a range of other actors, and traditional delimitations are challenged. Chinese and other Asian actors increasingly take active roles in business ventures in the West, but business models (still) differ between the regions, with price models geared at various forms of servitisation, rather than sale of goods, being employed more in the West. The broad-scale introduction of electrically powered vehicles places new demands on electricity infrastructure and, enabled by digital control, begins to employ household-owned batteries also as storage and sources of electricity for grid balancing, not just as energy sources for powering the vehicles. For this to work, not only do the business models of organisations like car manufacturers and electricity companies need to be compatible regarding battery use, there also need to be suppliers of charging stations enabling reverse charging and price models that encourage such use of the batteries. In traditional sale of goods, the ownership, use and responsibility for the goods pass to the buyers. There are then incentives for the buyers to take care of their possession, as undue wear will affect its value. With rental arrangements, not least the short-term, self-service, free-foat versions, use and care are not automatically coupled, so business models need to include aspects that encourage users and handlers to mind the vehicles, not only when using or taking care of them, but also when leaving them, to attempt to keep them out of harm’s way. Devising and operating sustainable business models is a complex task and requires continuous attention to developments in the surrounding ecology in order to adjust business models and their price-model aspects to meet existing and upcoming challenges. It is unlikely that all the actors appearing in this chapter will prove successful at this over time.
Strategic and Innovative Pricing in a Born-Digital Company The Pickit Case
Introduction It all started with a phone call to the legal offcer at Microsoft’s Swedish offce. “Are you aware of the fact that you are responsible for a great number of copyright infringements—every day!” Mathias Björkholm, the co-CEO and founder of Pickit, waited eagerly for the response to the claim he just communicated to the legal offcer. He and the other founder of the company, Henrik Bergkvist, had thought for a long time about how they could gain entrance to a global and almost unlimited market for their product. They had both been involved in various startup companies before, but this time they truly believed that they were onto something great. Something that could grow really big. Yet, they still had to overcome many diffculties in getting there. For one, they were operating out of Sweden, a small country in the northern part of Europe with a limited market. And, to make things even more complicated, they were running their business on the island of Gotland, in the middle of the Baltic Sea. The business was at that time described as “a Spotify for images”. It all began in 2012, when the art director Henrik and the IT guy Mathias started to talk about how many poor PowerPoint presentations they had seen. Not only bad visual quality, but also the fact that many of them seemed to contain copyright-protected images, directly downloaded from the Internet. The situation, they said, was not very different from what the music industry was like in the early 2000s. Henrik and Mathias saw a possibility. They came up with the idea of a digital solution that would not only help users create great PowerPoint presentations, but also make sure that all photos and illustrations would be 100% legally compliant. In this chapter we will present a short case study about Pickit, the company that Henrik and Mathias started.1 The initial telephone call to the legal offcer at Microsoft did not only result in Microsoft starting to promote the service as one of the top add-ins for Microsoft Offce. In 2017, it even resulted in Microsoft Ventures buying a stake in the company. Since then, Pickit has won seven App Awards, been appointed number one Offce add-in and received a 70% rating on Must-have Score. To date,
Strategic and Innovative Pricing
more than 50,000 companies are using the service. And, fnally, at several occasions, senior managers at Microsoft, like the CEO Satya Nadella and corporate VP Gavriella Schuster, have mentioned or demonstrated Pickit on stage at big events like Microsoft Build and Microsoft Inspire.
The Product Initial Product The frst version of Pickit’s digital service was a photo competition app where companies could create photo competitions, to which they could invite their customers or anyone who had a mobile phone with a camera and wanted to participate. The service was like an early version of Instagram, but instead of showing the images to others, they were used by Pickit and Pickit’s customers. Individuals kept submitting photos to the system, making the photo catalogue grow by the day. Henrik and Mathias were running the business and thinking of how they could use this large database of photos in additional ways. Johan Andersson, now head of product development, remembers: “We had a terrible mass of user-generated and authentic images, which we realised had an inherent value. We just had to fgure out who to sell it to”. According to Mathias, the idea just popped up in Henrik’s head suddenly, when he recalled seeing an estimate of how many Microsoft Offce users there are worldwide (more than 1.2 billion persons) and made a quick calculation of how many presentations were created within the Offce package every day worldwide—presentations in need of good images and visuals to make the message come through. Current Product Since 2012, the product has been continuously developed, but the original idea has been the same. Pickit offers users online access to legally cleared photos and illustrations for use in public presentations, and the photographers and illustrators get fnancial compensation when their photos are used. Pickit’s present mission statement seems to firt with contemporary lingo, aiming at “Making PowerPoint great again”. The mission statement is broken down into three propositions that target slightly different goals: 1) “Make people’s work matter—So often, people’s great ideas fall fat because they’re badly presented. We want to help people present their work better and do it justice”; 2) “Make legal images the norm—85% of images downloaded from the Internet are illegal, so we invented a new model that’s 100% safe and compliant called Legally Cleared™”; and 3) “Make photos fair for everyone—Since most presentation images are illegal, most photographers don’t get rewarded. We supply affordable images and still pay the providers”.
Cases and Examples
Following from the strategic partnership with Microsoft, Pickit’s images are only distributed through the add-in program, within the Microsoft Offce package. Images can easily be inserted into PowerPoint presentations (and other Microsoft Offce programs, like Word or Excel) with just a simple mouse click. Either the user actively looks for a suitable illustration or photo in the clip-art-like interface (that shows up as a new icon in PowerPoint after the add-in has been installed on the computer) or the user can ask the add-in to suggest layout and suitable images based on the content in the presentation. The user can also browse through images in curated collections based on various themes. The add-in, and access to the imageries, is sold as a subscription, in three different versions: Pro, Business and Enterprise. Pro is intended for singular use. The Business and Enterprise versions are sold to companies, and both include access to Pickit’s image catalogue and allow the customer to upload corporate images and layouts to a secure section in the system. The formal aspects of “legally cleared” images may not be an issue that employees in general think about daily. But the risks of using non-cleared images in corporate communication are for real. One such case was the Swedish dairy that BBC reported: “A Greek man is suing a dairy in Sweden for 50 million kronor ($6.9m; £4.5m) for using his image on pots of Turkish-style yoghurt. . . . Chief executive Anders Lindahl said it had come as a shock when the Greek man lodged a 40-page legal complaint saying that the company had used a misleading image because he had no links with Turkey. ‘We bought it from a photo agency so we assumed that everything was in order,’ Mr Lindahl told the AFP news agency”. This short story shows that “the business ecology view” is important to consider. Little did the Swedish dairy company know that they would end up in an expensive legal process, following from their use of an image they thought they had the right to put on a product. They were not prepared that a single man, in a faraway country, would become an actor who would suddenly start to consume precious management attention. To Pickit, who is offering GDPR-compliant images, incidents like this prove the relevance of their service.
The Business Ecology As will be highlighted later, the potential number of actors in Pickit’s business ecology is almost infnite. When investigating their business ecology, this will make the analysis a challenge. As mentioned earlier, individuals with no obvious relation to the company can also suddenly come to affect it directly. In the following text we have chosen to highlight actors and relations that we have identifed through interviews with representatives from the company and from reading articles about the company and its industry.2 The description of Pickit is a frst-step analysis. It would require several iterations before a more reliable, detailed and robust picture of the environment is established.
