biz model 4 method of value capture

Methods of Value Capture(and some value proposition and

scope of activities)

A/Prof Jeffrey FunkDivision of Engineering and Technology Management

National University of Singapore

Business Model

Value proposition: what to offer and how to differentiate

Customer selection: whom to serve and not serveValue capture: dominant sources of revenueScope of activities: what activities to carry out and

what relationships to haveStrategic control: how to sustain profitability (e.g.,

how to control architecture and standards)

Remember! Consistency Among Elements and an Iterative Process are Critical

Customer selection: whom to serve and not serve

Value proposition: what to offer and how to differentiate

Value capture: how to make moneyScope of activities: what activities and

relationships to haveStrategic control: how to sustain

profitability

For example, Method of Value Capture and Value PropositionMethod of value capture related to needs as

is value proposition, customers like to pay for those things that are important to them

As noted last week, key dimensions of performance change over time, this requires changes in method of value capture◦As dimensions of performance change, customers

monitor different dimensions and thus are willing to pay for different things

In Other Words

In choosing method of value capture, we want to maximize potential revenues while making all of our customers happy

OutlineOverview of Value CaptureExamples

◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video◦Mobile Phones and Services

Top Ten Business Models of 2010Conclusions

Methods of Value Capture

Revenue Model Basic Idea

Commission Fees levied on transactions where fees are based on level of transaction

Advertising End users subsidized by advertising

Markup Value added in sales

Production Value added in production

Referral Fees for referring customers to a business

Subscription Fees for unlimited use

Fee for Service Fee for metered service

Methods of Value Capture (more detailed ones)Dominantrevenue model

Basic idea Variants

Commission Fees levied on transactionsbased on the size of thetransaction

Buy / Sell Fulfillment, Market Exchange,Business Trading Community, BuyerAggregator, Distribution Broker, Virtual Mall,Metmediary, Auction Broker, Reverse Auction,Classifieds, Search Agent, Bounty Broker,Matchmaker, Peer-to-peer Content Provider

Advertising End-users subsidized byadvertising

Generalized Portal, Personalized Portal,Specialized Portal, Attention / IncentiveMarketing, Free Model, InfomediaryRegistration Model, Recommender System,Bargain Discounter, Community Provider

Markup Value added in sales Virtual Merchant, Catalogue Merchant, Clickand Mortar, Bit Vendor

Production Value added in production Manufacturer Direct, Content Producer, E-Procurement, Networked Utility Provider, BrandIntegrated Content

Referral Fees for referring customers toa business

Lead Generator

Subscription Fees for unlimited use ISPs/OSPs, Last Mile Operators, ContentCreators

Fee-for-service Fees for metered service Service Provider, B2B Service Provider, ValueChain Service Provider, Value Chain Integrator,Audience Broker, Collaboration PlatformProvider, Application Service Provider

Source: Afuah and Tucci, Internet Business Models and Strategies

At What Price?

After choosing one of the categories on the previous slides, an additional issue is: how much to charge for each element of the product or service?

What level of margins?Higher margins are needed when

◦cost of sales◦cost of R&D is high ◦maintenance is high and given for free

Has to do With Cost StructureWhat is your cost structure?

◦Cost of delivered product or service Internal costs Materials and outside services

◦R&D◦Sales◦Maintenance (if free to user)

Fixed costs vs. variable costs◦High fixed costs make volumes very important◦But can also provide barrier to entry

Gross margins for different types of disk drives and computers

For Many Electronic Products

The cost of assembly is very small, perhaps 5% of total manufacturing costs

Components make up 95% of manufacturing costs

Other costs can be very high◦Development◦Distribution◦Licensing◦And more

Cross Subsidization is Common in Many Industries

More income from complements than original product◦blades than razors◦printer cartridges than printer machines◦copier toner than copier machine◦i-pods (MP3 players) than music (iTunes)◦peripherals than computers (IBM mainframe)

More income from after-sale service than from product, particularly when switching costs are high◦Software, elevators, escalators, nuclear fuel, power generation

equipmentMore income from one customer than another customer

Cross Subsidization Between Customers is CommonIndustry Product Dual Customers Discount for

Real Estate Property sales Buyer, seller Buyer

Rentals Renter, owner Renter

Media Newspapers, Magazines

Reader, advertiser Reader

Network television Viewer, Advertiser Viewer

Portals and Web Publications

Web surfer, advertiser

Web surfer

Shopping Malls Merchant, shopper Shopper

Payment System

Charge/debit card Cardholder, merchant

cardholder

What if Another Firm Begins Offering Complements for Your Product?

