Don Sull's blog

The decline of business models resembles the process of dry rot, which eats away at a building’s timber, such that it looks solid but is in fact susceptible to collapse. Business models decline when they no longer create economic value, and this decline typically occurs when customer’s willingness to pay decreases. Thus the main indicator of decline is falling prices exceed reductions in costs to produce the good. Slipping prices are the best, but not the only indicator of dry rot. Below are five symptoms to help you assess whether your company’s business model may be at risk of decline:

1. Actions that used to work no longer do. One sign of a broken business model is that activities which worked in the past no longer produce the same result, even when executed well. Pharmaceutical companies continue to conduct large scale research, and yet produce precious few breakthrough drugs. Einstein defined insanity as doing the same thing over and over and expecting different results. Another form of insanity occurs when external circumstances shift, yet managers do the same thing over and over again and expecting the same results.

2. Your least sophisticated customers are your best customers. The most demanding customers are often the first to migrate away from a business model that no longer creates value. For professional service firms, including law firms, investment banks, and executive education providers, an exodus of discerning clients and an increased reliance on less prestigious firms often indicate creeping dry rot. If technology-savvy young users avoid your product-e.g., newspapers, CDs, land line phones, etc., you have a problem.

3. Customers would switch if they could. High switching costs prevent customers from abandoning a supplier even if they are dissatisfied with the offering, a more attractive substitute arises, or competitors offer better terms. Microsoft’s dominant position in Windows and Office prevent users from switching easily, even though some find the company’s software complex, slow, and annoying. Business history shows that switching costs buy a company time, but never last forever.

4. We would do things very differently if we started from scratch today. A good measure of whether a business model has outlived its usefulness occurs when new entrants eschew incumbents’ recipe. No new entrant to the airline industry, for example, would replicate the legacy carriers’ hub and spoke route network or mimic their labor relations practices. In the absence of new entrants to their industry, executives can imagine how they would start a greenfield operation. The differences between the new and old models often bring into sharp focus what is not working for established players. Identifying gaps does not make them easy to close, but a gap analysis can focus management on the right issues and clarify the extent of problem.

5. We have to tell customers what they should want. Managers locked in an outmoded business model often find themselves telling customers what they should want–typically what the company provides. Several years ago, I invited a senior executive from a large mobile phone company to class. I asked the students how many owned one of the company’s phones. Only two did, with the vast majority of the class prefering a Nokia phone. The executive proceeded to lecture the students on how they should stop focusing on “cosmetics” and make their decision based on the technical criteria that his company emphasized. Wrong answer.

My next post will list some business models that appear healthy, but that may well be suffering from business model dry rot.