Strategic and Innovative Pricing
Foreground Actors Pickit made a strategic decision in 2014 when they decided to join Microsoft’s ecosystem (the word ecosystem is used here to indicate that Pickit joined a certain subset of the ecology). At the time, this was not an obvious choice. A general opinion at the time was that Microsoft was not considered to be among the more future-oriented ecosystems (rather Apple, Google and Facebook were considered to be the stars of the future). The reason why Pickit still decided to join Microsoft’s ecosystem was an analysis of which route would be the most effective way to reach the potential users of the type of images Pickit could offer. The founders made an assessment of the number of potential users and arrived at the whopping number of 1.2 billion users times the number of presentations those users make (Pickit estimates that “35 million PowerPoints are made every day”). Embedding easy access to Pickit’s images, within the program where the images are used, resulted in a reliable estimate of the market size. It was big enough to keep Pickit busy for some time. Microsoft is an important gate-keeper in its ecosystem, as it manages and controls who gets to be part of it via e.g. Microsoft Store. Hence, Microsoft is the most important foreground actor and thus an essential partner to Pickit. Microsoft and Pickit are everything but equal. Still, the Pickit team has managed to work its way into the core of Microsoft. As mentioned, senior managers all the way to the top of Microsoft have referred to Pickit in public presentations. Microsoft has even pushed for and highlighted the Pickit product, which among other things has resulted in Pickit receiving awards like the number one Offce add-in product in 2019. On top of this, Microsoft also decided to invest—and become a shareholder—in Pickit, in 2017. This signals its belief in the commercial potential of Pickit. The partnership with Microsoft has also enabled Pickit to build strong relations with other important foreground actors, like the worldwide community of licensed Microsoft Offce distributors. These distributors package and sell bundles of applications that are installed on computers before they are shipped to corporate or organisational customers. The end users of Pickit’s offering are typically employees in big corporations. Mainly what Henrik refers to as “knowledge workers”. These corporations should also be regarded as foreground actors since they are Pickit’s customers who are paying for the subscriptions. To reach these customers, a close relation to distributors is completely essential. It is mainly the distributors who suggest and specify the vast bundle of big and small apps that are installed on corporate computers before they are put on the desks of the knowledge workers. To gain recognition, Pickit simultaneously wants to create awareness about the offering among end-users. A parallel approach, to get into corporate computers, is to market the service directly to knowledge workers, via Microsoft Store. From there, users can install it and sign up for a short
Cases and Examples
test period. If they like it, they can buy it themselves or suggest that their employer get it. On the supply side, additional foreground actors are photo agencies as well as private persons who upload photos to the Pickit database. These actors provide Pickit with the photos and illustrations that are the core of the offering. There are also foreground and background actors in the ecology in the form of competitors. The main foreground competitors are other photo agencies such as Shutterstock, Getty Images and Fotolia (now Adobe Stock). These photo sources offer, similar to Pickit, access to legally cleared images. In addition to them, there are also web-based services such as Unsplash, Pexels and Pixabay that offer images free of charge. The risk when using free sources is that the customer cannot make any claims or put requirements on the service. “Free” is offered “as is”, which means that the images may not be legally cleared. This might be an unnecessary risk. Following from the GDPR regulation, any individual in an image can claim that he or she should be removed. Hence, offering legal compliance can be used to gain competitive advantage. Background Actors In the extended ecology, many additional background actors may infuence Pickit’s business indirectly. As mentioned, legal regulation may play an important role. For example, the European Union has launched various initiatives that have directly affected Pickit’s offering. In 2018, the membership states decided to introduce a new law regarding storage of data about individuals: the General Data Protection Regulation (GDPR). This law, among other things, regulates how personal data should be handled by organisations. For example, organisations need approval from people if they want to store data about them. For Pickit, this became a sales pitch, since their product was GDPR proofed. Something they still communicate on their website: A unique new model that guarantees every picture on the Pickit platform is 100% legal and 100% cleared . . . with stricter General Data Protection Regulation (GDPR) and more advanced image tracking just around the corner, ensuring employees use compliant content is vital. Or as Henrik puts it: “GDPR was cheering for us, it was absolutely fantastic!” To summarise this introduction of Pickit’s ecology, the most important strategic decision was when they decided to join Microsoft’s ecosystem. The reason for this was the conviction that knowledge workers would prefer to use images in their presentations that were easy to insert. If legally cleared images could be reached and inserted to the document
Strategic and Innovative Pricing
with just one click, within PowerPoint, that would be considered much more attractive (to both the employee and to the employer) than having to go through the hassle of fnding an image via an Internet search, and then copying and pasting it between the browser and the presentation program. Also, a certain type of actor, next to Microsoft, has emerged as very important in today’s centralised management of corporate desktop (and laptop) computers: the distributor, who directly affects millions and millions of users. Distributors confgure and sell complete desktop computers, with bundles of pre-installed software, in large volumes to large companies. The 30 biggest global distributors cover a large volume of all the software bundles that are shipped to corporate customers around the world. By just addressing these 30 entities, Pickit can increase its likelihood to get into such bundles. And it has already been able to get close to some distributors. In an advertisement piece for Pickit, Michael Kenney, VP of Strategy and Business Development at Ingram Micro (one of the biggest distributors), states that “Pickit helps clean up my messy decks and makes me look awesome”.
The Business Model One of the most fundamental parts of the business model is the value proposition. As highlighted in Chapter 3, the value is what satisfes the customer’s needs. It is crucial that the value proposition is aligned with the identity of the organisation and the strategies and goals the organisation strives to realise. Pickit’s current value proposition is: Make impactful PowerPoints in minutes. Install the award-winning Pickit add-in and get unlimited access to licensed photos, clipart and your company’s images in Offce. The following section will describe how Pickit 1) creates value for the customer, and 2) captures and monetises this value. Value Creation in the Business Model The partnership with Microsoft is essential in being able to deliver the promise to “make impactful PowerPoints”. Getting close to Microsoft has enabled Pickit to integrate its add-in tightly with the Microsoft Offce package. Pickit could have chosen a completely different route to supplying knowledge workers with images (e.g. offering a web-based interface where the users could fnd and download images for their presentations). But, the decision to embed the service within PowerPoint itself, in a seamless set up, required Pickit to excel at programming an add-in for this very specifc Microsoft Offce environment. Much resources have been spent
Cases and Examples
on developing the relationship with Microsoft, and today this is one of the strengths of the business model. This tight integration is a strategic bet—and it creates a risk. If Microsoft, for some reason, would lose the grip of the corporate software market, Pickit would have to make a radical shift of its business model—or it will most likely go out of business. The next part of the value proposition proceeds “get unlimited access to licensed photos, clipart”. This highlights the importance of the relation to the upstream partners and subcontractors. For the moment, Pickit has about 15 large suppliers of photo catalogues. They regularly deliver highquality photos taken by professional photographers. In addition, Pickit also has around 80,000 individuals who upload photos. Those individuals can be referred to as subcontractors. According to Henrik, some of these photos are of good quality, while others are not. However, only a fraction of these individuals continuously upload pictures and respond to Pickit’s messages on which new types of images the end users are asking for. Beside photo agencies and photographers, Pickit has also started to build relations with illustrators who provide drawings to the image catalogue. Henrik elaborates on Pickit’s “sourcing” strategy: We communicate to illustrators, what we want based on our knowledge of what is demanded. Different types of metaphors, images, and illustrations that are requested by our customers. Themes can for example be emotions and metaphors in the business world. How do you illustrate “growth”? That is something an illustrator can contribute with. The Value proposition governs what activities and resources Pickit should develop and maintain. The activities can roughly be divided in two parts: technology and artistic. Technology focuses on the constant development of the software. This includes activities to ensure that the software is compatible with new and upgraded versions of the Offce package, but also hard core back-end design of e.g. database management issues and front-end issues like the user interface. If the technology is not well designed, it will be diffcult to deliver the value “impactful PowerPoints in minutes”. One aspiring functionality is that the system will also be able to suggest images and themes automatically when the user writes the text in a PowerPoint presentation. In addition to technology, also artistic activities, are important to offer “impactful PowerPoint presentations”. Essentially, this focuses on curating pictures in the database, i.e. selecting, compiling and assigning tags to them, that connect to various themes and potential keywords. Some of these curating activities are made automatically, but the process is also monitored by resources in the form of employees who work as curators and do some of the manual tagging of illustrations in the database. Given that the software is the core product, skilled software
Strategic and Innovative Pricing
developers and programmers are an essential resource. According to Henrik, the location of the head offce to Gotland, and the world heritage city of Visby (the biggest town on Gotland), is a strength. People who choose to establish a life on this slightly remote island have a tendency to stay around longer than what might have been the case in a bigger city. (Hopefully, people will also stay because they like the working conditions at Pickit.) Another factor is that there are fewer other organisations competing with Pickit for these valuable human resources. Still, the decision to grow into Microsoft’s ecosystem resulted in a physical split of Pickit’s offce. Visby is not the only location of Pickit’s resources anymore. Since 2015, Pickit also has an offce in Seattle, very close to Microsoft’s head offce. The main reason for establishing Pickit there was the need to deepen the relationship with key personnel at Microsoft. Physical proximity to the main partner was completely necessary, according to Henrik and Mathias. Without being on the spot, the relationship with Microsoft would not have developed as it has. This is why Mathias nowadays runs the Seattle offce, where part of the technological development of the product is also performed. The internal costs related to the value creation are salaries to employees, offce rent, and hardware and software licenses. The main external costs are remuneration to image suppliers and the cost of the cloud. Johan, the head of product development, explains how the external costs have changed over the years as the technology of Platform as a Service (PaS) has developed: We only buy one computer capacity contract, and it is automatically scaled and distributed globally. We no longer have to worry about our infrastructure. In our case, this means that the partnership with Microsoft will take care of all our operations and we can focus on our business problems that we want to solve. It has changed how we as a third party provider of SaaS service can build our IT. We can build more cost-effective services in the cloud. It’s a great trip for us. Regarding compensation to partners and subcontractors, Pickit applies a model where it has chosen to split the revenue 60/40 with the image suppliers. Henrik explains: It is important for us to work with the suppliers in terms of content. It is a bit of our weak spot, we do not come from the photo community so the relationships we have are based on that they [photo agencies and private photographers] like to work with us. They are a Cost of Goods for us. We have chosen to call this relationship 60/40. Pickit takes 40% of the revenue and gives 60% to the suppliers.