Another firm begins offering inexpensive◦blades for your razors◦printer cartridges for your printers◦toner for your copiers◦MP3 players for your iTunes music site

Another firm begins offering inexpensive services for your hardware◦Software, elevators, escalators, nuclear fuel, power generation

equipmentYou might lose your key revenue stream and thus your

profitability

Outline

Overview of Value CaptureExamples of Value Capture Methods

◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet ◦Video◦Mobile Phones and Services


Rolls Royce Jet EnginesA leader in providing jet engines for

aircraft manufacturersWhere do its revenues come from, i.e.,

what is its method of value capture?Most of its revenues used to come from

sale of enginesBut over time, things have changed………

Rolls Royce Jet Engines

Where are revenues?◦Selling engines or spare parts?◦Servicing the engines?

Investment analysts estimate that some engine suppliers ◦get seven times as much revenue from servicing

and selling spare parts as from selling engines◦Do they sell engines at a loss? hard to know due

to long-term contracts ◦The problem is that these large margins have

attracted independent servicing firms (and engine-makers after each other’s business)

Source: Economist, January 8, 2009. Britain's lonely high-flier

Rolls Royce’s New Method of Value CaptureInstead of selling first engines and then parts

and service to airlines, Rolls-Royce ◦ receives a fee for every hour that an engine runs◦promises to maintain it and replace it if it breaks

down“They aren’t selling engines, they are selling

hot air out the back of an engine,” says an investment analyst (i.e., new value proposition) More than half of its engines in service are covered by such contracts, as are about 80% of those it is now selling.

This New Method of Value Capture Requires New CapabilitiesRolls Royce continuously monitors performance of its

3,500 jet engines around the world, ◦ raising an almost insurmountable barrier to any rival

(method of strategic control)This data enables it to predict when engines are

more likely to fail, letting customers schedule engine changes ◦ fewer emergency repairs and fewer unhappy passengers

The data are equally valuable to Rolls-Royce◦ Spotting problems early helps it to design and build more

reliable engines or to modify existing ones◦ Aided improvements in fuel efficiency and extended the

operating life of engines tenfold (to about ten years between major rebuilds)

Alstom Transport (1)Alstom is a leading provider of transport

equipment and (e.g., rail) solutions in the worldProblems with train downtime caused rail

companies to demand and pay for lower downtimes

London Underground specified in a contract that 96 trains be available for service each day

This required Alstom to gradually take over customer’s operational activities and to redesign the system for lower downtime

Should Alstom charge for time and distance that trains travel?

Alstom Transport (2)Another change Alstom made to support lower

downtime of its transport division was to create two customer-facing divisions:◦Alstom Systems provides turnkey solutions for trains,

signaling systems and maintenance services◦Alstom Services offers operational services, such as

train maintenance, technical support, product upgrades and renovation

This change represents a form of organizational capability. For example, feedback from Alstom Services enables Alstom’s Systems design better turnkey systems

Similar Examples (1)

Many providers of ◦mobile phone infrastructure providers (e.g.,

Ericsson)◦electrical generating equipment◦nuclear fuel◦manufacturing equipment

are selling services (value proposition) and getting paid (method of value capture) for doing services

Similar Examples (2)These providers of equipment and service

know the equipment and service better than the customer – thus they do the service

One reason they know the equipment and service is because they spend a lot on R&D

They spend a lot on R&D because they sell systems to many customers

Related to method of strategic control◦economies of scale in R&D◦covered a few weeks ago

Remember

Changes in business models often cause the shares of firms to change……..

Change creates opportunities

ExceptionsSome providers of services design their own systems

and do their own R&DThis is common in Japan

◦NTT DoCoMo in mobile phone services◦Japan Railways (JR) in train services◦NTT in Wireline phone services

This leads to high R&D costs per sales and thus high costs for final services

One reason they can do this is because of high barriers to entry for foreign firms

How About Electric Vehicles?Do potential users want to pay for electric

vehicles in same way they pay for regular cars (i.e., internal combustion engines)? ◦Separately pay for cars and for electricity charging◦But what if there are no charging stations?

Alternative business model◦What if users mostly pay for use of car, i.e., pay for

miles driven?◦Could do this for rental or ownership◦Then suppliers have incentive to provide good

coverage of charging stations (just like mobile phone companies have incentive to provide good coverage of base stations)

Two Distinct Choices for Electric Vehicles

Sell electric vehicles Sell miles driven

Customer selection

Conventional customer Risk averse customer

Value Proposition

Provide electric vehicle Provide driving with electric vehicle

Scope of Activities

Design and make automobile

Manage charging stations

Value Capture Receive payment for automobile

Receive payment for miles driven

Method of Strategic Control

High entry cost for design/manufacture of auto

High entry cost of charging stations

OutlineWhy do you think Singapore might be a better place

for the “sell miles driven” business model than doing it in Malaysia, Indonesia, or the U.S.?

