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September 30, 2013
Digital disrupts the foundation of business
By: Mark McDonald

Transactions drive every business. The transaction defines the basic unit of commerce, the thing that reflects business activity. Each industry has its own definition of its basic business transaction. An airline ticket, order line item, an insurance policy, a download, a contract, or office visit represent different transaction types. Revenue is a function of the value of each transaction multiplied by the volume of transactions over a certain period.

Value and volume describe the foundation of business models

Transactions form the foundation of the business. Transactions define the basis for a firm’s economic model, their capital intensity, capacity for growth and capability to delight customers. Value and volume provide a means to describe the changing nature of business transactions and business models.

  • Value refers to the monetary size of each transaction. An automobile, house or major appliance represents a high value transaction. Likewise signing a major contract, real estate, equipment are high value business transactions.

  • Volume captures the frequency of business transactions in terms of the number of transactions required in the business model. Commercial real estate is a low volume industry. The media industry is a high volume industry in terms of the number of purchases and downloads required to generate revenue.

Combining value and volume provide a basis for classifying business models and the nature of industry economics. The figure below illustrates a framework for expressing this relationship and provides a few examples.

View full illustration

Changing the nature of transactions changes the industry terms of competition. Notice in the figure above there are no examples of businesses based on low value – low volume transactions. Likewise it is hard to see a business, however desirable, able to sustain a model based on high value and high volume transactions.

Businesses cluster around two value and volume mixes. High-end or commercial business models feature high value transactions in relatively low volume. Low-end or consumer businesses have the opposite mix – low value but high volume. Understanding the value to volume mix in an industry is important. Change the relationship between the two and you disrupt the

Digital technology busts internal and external business bundles

Digital technology changes the mix of value and volume in just about every industry. eCommerce, mobility, social media and the cloud make it economically feasible to turn the value to volume mix on its head. Digital technologies reduce administrative costs, enable greater just in time fulfillment and open immediate or low latency channels between the company and consumers. The result is a deep disruption of business models often under recognized in digital strategy or business operations.

Bundling is a common market strategy. It packages multiple features into a single product offering. A bundle is intended to appeal to a broader audience more economically than offering individual products to individual markets. Software bundles features to appear to a broader audience. The media industry bundles individual songs into a record album. Bundling seeks to preserve the value of the transaction by offering more.

Internally, organizations reduce administrative and overhead costs often by bundling business transactions, a higher value –lower volume approach. “If it costs as much to sell a 100 units as it does to sell 1 unit, then we should look to sell 100 units at a time.” The answer in the digital world is that if it costs the same, then it just costs too much regardless of how many you sell.

Digital technology busts bundling both internally and externally. It drives a more just-in-time, just-as-much business model as it connects consumers and company processes and information. It has transformed many industries compromising high value – low volume models. This is going on in just about every industry, from insurance to music to retailing and automobiles, markets are moving from a model based on generating high value – low volume businesses into ones growing based on offsetting lower value transactions with significantly higher volumes. The figure below illustrates this shift.

View the full illustration

Increasing information intensity and connectedness – the definition of digital – deconstructs the high-end business model. Digital lowers barriers to market, sell, serve and support reducing relative impact of bundling. Individuals get just what they want, just in time paying for it ‘by the drink’.

Automobile insurance provides an example. Telematics enables the company to know more about driving habits. Currently insurance companies use this information to bust bundles known as liability pools. In the future, insurance purchases will be continuous and personalized – the ultimate low value – high volume model. Why? Because it’s possible and it can be profitable with the right business platforms and operating models. Expect similar styles of products in other industries from transportation to healthcare and everything in between.

Shifting the business mix disrupts company economics and profitability. Busting bundles lowers the revenue per transaction, requiring internal transformation to cope with higher volumes and lower marginal revenue. It is no longer feasible for high value – low volume model processes and capabilities to survive in a digital world.

Digital disruption of the basic business transaction model sounds abstract, academic and economic. But the disruption can be profitable; Apple’s iTunes store generated $12.9 billion dollars in fiscal 2012. It is a clear example of a low value – high volume model. Square seeks to do the same thing in financial services, capturing low volume credit card transactions from a large number of part-time sellers. Cloud-based business services pursue a similar strategy. Look for more of these models in the future as they use technology to bust business bundles in external products and internal processes.

Every organization embarking on a real digital strategy and journey should look at the impact of changing the value and volume mix of their business. Success requires more than investing in digital technology. It requires understanding the new profit model for digital business and its internal and external implications.

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