Cases and Examples
Pickit could not have run this business without subcontractors and partners. Together with them, Pickit perform key activities on resources to create a value that is in line with its value proposition. But, the value creation is of no good if Pickit will not be able to capture it. Value Capture in the Business Model As highlighted in the description of the ecology, the end users of Pickit’s service are knowledge workers who use PowerPoint in their work to communicate their knowledge. But the end users are typically not the customers in Pickit’s business model. Instead Pickit’s customers can be segmented in two main categories. The frst segment is Individuals who use the product in their profession, such as independent consultants. The relation to these customers is typically established via the Pickit website, where they can get a link to download and test the service for free for 7 days, and then sign up for a subscription. These customers are few. The majority of Pickit’s customers belong to the second segment: Organisations that need to control which images and templates are used in their offcial communication and want to offer their employees support in making impactful PowerPoint presentations. As the analysis of the business ecology revealed, there are myriad organisational customers out there and approximately 1.2 billion potential end users. To be able to reach them, Pickit early on (as pointed out in the ecology description) chose to form relationships with distributors of Microsoft products. Globally, there are around 30 major distribution partners to Microsoft. Henrik explains the reason for why they have selected to use an intermediary to reach the customers, instead of addressing them directly: We prefer to sell through partners, because there are problems with direct sales. For example, if someone from the marketing department in a potential customer organisation would say “yes, we want this!”. Then we have to ask her what Microsoft Offce license they have and they usually don’t know. Then our sales process starts over again. If the company does not have the correct version of PowerPoint, our add-in might not run smoothly with them. Who decides regarding Microsoft offce at the company? Market may be all over us, but if they have the wrong offce license they can’t use our product. And getting a company to go from one PowerPoint version to another can take some time. He continues: An example: In Sweden, one build [a build is a version of a version] of Offce 2016 has been distributed in large volumes. In this build a small code strip that is essential for our add-in is missing. This Offce
Strategic and Innovative Pricing
version allows our product to be downloaded, but you can’t drag a picture from our interface to the PowerPoint presentation. One advantage of selling Pickit’s service via distribution partners is that it knows which customers to offer it to: those who run compatible versions of the Offce package. This also decreases the number of cost-driving customer support calls and the risk that end users do not use the product at all. But, using distributors for establishing customer relations does not automatically generate sale of the product. What Pickit needs to do is to establish a close relation with the distributors and convince them that its product is “a must have” add-in. Otherwise the distributors will not include it in the bundle of software they offer to their customers. Getting into the distributors’ sales processes is a two-layer task. Pickit needs to win both the distributors’ management team and the sales reps. Access to the management teams has been fairly smooth, thanks to Pickit’s position in the Microsoft ecosystem (being promoted on stage by various Microsoft representatives at several occasions). Winning the sales reps, on the other hand, has proved to take some more effort. Today, Pickit’s message to sales reps within the distributors is “Double your margin”. In the sales pitch, Pickit compares the proft margin when selling an Offce license to selling a Pickit subscription. The retail price of the Pickit subscription is one-third of the price of the Offce subscription, but the absolute margin in dollars is the same for the two. By including the Pickit subscription as an added component in a bigger Offce bundle, the sales rep will be able to double her margin without raising the price of the complete bundle to an unreasonable level. The customer channel for delivering the service is the Internet. Data communication on the Internet is on the verge of a great change as 5G technology is gradually establishing itself. Exactly what the effects of the 5G technology will be is hard to predict. Compared to the previous standard of 4G, 5G is estimated to handle 1,000 times greater the amount of data traffc, having 10–1,000 more devices connected to it and 10–100 times greater speed of transmission, and to contribute to a greater battery effciency in connected devices. In this way, the 5G technology will be an important foundation for the Internet of Things (IoT). This kind of technological leap will probably infuence Pickit’s customer channels. A big challenge is to estimate how this will turn out and what actions Pickit will need to take accordingly. Meanwhile, the great majority of Pickit’s revenues come from subscriptions. The individual customer segment can sign up for access to a version called Pro for 4.99 USD per month (November 2019). Organisations, on the other hand, have two options: a Business version or an Enterprise version. The price of the Business version is based on number of users. The Enterprise version, on the other hand, does not have a specifed price tag; instead it is up to negotiation with Pickit to decide a fnal price. (We will
Cases and Examples
come back to this in the next section when we discuss the price models.) The direct sales of the Pro version via Microsoft Store constitute only a small part of the revenues. Even though the volume via Microsoft Store is small, selling subscriptions in this channel is very important since they create a point of reference regarding the price that the distributors can refer to when they include the service in bigger bundles. According to Henrik, Pickit has experimented with various set-ups for pricing. It has tried a “freemium” version for some time, but it didn’t result in the conversion rates they expected. It has also tried various price levels and found that there was no big difference in conversion rates between today’s price levels and lower price levels that have been tested before. First we offered customers a freemium product on our web site [with option to pay for add-on functionality]. But then we didn’t get people to pay. However, it is important that we have a price tag. Because now, the distribution partner knows what we charge as we have an explicit price. So then they can start looking at the margins. Summarising Pickit’s business model, it is clear that it primarily depends on three factors: 1) the conviction that its value propositions are highly relevant to enough of the 1.2 billion users of Microsoft Offce, 2) the ability to convince Microsoft distribution partners to include Pickit’s add-in in the bundles it creates for its customers, and 3) the presence of reliable partners to deliver high quality photos. The analysis of the business model highlighted the price tags that Pickit put on the versions of its product. In Part I of this book, we have argued that establishing a price is more diffcult than just establishing a price level. Strategic pricing starts with the design of the price model. If the price model is inadequate, there is an obvious risk that the value will not be captured, and there will be nothing to split with Pickit’s partners. Let us therefore study Pickit’s price models.
Price Models The price model is the very interface that regulates obligations and remunerations between an organisation and its sub-contractors, partners and customers. Here, we will focus on the three outbound price models that Pickit is using. Three Different Price Models In 2019, Pickit had three different price models directed towards its two customer segments: individuals and organisations. Each price model represents a version of the product, and they are labelled Pro, Business, and Enterprise. As visualised in Figure 8.1, two of the price models, Pro and
Strategic and Innovative Pricing
Business, are similar in the Scope dimension. Enterprise is the version which differs the most compared to the other two. Here is a more detailed description of the price models. Scope As illustrated in Figure 8.1, the Scope varies depending on the version of the product. The Pro version is intended for individual users. It has the basic functionality but lacks, for example, possibilities to create and share collections and templates with employees, as well as getting professional help of curating the image bank. It only includes access to Pickit’s big catalogue of photos and illustrations. Compared to the Pro version, the Business version also includes functionality such as storage and management of the company’s own visual assets in the system, as well as access to Pickit’s images. The Enterprise version is composed of additional attributes such as volume discounting and API functionality. Temporal Rights All three versions of the price model use subscription as Temporal right, as it is the standard price model for many cloud-based digital services. A beneft with this temporal right is that the customer will get access to continuous upgrades of the product, rather than having to pay for each upgrade. As noted in the description of the business ecology, subscription deals require that the supplier keeps up-to-date what the customers want
Figure 8.1 Pickit’s outbound price models
Cases and Examples
and keeps adding new functionality. Otherwise, the customer will stop paying for the subscription since it does not add anything to the functionality she already has access to. Infuence Two of the versions are based on a price list. In 2019, Pro was available for 4.99 USD per month if the customer signed up for 12 months, otherwise the price was 9.99 USD per month. The Business version was priced at a similar level. The Enterprise version, on the other hand, is sold after a negotiation with Pickit, as is described on their website: “Tailor the solution to meet your unique needs”. As aforementioned, Business and Enterprise are the two versions that Pickit offers to the customer segment Organisations. The Business version can be seen as an entry or a try-out. If the customer is pleased and appreciates the value that the system delivers, it may lead to increased sales. However, this will also depend on who is heading the negotiation. If the deal is negotiated between a distributor and a customer, Pickit may have limited, or no, infuence over the negotiation process. Hence, it is necessary for Pickit, in its relations with the Microsoft distributors to ensure that it gets access to knowledge about what the customer appreciates in the Enterprise version. Price Base Pro and Business have the same setting in this dimension also. The price level is based on comparable products. Henrik admits that setting the right price level has been a challenge for Pickit: We were at USD 1.99 in freemium service. But then we didn’t get people to pay. As for the individual service, we still have no idea. We just had to make a decision, and test. And sales were not very different, whether the price was 1.99 USD or 4.99 USD. As the price for the Enterprise version is set via negotiations, it is possible to argue that such negotiations can lead to customer value as Price base. This does not happen automatically, but it may typically be a result of a continuous dialog with the Enterprise customer regarding the product. A central question is what additional features Enterprise users require. Price Formula The Pro and the Business versions are payed per unit. The price is calculated based on the number of users. An organisation with 10 users pays 49.90 USD a month while an organisation with 100 employees pays 499 USD. Larger, or growing, organisations have an incentive to
Strategic and Innovative Pricing
choose the Enterprise version, as it enables them to negotiate the conditions for the Price formula. One agreement that has been tested was to offer a per unit + ceiling price model. When the customer reached a certain number of users, which made the deal attractive to Pickit, additional users could get the service for free. By doing so, Pickit could avoid price erosion per unit and stick to the list price. If the ceiling was set to e.g. 400 users and the price is 4.99 USD per user, then the organisation would pay around 2,000 USD per month for this offering. For the customer this means greater security, as the risk of the monthly cost becoming “too high” is avoided. However, for Pickit it is important to carefully calculate how the limitation up to a certain ceiling infuences the overall revenues.