Computers (1)Most of us buy computers at retail outlets

and retail outlets pay the computer manufacturers

But this is just the last step in a long process of modification◦firms have modified methods of value capture

(and other aspects of biz model) many times both to survive and find the most profits

Each “discontinuity” has involved a new method of value capture◦Also differences between firms for the same

discontinuity

Computers (2)Mainframe suppliers such as IBM used to

lease computers and software for a monthly fee◦this low monthly fee and IBM’s large software

library created a barrier to entry for other suppliers

Mini-computer suppliers found a niche by selling computers and providing documentation for engineers and scientists who developed their own software

Computers (3)PC suppliers took mini-computer method of

value capture one step further◦More documentation in the form of more “open

system,” which enabled greater choice of software for users

◦Purchased microprocessors, other ICs, software from other firms, sold computers through retail outlets

◦Low development costs, no sales people, and higher volumes enabled them to have lower margins (see next slide)

Software suppliers tried various methods of value capture◦Microsoft received licensing fee for each PC sold

Lower grossmargins formini than mainframeand even Lower for PCs

Computers (4)PC software

◦IBM offered Microsoft a lump sum payment for OS

◦Microsoft wanted a licensing fee per PC◦What are the advantages and disadvantages

of each approach?Now, service revenues are now greater

than licensing fees (see later slide) for software

Software is moving towards services

Service/Usage Fees are even more Important with Software as a Service (SaaS)Value proposition

◦Provides software for lower price than packaged softwareCustomer selection

◦Small organizations (security software is exception)Scope of activities

◦No installation activities, instead a focus on delivering new products/services

Value capture: subscription/usage fees as opposed to high initial cost of packaged software and installation

Utility/Cloud Computing: Complete outsourcing of IT to utilities (similar to electricity)

Internet

Many Examples of New Methods of Value Capture in Internet

Will focus on one here, PayPal, and some others later

PayPal (1)

Problem addressed by PayPal’s service◦Difficult for individuals to receive payments with credit

cardsFirst method of value capture

◦Although always free to senders, it was initially free to receivers and PayPal planned to use e-mail as identifier and make money from interest when receivers left money in accounts

The PayPal Wars: Battles with eBay, the Media, the Mafia, and the Rest of Planet Earth by Eric M. Jackson

PayPal (2)Resulting Problem

◦Receivers quickly removed cash and used credit cards to make payments

◦PayPal was forced to pay credit card fees (about 2%) since users didn’t have any cash in their accounts

Second method of value capture◦Charge large receivers (>$500 in six months) transaction

fees ◦Large receivers must upgrade or cannot receive payments

via credit cards


◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video, eBooks◦Mobile Phones and Services


Producers of Videos/MoviesTheater tickets from about 1900Broadcast television ad revenues from late 1940sCable (from 50s) & satellite (from 90s) subscription

feesRental and sales income from VHS from late 1970s,

from DVDs in 1990s◦Rental stores pay movie companies fixed fee or percentage

of rental/sales income◦Netflix extended this model to mail delivery service and

Redbox extended it to rental kiosks in 2000sInternet services

◦Big changes occurring now

Internet ServicesIndependent sites control most of the Internet

businesses, but some of them are owned by content owners/broadcasters

Movies/programs mostly viewed on computersThree methods of value capture

◦Sell digital movies (e.g., Amazon, Apple iTunes)◦Provide movies/programs for free, make money on ads

(Hulu, YouTube, CBS)◦Subscription services (Netflix, TV Everywhere)

Innovations (and new methods of value capture) are also needed in television receivers◦Google TV◦Apple TV

Source: Netflix, valuing a new business model, HBS Case 9-113-018


◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video, eBooks◦Mobile Phones and Services


What about e-Books?If you are an online book provider, should

you sell files for a specific reader or other types of files?

Should you sell your own branded readers?Should you sell or rent books?What percentage of revenues should you

share with publisher (or author)What should be the price?Who sets price?

◦Online book provider: may sell low and at a loss to promote sales of readers

◦Publisher: may set high price to discourage sale of eBooks

What about e-Books? (2)In the long run……….Libraries and stores (i.e., private libraries)

can rent out individual books to the public online (i.e., anywhere in the world)

While it takes a while for users to return physical books, a copy of an e-book could be returned much faster

This would lead to much lower rental prices (perhaps daily rental fees) and thus◦a much larger rental market◦and perhaps a smaller purchase market


◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Video◦Mobile Phones and Services


Phone Manufacturers

Until recently, traditional cost plus fee pricingStrategic control: Economies of scale in R&D provided

advantages to large manufacturers such as Nokia Emergence of modular design/vertical disintegration has

reduced cost of R&D and thus enabled new entry (Apple, Google)

More importantly, other revenues are emerging and phone manufacturers want some of these revenues◦Content, Application, Advertising

How can phone manufacturers obtain some of these new revenues?