Implications The analysis in this chapter indicates there are possibilities as well as challenges for Pickit. Offering three different price models is positive since it enables Pickit to segment its customer base. One challenge when offering a variation in Scope is that it may be perceived as unfair by some customers if the functionalities are almost the same, but the price tags differ substantially. Furthermore, using negotiation in the Infuence dimension can be benefcial if it leads to more long-lasting relations with customers. Still, in the Pickit business model there are few activities and resources that are up for negotiation. One of the strengths of using the Microsoft distributor network is that it enables Pickit to become part of a large and global market. Another advantage is that the distributors know which customers are running which versions of Microsoft Offce. Hence, Pickit’s add-in will not be sold to customers that run incompatible versions of Offce. Still, if Microsoft distributors do not have suffcient knowledge of Pickit’s products when negotiating the Enterprise version, there is a risk that the outcome of the deal is not as favourable for Pickit as it could be. The distributor is mainly focusing on making a good deal for herself and the company she is working for. Therefore, it is of great importance that Pickit have close relations with the Microsoft distributors to ensure that they see the benefts of including Pickit’s add-in in the bundles they offer to their customers. This is when Pickit’s message “Double your margin” is played out. The distributor will, most likely, only include Pickit’s product if she will gain a reasonable proft from selling it. Pickit is only a small add-in in the large contracts the distributors sell. Another implication to highlight is the close affliation with Microsoft. It is currently an advantage for Pickit to be considered an explicit partner to Microsoft, given that Microsoft will continue to be a major provider of software to companies with knowledge workers who are not creative professionals.
Cases and Examples
This case description has illustrated how strategic and innovative pricing can be analysed inside an organisation. But, keep in mind, this is an illustration of a plausible and initial analysis. To be able to establish a more robust, reliable and “true” picture of the conditions, several analytical iterations would be needed. In such iterations, the price models should be discussed based on questions like: How are the price models designed compared to industry standards or immediate competitors? If the company is to adjust the price model, which dimension would most likely contribute to greater competitiveness? Given an adjustment of the price model, how will this infuence the current business model, and how will it infuence the roles and relationships to the actors in the business ecology? Finally, this case study mainly illustrates the outbound price models, the interface to the two customer segments. Simultaneously, Pickit has partners, as well as subcontractors, to whom it has relations. In an expanded analysis it would be interesting to determine and analyse these inbound price models and how well they are aligned with the business model and the outbound price models. We hereby end the empirical section, where we have applied the theoretical concepts presented in Part I of this book. Next, in Chapter 9, we will go full circle by summarising the key points as well as looking ahead and beyond the main issues covered in this book.
Notes 1. The content of this chapter is based on interviews completed in 2016 and 2019 with founder and co-CEO Henrik Bergqvist. Additional to this, an interview was also made with the head of product development, Johan Andersson. All interviews were performed at the head offce of Pickit and lasted between one and two hours. Besides the interviews, we have also used publicly available material published in 2019 on the Pickit website www.pickit.com/ and other additional websites and newspaper articles. 2. See endnote 1.
Conclusion, Discussion and Way Forward
Introduction Let us start this fnal chapter of the book with a short re-cap of the chapters and their main arguments. In Chapter 1, we introduced the idea of innovative price models as a strategic opportunity in “the digital economy”. We use this phrase with some hesitation, as many of the traits we discuss in this book can be found in price agreements in “pre-digital” markets. However, we have observed that successful pricing moves beyond negotiating levels for pre-defned price objects. Closer relations between business partners and consumers have become enabled through frequent and purpose-made exchange of digital information, and relations move towards long-term joint production of value through outsourcing and investments in deepening knowledge about each other. Digitised information and rethought competitive strategies, adapted for the digitised processes now used by both organisations and households, have changed value propositions and how they should be priced. This digital transformation is ongoing and will most likely keep on accelerating in the coming decade. Introduction of 5G communication technology and development of AI applications have the potential to transform conditions for how we organise our societies and business activities and our personal lives. Trying to predict what may happen in this constantly transforming digital economy requires solid analytical tools. Through such tools, we can identify some of the dynamic courses of events as well as understand, explore and suggest how we can organise our business. The theoretical concepts for strategic and innovative pricing analysis presented in this book may assist in such an exploration.
Theoretical Concepts for Strategic and Innovative Pricing Our journey in this book passed through three important analytical “stations”: business ecology, business model, and price model. In Chapter 2, we focused the concept of a business ecology. We argued that in order to navigate towards the future, any organisation needs initially to
Conclusion, Discussion and Way Forward
understand how its destiny is co-produced by other organisations and circumstances that we depicted using the metaphor of an ecology: a universe of living organisms who infuence each other, enter into contractual relations, compete, imitate, constrain, merge, split and absorb each other through acquisitions. Of particular interest here are the ideas that exist near or far in the ecology and form elements of business models or inspire their design, the constraints resulting from rules and regulations that some of these actors may impose and especially how relations are formalised through commercial contracts between some of these organisations. Actors—the “core” organisation that is in focus for our analysis, its customers, suppliers and competitors, other organisations in its markets, unions, government offces, etc.—depend on one another in many ways. Here we are particularly interested in the relations with those that the core organisation attempts to establish more intimate and permanent links with (for instance business partners and loyal customers), draw inspiration from or feel some other need to consider when designing or refning the business model. The second station on our journey therefore focused on the business models we discussed in Chapter 3. We defned a business model as a map or blueprint for how the organisation can create and capture value in the business ecology. It does so by entering into informal and formal relations—and by doing so it invariably intends to become successful and sustainable in the long run. We are obviously here primarily talking about commercial entities, but even a government agency will need to convince politicians and taxpayers that it creates value, so that they reward it with suffcient resources to carry on. Any organisation needs to understand how to navigate in its business ecology and contract with other parties. Such agreements are the subject for the concept in Chapter 4: price models. Primarily, most will think of the prices charged to the organisation’s customers: outbound pricing. When an organisation advertises its products, or enters a sales negotiation with prospective customers, its offerings soon get linked to one or several ways to pay. To link payment to quantity (for example, number of units or hours) has traditionally been the dominating model, but there are many alternatives. In this chapter we introduced our price model equaliser, a simple graphical tool for imagining and considering the range of possible alternatives for pricing in a specifc situation. As every seller also is a buyer from someone else, Chapter 4 can also be read as a primer in the options available when procuring services or goods. Price models are boundary objects between organisations, articulating their relations in contractual form, infuencing how advantageous available courses of action seem to both buyer and seller. Through this, an innovative price model may turn out to be a source of competitive advantage when it cements the intentions expressed or latent in a business model.
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The Relevance of Cost Analysis In Chapter 5, the fnal chapter in the theoretical Part I of the book, we focused on cost. This may seem a bit old-fashioned, as the pricing literature has castigated practitioners for several decades for the pervasive use of mark-up or cost+ pricing, where perceived full cost plus a “fair” proft margin is the guiding light for pricing. Writers on marketing have long pointed out that salesmen should try to estimate prospective customers’ willingness to pay, and that this has more to do with perceived value than with the cost of producing goods and services. Even though students in economics are taught that market competition in the long run will reduce prices to a level of cost plus the minimal level of profts that will keep frms in business, a good businessman does not anticipate the workings of the market’s “invisible hand” by using cost as his price base. Instead he tries to capture as much as possible of what customers are willing to pay. This has however proved notoriously hard to measure, and the persistence of cost-based pricing may also have something to do with perceived fairness. However, if we start imaging business models as long-lived joint value creation between informed and willing partners, it makes sense to take an interest in costs. Perhaps even openness about alternatives and their costs may be advantageous for a deepening business relationship. Price models determine how costs and investments are shared between participating frms and under which conditions fnal consumers get to pay for their requirements. Chapter 5 closed Part I of the book, which was geared towards theoretical aspects of strategic pricing.