Service Providers

Very high fixed costs: Subsidize phones to attract new subscribers

Voice era: combination of subscription & fee for serviceSMS and roaming: is lucrative market in which prices are

much higher than are costsOther revenues are emerging and service providers want

and need some of these revenues (think of wireline telecom providers)◦Content, Application, Advertising

How can service providers obtain some of these new revenues?

Outline

Overview of Value CaptureExamples

◦Rolls Royce Jet Engines◦Transport: Alstom Transport, Electric Vehicles◦Computers, Software, and Internet◦Mobile Phones and Services


Conclusions (1)

New technologies, new markets, and new levels of value (dis)integration often require new methods of value capture

But there are no simple answers to the best methods of value capture

Of course you want to maximize revenue, but without losing customers and collaborators

One firm’s method of value capture depends on ◦method of value capture by competition, collaborators◦customer needs

Conclusions (2)

Contrasting industries and analyzing whether methods of value capture can be borrowed from other industries is a good place to start

Also look for consistency among different elements (customer selection, method of value capture, value proposition, scope of activities) of business model

For Your PresentationsDo not just tell me the sources of revenue for your firm

◦Identifying these revenue streams is just one step in your analysis

Analyze alternative methods of value capture. As stated on previous slide◦Contrasting industries and analyzing whether methods of value

capture can be borrowed from other industries is a good place to start

◦Also look for consistency among different elements (customer selection, method of value capture, value proposition, scope of activities) of business model

Appendix

Early Years of Mobile Internet (<2004)

Japanese service providers ◦Charged subscription fee (5 SGD/month) and fee

for service (for data downloaded)◦Charged monthly fee for content and gave about

90% to content providers in micro-payment service. Encouraged content providers to modify content for mobile phones

◦Offered inexpensive mail servicesEuropean and U.S. service providers

◦Did not devise micro-payment service◦Expected content providers to devise own method

of value capture◦No growth occurred

Inexpensive Mail Facilitates Browsing (1)

Users subscribe to mail services and click on URLs inside mail to access additional information

Many content providers use such mail service to increase the number of visitors

Such mail services are more important for phones than for PCs because◦Phones have inferior user interfaces, particularly in early 2000s

Japanese service providers made mail services a standard function on all mobile phones by year 2000

Western service providers did not introduce such mail services because they did not want to cannibalize their SMS revenues

Inexpensive Mail Facilitates Browsing (2)

Example: new Japanese fashion company Xavel (site name is Girls Walker)◦Offers “mail magazines” that are written by 3rd parties◦Xavel does not have to pay to send mail◦Users pay less than $0.01 to receive mail◦Links to fashion products in the fashion-related mail magazines

has led to sales of fashion-related products (cosmetics, perfume, vitamins, clothing)

◦<1% of mail magazine readers purchased products in 2004◦Achieved greater than US$ 40 M in sales and 4M$ in profits in

fiscal year ending September 2004

Responses by U.S. and European Service Providers by 2004

Began offering micro-payment system and sharing some content fees with content providers

But differences remained. U.S. and European service providers◦only shared about 50% of revenues with content providers◦did not provide inexpensive mail services since they did not

want to cannibalize SMS revenues◦could not solve many standards-related problems and thus

could not offer sophisticated content and applications. These applications and content had to wait until phones had processing power and memory sufficient for PC Internet standards

But why Couldn’t NTT DoCoMo Export its i-mode Service?

NTT DoCoMo’s Efforts to Export i-Mode

Attempted to make its i-mode service a global standard

Needed to but failed to create a critical mass of◦Service providers◦Phone manufacturers◦Content providers◦Users

Only convinced a few small service providers and phone manufacturers to adopt i-mode

Key Questions by Western Phone Manufacturers when they Considered i-Mode

Will the market be large for i-mode?◦Will many service providers adopt i-mode?

Can we make profits? i.e., method of value capture◦Doesn’t NTT DoCoMo control everything in Japan?◦Isn’t this why Japanese phone manufacturers don’t make

much money in Japan?◦Also, aren’t development costs very high for i-mode phones? ◦If costs are high and benefits are low, why should we support

i-mode?

NTT DoCoMo’s Mistakes

Didn’t hire Western executives before creating global strategy

Believed that technology (e.g., c-HTML) was the reason for i-mode’s success

Underestimated difficulties of creating critical mass of service providers and phone manufacturers outside of Japan

Didn’t modify i-mode for outside JapanDidn’t work with Western press wellAttempted to be the sole source of information on i-

mode and mobile Internet in Japan

biz model 4 method of value capture

Business

razors printer

ebooks mobile

online book

electric vehicles

methods ofvalue

strategic

business model

internet video