Applications of Concepts for Strategic and Innovative Pricing on Empirical Examples The subsequent second part of the book was devoted to cases and empirical aspects of the earlier-presented theories and models. The purpose of this part was to provide examples that can help in developing an understanding of how the theoretical concepts in Part I can be applied in various contexts. Another aim as to illustrate ways to perform an analysis where the outcome of it can be a development of strategic and innovative pricing in a digital economy. We started Part II with Chapter 6, which provided examples of innovative price models devoted and structured in accordance to each of the fve dimensions of the price model equaliser. These examples were also from different industries where digitisation had been one important key enabler for price model innovation. More specifcally, we showed how Readly extended the Scope of offering within the magazine business, how Husqvarna challenged its own business model by switching from selling to letting their power products, how Google AdWords left price-level issues to the market by using auctions, how Siemens has changed its price model (and mindset?) from pricing based on
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costs towards customer value, and fnally how Cabonline increased its market share by adjusting its price model towards the selling side accepting the full risk by offering fxed-price cab rides. Chapter 7 provided broader analysis of related business models as it explored business-ecology views starting from actors related to motor vehicles for user-controlled transportation. It demonstrated how exploring business-ecology views could help detect the transformation and an increasing entanglement of business models from previously separate markets and felds of business. The entanglement poses increasing demands on compatibility between actors’ business models and development of standardised infrastructure. One such entanglement is how electrifcation by use of batteries in vehicles not only makes the vehicles use electricity to run (which poses demands for electrical charging infrastructure and provides openings for new business ventures) but also, as the quality of the batteries and the number of vehicles increase, is giving rise to business models where the car batteries are also components in electrical-grid management. The exploration of applications of the free-foat vehicle feet concept, enabled by digitisation, also demonstrated how business- and price-model experimentation is conducted to fnd sustainable business models in novel felds. The next chapter (Chapter 8) provided yet another angle of exemplifcation of the concepts from the frst part of the book through an in-depth analysis of the venture Pickit. Pickit is a small born-digital company that has managed to partner with a dominant actor: Microsoft. This partnership has translated into a dependence on traditional re-seller networks (Microsoft Offce dealers) in order to reach out to a global and potentially enormous market for its product. Challenges consist in crafting value propositions that simultaneously appeal to buyers, users, dealers and content suppliers and devising price models that make the business model economically sustainable. From the empirical examples, we observed that innovation in price models certainly happened, and could have happened to a larger extent than it did, even in pre-digital markets. Closer, more long-term collaboration and a more extensive exchange of information took place between more-or-less separate frms and other organisations, and certainly within large corporations between separate divisions and proft centres. But it was with the improved exchange of information enabled by digitised data— captured, processed, stored and presented using computers—that collaboration based on closely-knit, high-interaction, large-scale information processes involving business partners could happen. Organisations sped up the building of relations across borders and fnding of partners among organisations with complementary skills, often far afeld, where formerly they would have tried to achieve similar joint value creation through integrated and often much slower processes in-house, or refrained from building scale. The integration of processes increasingly extends to customers, through self-service models that can be monitored at a distance,
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and through deeper and richer relations based on exchange of digitised data, for example in servitisation of industrial installations. Closer ties encourage business models where not every transaction is separate and focused on price level. Trust develops through transparency, but this means also that relations should be based on commercial agreements where partners try to articulate their expectation of joint value creation—and sharing. Innovative price models provide a way of developing both, and the equaliser is a tool for fnding out how.
Beyond: More Pricing Themes to Explore Towards the end of this book, we wish to encourage our readers to think of organisations where they are active or otherwise know well, take out pencil and paper, and start fantasising about dependencies existing within possible business models and how they can be encouraged through different forms of pricing. However, there are six themes that are important to note before doing so. These six themes form an extension of some of the underlying and interconnecting aspects of the triad of ecology, business models and price models and they have recurred in our research for the last ten years. The themes are composed of: • • • • • •
Division of labour in co-producing value Time: exploring the benefts of lock-in Risk: predictions and conjectures Price models as strategy: impressions vs. analysis Matching out, in and between—and cost and incentives Controlling price offers
We now briefy discuss these six themes and then revisit the RITE model that we introduced at the end of Chapter 5, as we suggest it can be used to narrow the range of price models that can beneft your organisation. Division of Labour in Co-Producing Value The innovative price models we imagine are tools for competition, but more often through lasting joint value creation than short-term maximisation of earnings. We took our departure in “the digital economy”, where we believe many benefts formerly achieved through planning (hierarchical leadership) in large, integrated frms instead are achieved through collaboration among business partners. Modern business models tend to rely on information-based cooperation: in real time and across borders. As a necessary adjunct to this, a mutual understanding of fnancial consequences and long-term survival, growth and benefts to stakeholders needs to be worked out.
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Partnering in such business models requires a certain level of shared expectations. As Hedberg et al. (1997) pointed out concerning what was there called “imaginary organisations”, total agreement may not be necessary—after all, we are primarily concerned with a “lead enterprise” making choices that its leaders expect to beneft their interests. However, partner frms need to share views about likely futures to the extent that they agree how to progress, how necessary investments should be shared and how future rewards will be calculated and shared. Time: Exploring the Benefts of Lock-In Already a moderately complex new price model will often need some time to prove its worth, and when the intention is to encourage long-term collaboration, it is obvious that time enters into consideration. Sometimes the joint value creation that we just discussed requires a certain element of “lock-in”: investing in tailor-made solutions only makes economic sense if a relationship will last for a few years. Traditional price competition for the lowest (or for the seller, highest) price level is essentially faithless. By pricing a predefned price object, price comparisons become easy. Terms may be renegotiated often, sometimes in a threatening mood. In contrast, the innovative price models we have been discussing encourage long-term relations. As we explained in Chapter 5 on cost, it often makes sense to think about innovative pricing in terms resembling those of a capital investment proposal. In developing the ability to deliver a range of offerings, several frms among those collaborating in a business model may have to invest in tools, skills and processes, expecting to be rewarded later. “Up-front costs” may be high. To what extent should these be shared among suppliers or paid in advance by users? In the extreme case, a joint venture where development of capabilities is paid up-front may be indicated. But this also raises questions of later, different applications of what is developed and consequently ownership of solutions. Such considerations are obviously not new. But in what we have termed the digital economy they acquire increased importance. Risk: Predictions and Conjectures Risk is at the heart of what we just discussed. There will rarely be total agreement among contract partners about likely futures. In fact, for many kinds of business a reason for trade is that their expectations are different. If a buyer expects high usage and service needs, while the seller believes that usage and service requirements will be low, this makes it easier to agree on a price level with which both parties will be satisfed. The deal—without explicitly stating so—is a bet on how extensively the buyer will utilise her rights. Behind the differing expectations, there are
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often different predictions about the future, where often a seller may have more statistics on how average customers behave. Individual buyers used to have a better grasp of their own use patterns than sellers, but with increased use of sensors and monitoring of use, charting and analysis of use patterns is even becoming a service that can command a price, whether it be systems use in radiology wards; smart metering charting electricity consumption; sensors, GPS units and communication units enabling monitoring of tools or vehicle use; or the surveillance of large machines for individualised preventive maintenance and optimisation of use. If the buyer is a smaller frm and risk-averse due to fnancial limitations, or a larger frm wanting to outsource feet management, both seller and buyer may fnd service guarantees attractive. But for a business model shifting risk between parties to be sustainable and resource-effcient, its price model should encourage care at both ends. Price Models as Strategy: Impressions vs. Analysis Focusing on one particular frm (the “lead enterprise” of Hedberg), the strategy that it translates into business and price models can be regarded as its “bet” on the needs and the taste of its prospective clients, and (through the business model) its own ability to orchestrate attractive value propositions. To use an over-simplifed example: if a seller “knows” that its products will never break down, it can guarantee 24/7 service without risking expensive service work, while customers whose experience of product durability is different will be willing to pay because they believe service cases will indeed happen. These predictions or conjectures will tend to be intricate combinations of prior experience, conclusions applied to the future and impressions gained from logic and rumours. Both factbased analysis and “impressions management” will come into play. Depending on how close relations are, joint problem solving or attempts to exaggerate or downplay will come into play. We have touched repeatedly on the part played by investigations and factual knowledge in designing offerings and price models. It is unavoidable that such decisions will build on both analysis and intuitive judgment. If relations with customers and partners are close, open discussions may sometimes be possible. But judgments of likely future developments will always differ, and often such differences even are important reasons for business relations, as noted earlier. The insurance industry largely builds on customers’ realisation that incidents and accidents will occur and that sharing the cost for these with others through insurance often is better than carrying the risk single-handedly. Actual numbers on how likely incidents and accidents are will improve decisions and fuel discussions about how much it is reasonable to pay. In general, we believe more extensive analysis will provide facts that lead to better price-model use. The equaliser itself is a tool for structuring
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discussions of what variables should be considered, and each of these can be the starting-point for investigations of what has been tried, and which reactions there were. As demonstrated by examples in earlier chapters, even single-variable changes in equaliser settings can provide valuable differentiation—and possibly require far-reaching changes in the business model. Sometimes inspiration can come from seemingly dissimilar other industries, as emphasised in Chapters 2 and 7. Ultimately, however, there will be an element of “betting on the future” when a new price model is introduced. We talked earlier about distinctiveness and the need to differentiate one’s offerings. This implies that there are customer segments and partnership candidates who may be waiting for the innovative sharing of risks and rewards that result from an innovative price model. Matching Out, In and Between—And Cost and Incentives As part of the analysis, it is wise to go back to the matching of inbound, internal and outbound pricing we discussed in Chapter 5. Using a multiyear systems approach, we need to envision what investments, revenues and costs are likely for each signifcant actor, ideally both according to our own forecasts, and those imagined by each such actor. In Chapter 5, we mention that “up-front costs” are characteristic for many digital services, and even if we sell traditional products, it is likely that the capability of partners to provide the outsourced services we need, like our own activities and even those of our customers, will require substantial initial outlays before our offerings are established in the market and lead to secure revenue streams. How will the fnancial consequences look for each signifcant actor, given different price models? As usual, fnances depend on both cash fow and reported profts. Tweaking price formulas and increasing commercial rights (ownership of solutions rather than right of use) may make the collaboration your frm offers more attractive. This analysis should also include the needs of signifcant actors. Maybe they lack the fnancial strength to take on the commercial market-risk that is required to make your joint venture a success. A modifed price model, with a higher fxed remuneration, may reduce that risk. Or a prospective partner can be so convinced about future success that he will be happy to have a price agreement with a strong variable component. Selling to consumers or to businesses will obviously lead to different such analyses, and also to different intuitive arguments about likely futures. Controlling Price Offers We have discussed price models mainly as something you develop for a particular situation. However, a frm’s range of price models may also be
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seen as a “repertoire”. Linking prices to usage will, for instance, require processes for measuring usage in a credible way that is also accepted by customers or suppliers. To sign a contract, frms will beneft from experience of how to defne terms and conditions, and using our equaliser may easily upset industry practices regarding what rights and obligations are included. This is not only a matter of practical importance for many managers and employees, which may determine how possible innovation in pricing turns out to be. It is also something that encourages or discourages marketing people from suggesting unconventional price models when negotiating a business contract. In practice, this causes a need for a “price model policy” that summarises solutions that a frm fnds strategically attractive, and provides guidance for anyone involved in price negotiations. It should include reference cases that can act as inspiration, and it should also provide a manual for the investigations we have briefy described in this chapter. In order to work, it need also be understood and accepted by those who are involved in contract and pricing matters. This must still be seen as a matter for development; in our contacts with companies and other organisations, it is rather the rule than the exception that views, attitudes and behaviour differ across the organisation. A policy may be little more than a paper or an electronic document unless care and effort are spent on anchoring, and keeping, such a policy anchored among those who are to practice it. Also, we tend to meet diffculties in getting salespeople, or those affected by internal pricing, or those handling purchases in the organisation, to uniformly buy into novel price models and try to implement them with conviction. Sometimes, getting one’s own organisation on board proves more diffcult than having the counterpart embrace a novel price model. One point we really want to stress is that of proft recognition. Not least for internal control purposes, changed price models will usually impact how business results are reported. Like we have touched on, they may even change the time sequence of profts. This is the case when a supplier (within a partnership among frms sharing a joint business model, like in Chapter 3) enters into a multi-year agreement, expecting future rewards when fnal customers start to pay, rather than getting paid immediately by the “lead enterprise” for development work that is required to enable such future sales.
A Final Reminder: RITE Finally in this book, we want to stress that we believe innovative price models are becoming an important part of new types of contracting, both in B2B and B2C contexts. It can be a vital part of so-called relational contracting, as shown by a quote from an article in Harvard Business Review by Nobel laureate Oliver Hart and colleagues (Frydlinger et al.,
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2019, p. 123). The case concerns a local health authority and a hospital in British Columbia and illustrates how price models can cement—or endanger—a trustful relationship: “We consciously approached the economics of the relationship with full transparency and a problem-solving mentality instead of a negotiations mentality,” she told us. “We put everything on the table, and we challenged the contracting team to fgure out ways to work with the money we’ve got.” The parties ultimately came up with an alternative to the standard fee-for-billable-hours method. They designed a hybrid pricing model with a combination of fxed and variable rates, coupled with incentives to improve effciencies. Hart and his colleagues (Frydlinger et al., 2019, p. 121) also point out that “Some relationships, such as those involving the purchase of commodity products and services, are truly transactional and only need traditional contracts”. We need to distinguish when innovative price models are required and what parts of the equaliser might be used to adapt to the needs for each transaction. In this context, the RITE model (Cöster et al., 2019—cf. p. 92 supra) can be used (Chapter 5). The RITE model is intended as a tool for analysis in moving from business ecology (Chapter 2) through business model (Chapter 3) to price models (Chapter 4). Like cost (Chapter 5), it serves to identify the preconditions when each of the several relations in a business model is articulated in a contracted price agreement. Let us comment a bit more on each part of it. Relation Relations will differ in duration and resources. Like Frydlinger et al. (2019), we fnd it useful to contrast arms-length and partnerships. For commodity-like, well-defned and relatively undifferentiated goods and services, it can suffce to rely on competitive markets and subject a relationship to its forces. If you are able and willing to switch suppliers at short notice, or fnd new customers if the old ones move their business elsewhere, there is no need to enter into a more developed partnership. Unfortunately, we are seeing—not least within EU—how public procurement of welfare services has come to rely on arms-length competition as a way of battling cost and corruption. It has led to service disruptions and sometimes higher cost than necessary, when buyer and seller lack incentives to explore jointly the economies that can be achieved by closer and more open relations—cf. “transparency” in the quote above. We believe that there are many occasions when more partner-like relationships are desirable. Then, the price models employed should be designed to support the partnership idea.
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Intention Are the parties to a transaction guided exclusively by short-term commercial success (proft), or do they want to take into account multidimensional benefts like learning, preparing for future collaboration or establishing reputation through the reference-value of a sale? To move towards relational contracting, it becomes key to explore win-win possibilities based on joint capabilities and assets. This is where the shared business model comes in. We believe in spelling out joint objectives, like more rapid service for fnal consumers, cost savings from shared information systems, etc., in some detail. They should then be scrutinised for their needs for investment, and price models should refect how fnancial fows for the preliminary duration of the partnership (e.g. the next three years) should be linked in a price formula to important indicators. These should be a logical consequence of a narrative, maybe expressed graphically as a strategy map, showing joint efforts to explore and exploit the partnership. Unless such intended extra-transactional considerations are spelled out and shared by those who execute pricing negotiations and price-model use, the price model in use risks appearing illogical or unproftable, will not be employed as envisaged, and the intended strategic consequences risk being lost. Technology How to move towards the intended outcomes will be much infuenced by which technologies are involved. What kinds of assets—knowhow, new processes, equipment—will the parties in a transaction or continued business relation have to invest in? Are they specifc to the partnership, or do they have a value outside it? Can they and partners’ performance be inspected? Traditional physical sales often concern goods that are well-defned and where a successful fulflment of an order can easily be agreed on, while for instance an innovative computer system’s success may depend on many factors, be diffcult to agree on until after years of use and even then be diffcult to evaluate due to changing circumstances. Likewise, the effects of counselling, marketing campaigns or research can be diffcult to determine, even afterwards. Uniqueness or standardisation of technical solutions and the knowledge needed to use them is a factor that infuences the recoverability of investments and should therefore be considered when designing price models. Likewise, the inspectability of the output and the achieved value will be an important consideration when designing business models and their price models. Environment Institutional factors and uncertainty will play an important part, as we saw already in discussing business ecology in Chapter 2. In highly regulated felds with low levels of change, agreements may be very different
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from situations where future market conditions are unpredictable. To prepare for a durable and sustainable future, price models will have to build on scenarios that take into account such possible variations. If the ambition is to achieve a trustful relationship, it may be advisable to be transparent with such scenarios and show how different contingencies involve risks for both parties to a deal. Price models will then infuence how such risks will impact both. The three-step progress we describe in Chapters 2–4 remains the fundamental message of this book. However, by linking it to fnancial considerations and strategical intentions, we want to remind readers that pricing needs to be seen as an important part of management control. One core component of management control is metrics: how we use numbers that describe objectives and performance, through established and welldesigned processes in an organisation, to infuence behaviour and ultimately the fulflment of its objectives. Business models today increasingly are about partnerships, and to beneft from them we need innovative price models which provide information and incentives adapted to the needs of actors in the business ecology in which the organisation is situated. RITE and the other points brought up in this concluding chapter can help contextualise the design and use of price models. They are intended to further complement the considerations that business ecology analyses and business model design bring to attention. We hope that the tools, concepts and examples in this book have contributed to your understanding of pricing and will serve you well in developing and maintaining the ventures you engage in in our dynamic and increasingly digitised world.
References Cöster, Mathias; Iveroth, Einar; Olve, Nils-Göran; Petri, Carl-Johan & Westelius, Alf (2019). RITE: Meta-model for conceptualising innovative price models, Baltic Journal of Management, 14(4), pp. 540–558. Frydlinger, David; Hart, Oliver & Vitasek, Kate (2019). A new approach to contracts, Harvard Business Review, 97(5), pp. 116–125. Hedberg, Bo; Dahlgren, Göran; Hansson, Jörgen & Olve, Nils-Göran (1997). Virtual Organizations and Beyond: Discover Imaginary Systems (Chichester: Wiley).
Mathias Cöster is Assistant Professor in the Department of Business Studies at Uppsala University Campus Gotland. He researches the impact of digitisation on industries, organisational business models and price models; furthermore, how organisations develop control systems for realising sustainability strategies. His research has been published in international journals such as European Management Journal and Sustainability. He has also co-authored several books and is a much-appreciated and hired lecturer in various educational contexts. Einar Iveroth is Associate Professor at Uppsala University. His expertise and research includes strategic pricing and organisational change and digitalisation. He has published widely in leading journals such as the California Management Review, Journal of Change Management, Journal of Environmental Management, European Management Journal, and Health Care Management Review. He has also published the book Effective Organizational Change: Leading through Sensemaking with Routledge, and his forthcoming book is Leadership and Digital Transformation: The Digitalization Paradox. Nils-Göran Olve received his doctorate from the Stockholm School of Economics in 1977. He worked in management education as a consultant and as a guest professor at the universities of Linköping and Uppsala, with which he is still associated. He wrote more than 20 books in Swedish and English, and several have been translated into Spanish, Japanese, Chinese, Russian and other languages. Carl-Johan Petri is Assistant Professor at Linköping University. He has worked with strategy, management control and innovative pricing issues for more than 20 years. He has published several books on management control that have been translated into a dozen languages. Petri was one of the founders of CASIP, and he teaches regularly on strategic pricing in university and management education.
Alf Westelius is Professor of Digitisation and Management at Linköping University and consults in strategy, management control and digitisation. His writings deal with the changing business landscape. Topics treated include entrepreneurship and business ethics. He has published in e.g. Refections, Entrepreneurship Theory & Practice, Journal of Business Venturing Insights, European Management Journal, Cross Cultural Management and Scandinavian Journal of Management.
Note: Page numbers in italics indicate a fgure and page numbers in bold indicate a table on the corresponding page. absorption costing 85 accountability reporting and cost information 78–79 activities in a business model 31–32, 34, 38–39, 142 activity-based costing 83–85, 94 advertising, online 109–113 aggregation in business models 43–45 Aixam Mega 23–24 Apple 15, 17, 64 Apple News+ 101, 102 Assa Abloy 134 asset specifcity 84 attributes: of a business model 31–32; of scope dimension in price model equaliser 54–55, 62, 63, 86 auctions 58; online 65, 110–111 Audible 101, 103 battery charging in cars 128–129 Begley, Ranj 101 Bergkvist, Henrik 136 Björkholm, Mathias 136 Blendle 101, 102 Bluetooth 134 BMW Daimler 131–132 boat renting 132 Brin, Sergey 108 business ecologies 1, 11–27, 29, 34, 151–152; of Cabonline 119–120; car industry 22–24; components of 26, 26–27; examples 18–24; functional rental 24–25; of Google AdWords 108; of Husqvarna 104; interaction as directed collaboration 12–15; as interaction between
enterprise and environment 15–17; Internet-based game ecology 18–19; motor-vehicle based transportation 127–135, 154; of Pickit 138–141; of Readly 101; relations in 43–45; of Siemens 113–114; of Skype 19–20; of Spotify 20–22 business models 1, 29–48, 152; as an attribute of an organisation 31–32; of Cabonline 120–122; as a cognitive or linguistic schema 32; components 35; defnition 29–31; in digital publishing industry 101– 102; formal description of 33–36; of Google AdWords 109–111; of Husqvarna 105; implications of 45–46; levels of aggregation in 43–45; perspectives of 31–34; of Pickit 141–144; Siemens 115–116; strategy and 30; value capture and 34–43, 144–146 buyers and power balance between sellers 56–58 buy-or-lease decisions 82 Cabonline 100, 118–124, 122, 154 car industry as a business ecology 22–24, 127–135 cars: electrifcation of 127–129, 135, 154; renting instead of buying 130–133, 135; self-driving 133; sharing 131–133 channels, customer 39, 41, 145 Charge Amps 128, 129 Christie’s 65 CIRC 129
circular economy 107 collaboration 114; among partners for determining costs 89–90; about transportation providers 132 communication ecology 3–5, 19–20, 66 competition: Internet impact on 12; perfect 11, 65, 87; pricing and 3–5, 77, 103 competitors: known as business partners 14; of photo agencies 140; price levels 106; pricing of 58, 59, 62, 65, 123 coopetition 13 copyright violation of images 136–138 costing: for accountability 74, 76; activity-based 83–85, 94; for decision making 74, 76; life-cycle 85; relation to pricing 74–94 cost models and assessing relevant costs 85–87 cost model sheet 75 costs: allocation within frms 82–83, 85; analysis 153; assessing relevance of 85–87; assessment and price models 92–93; assumptions about 76–78; in business models 39; competition and 65; customer value and 86, 113–118; differentiation between internal and external 76; direct 78, 84, 85; dynamics and pricing 81–83; fxed 83; importance in potential price models 78–81; indirect 85; measuring 83–85; overhead 76; partner collaboration in determining 89–90; pricing and 77, 81; recognition of in accounts 82; revenues and 90–91; timing of 81–82; up-front 77, 80, 81, 84; value creation and 143; variable 83 cost split 76, 80, 87 COVISINT 23 customer-centric price model 115–118 customer channels 39, 41, 145 customer groups 40 customer-initiated price model 119–124 customers: changing relations with enterprise 11; relations with partners 40–41, 92; role in value capture 40–41 customer segmentation 35–36, 40–41, 144 customer value 6, 58, 59; cost and 86; pricing and 65; for pricing instead of costs 113–118
data analytics in digitisation 64 decision making and cost information 78–79 dematerialisation 81, 90–91 Desten 134 DiDi 132 differentiation of products 11, 23 digital economy 2, 151 digital marketing 109–111 digital products and subscription 60, 66 digitisation 18, 151; affecting business models 38–39; Cabonline as case study 123–124; customer data and relations 40–41; defnition 8n2; enabling data analytics 64; in gas turbines industry 115–116; Google AdWords as case study 107–113; impacting business models 33; impacting costs 39–40; impacting revenue streams 42–43; infuencing timing of costs 81–82; infuencing value offerings 37; innovative price models and case examples of 99–125, 100; in outdoor power product industry 103–107; price models and 63–66; pricing and 1–3; Readly publisher as case study 100–103; Siemens as case study 113–118; in transportation industry 118–124 direct costs 78, 85; decline of 84 directed collaboration 12–15 distribution channels: Internet as a 36; in value capture 40–41 division of labour 155–156 eBay 65 e-bikes 129 education ecology 19 electrifcation of cars 127–129, 135, 154 enterprise: changing relations with customer 11; dynamic interaction between environment and 15–17 environment: dynamic interaction between enterprise and 15–17; in RITE framework 92–93, 161–162 Ericsson 7 e-scooters 129–130 exogenous pricing 58 Facebook 35; music ecology and 22 fxed costs 83 fxed price plus per unit pricing formula 60, 62
fxed pricing 60, 118–124 Fotolia 140 functional rental 24–25
lock-in pricing 156 Lyft 132 Lynk & Co. 133
General Data Protection Regulation (GDPR) 140 Getty Images 140 Global Positioning System (GPS) 37 Google 15, 19 Google AdWords 100, 107–113, 112, 124, 153 Google search engine 108–111 GPS see Global Positioning System (GPS) grid balancing, electricity 114, 128, 129, 133, 135, 154 groceries as a subscription 64
marketing, online 109–113 mark-up cost 78 Meituan 132 microcars 23–24 Microsoft 15, 136, 139, 141–145, 149, 154 Minecraft and Internet-based game ecology 18–19 MinecraftEdu 19 mobile phone industry with varying price formulas 3–5, 66 Mojang 18, 19 Moovel 132 motor-vehicle based transportation ecology 127–135, 154 Munthe, Axel 57–58 music ecology 20–22 Musk, Elon 127, 128, 133
HBO 39 Husqvarna 100, 103–107, 106, 124, 153 images: copyright compliant 136–138; of organisational systems 32 imaginary organisations 13–15, 156; business ecologies and 16 impression-based price model 111 inbound pricing 5, 30, 66–67, 83, 87–90, 158 indirect costs 85 infuence dimension of price model equaliser 52, 54, 56–58, 62, 65, 70; case study 103, 117, 148; costs and 86 innovative price models 1; defnition 8n1 innovative pricing 78, 83; see also pricing intangible values 36–37 intention in RITE framework 92, 161 interaction as directed collaboration 12–15 internal pricing 66–67, 158 Internet 108; advertising 109–111; as a distribution channel 36; impacting competition 12 Internet auction companies 65 Internet-based game ecology 18–19 isolated-transaction view 11 jewellery as a subscription 64 joint value creation 1, 2 Koivisto, Santeri 19 leasing 56 life-cycle costing 85 Lime 129
negotiation between buyers and sellers 57, 63 Netfix 39, 60, 64, 93, 100, 101, 103 Ninebot 129 Nokia 32 online advertising 109–113 online auctions 110–111 online marketing 109–113 outbound pricing 5, 30, 61, 66–67, 74, 87–89, 102, 106, 117, 122, 147, 152, 158 outside-in perspective of a business model 31–32 outsourcing 12, 33 overhead costs 76 Page, Larry 108 partners: in a business model 34; relations with customers 92; role in business models 38; subcontractors and 141–144; value capture and 41 pay-per-click price model 111–112 pay per use 56, 62, 106 pay-what-you-want model 57–58 “perfect competition” 11, 65, 87 “perfect markets” 65 perpetual rights 55–56, 64, 69 Persson, Markus “Notch” 18, 19 per unit plus ceiling pricing formula 60, 62
phones and price competition 3–5 Pickit 136–150, 154; price models of 146–149, 147; product 137–138 Piëch, Anton 128–129 Platform as a Service (PaS) 143 power balance between buyers and sellers 56–58 price base 62, 63, 106, 148; customercentric 115–118; dimension of price model equaliser 53, 54, 58–59, 65, 70, 86 price ceiling 59 price foor 58–59 price formula dimension of price model equaliser 53, 54, 60–61, 63, 66, 70, 81, 87, 123 price formulas 60–61, 62, 81, 90, 148–149; cost allocation and 83; of mobile phone industry 66 price list 57, 62, 123 price model equaliser 1–2, 11, 49, 51, 51–63, 52–53, 93, 152, 157–158; application of 61–63; cost impact on 86–87; implications of 68–69; infuence dimension of 52, 54, 56–58, 62, 65, 70, 96, 103, 117; organisational changes connected to 68–69; price base dimension of 53, 54, 58–59, 65, 70, 86; price formula dimension of 53, 54, 60– 61, 63, 66, 70, 81, 87, 123; scope dimension of 52, 54–55, 62, 63, 69, 82, 86, 116–117, 147; temporal rights dimension of 52, 54–56, 60, 62, 64, 70, 81, 84, 86, 102, 106, 117, 124–125, 131, 147 price models 31, 33, 49–70, 152; background 50–51; business ecologies and 17; of Cabonline 122, 122–123; cost assessment and 92–93; created by market changes 84; defnition 49; differing 3–5; digitisation and 63–66, 99–127; of Google AdWords 111–112, 112; of Husqvarna 105–106, 106; importance of cost information in 78–81; impression-based 111; infuencing costs 6; pay-per-click 111–112; of Pickit 146–149, 147; of Readly 102; relation between inbound, outbound, and internal 66–67; of Siemens 116–117, 117; as strategy 157–158; varying phone contracts 3–5
price offers, controlling 158–159 pricing: becoming multidimensional 6; case studies 153–155; corresponding to costs 77; cost dynamics and 81–83; digitisation and 1–3, 136–150; exogenous 58; fxed 60, 118–124; inbound 5, 30, 66–67, 83, 87–90, 158; innovative 78; internal 66–67, 158; lock-in 156; outbound 5, 30, 66–67, 74, 87–89, 102, 106, 112, 117, 122, 147, 152, 158; relation to costing 74–94; risk exposure 67; shift from perpetual to subscription 64, 69; switching from selling to renting 103–107; traditional 49; transfer 30, 67, 87–90 proftability 90–91 publishing ecology and digitisation 100–103 purchase volume plus per unit pricing formula 60 Qingdao TGOOD 128 Readly 100, 100–103, 102, 124, 153 relational contracting 159–160 relations 2; in business models 43–45; with customers 11, 33, 35–36, 39; infuencing long term investments 84; in RITE framework 92, 160; in value capture 40–41 rental 56, 62, 69; functional 24–25 renting: of boats 132; of cars 130–133, 135; instead of selling 24–25, 103–107 resources in a business model 34, 38–39, 142–143 result based in price model equaliser 57 revenues: costs and 90–91; from subscriptions 145–146; value capture and 42–43 ridesharing 132–133 risk 2, 156–157; exposure in pricing 67; -sharing 87, 90–91; taking by Cabonline 118–124 RITE (Relation, Intention, Technology, Environment) 92–93, 159–162 Ryanair 61, 61–63 SaaS 64 Samsung 2, 15
Index scope dimension of price model equaliser 52, 54–55, 62, 63, 69, 82, 86, 116–117, 147 search engine 107–113 self-driving cars 133 sellers and power balance with buyers 56–58 servitisation 37, 55, 131, 134 ShareNow 131–132 Shutterstock 140 Siemens 100, 113–118, 117, 124, 127, 128, 134 Skipperi 132 Skype and communication ecology 19–20 smartphone apps in transportation industry 132–133 Software as a Service see SaaS Sotheby’s 65 Spotify 20–22, 44–45, 60, 64, 100, 101, 103 strategic pricing: business-ecology perspective 1; defnition 2; levels of 49; new perspective on 1–3; see also pricing subcontracting 12 subcontractors in a business model 34, 38 subscription based pricing 56, 64, 66, 93, 107, 117–118, 145–148; digitisation and 100–103 Sweden’s taxi market 118–124 system in scope dimension of price model equaliser 55, 62 take it or leave it basis between buyers and sellers 57 tangible values 36–37 target costing 80, 86 taxis: developing brand 119–120; fxed pricing with riding 118–124 Teachergaming 19 technology in RITE framework 92, 161
telecommunication industry: shaped by business ecologies 19–20; with varying price formulas 3, 5, 66 temporal rights dimension of price model equaliser 52, 54–56, 60, 62, 64, 70, 81, 84, 117, 124–125, 131, 147; case study 102, 106; costs and 86 Tesla 127, 129, 133, 134 Toca Boca 64 Toca Super Bundle 64 transfer pricing 30, 67, 87–90 transportation ecology, motor-vehicle based 127–135, 154 Uber 41, 132, 134 unbundling approach to pricing 63–64 up-front costs 4, 63, 77, 80, 81, 84, 156, 158 Valeo 23, 127, 128, 134 value capture 35, 40–43; revenues and 42–43; role of customers 40–41 value creation 7; in business model 34–43, 141–144; cost of 39–40; role of subcontractors, partners, activities and resources 38–39 value, defnition 36–37 value proposition 34, 41; in business models 37 values: added 43; intangible 36–37; tangible 36–37 versioning: defnition 8n3; in pricing 63–64, 83 Voi 129 volume in price formula 60 WeTrott 129, 130 Wikipedia 65 Xiaomi 129, 134 YouTube 35; and Internet-based game ecology 18