What do you do when your chief product threatens to become a commodity? You can of course cede the low end of the market and try to shift your business model to something for which customers will continue to pay premium prices. Or, maybe more daringly, you can do what Dow Corning did: beat commoditization through business model innovation that faces the threat head on.
Business model innovation of either kind isn’t easy. You have to find ways of doing things that are new and sometimes diametrically different than the core business model.
In a few years leading up to 2002, the company recognized silicone was becoming a commodity as markets matured, the competitive landscape began to grow and customer needs began changing. A strategic review lead to an exercise in customer segmentation which revealed information that created a huge opportunity for the organization.
The segmentation lead to the discovery that, regardless of the market segment, customers existed within four segments ranging from pure “innovation seekers” to “price seekers” with varying degrees of each in between. With this segmentation, Dow Corning could easily see which segments it was serving very well and which left room for opportunity. In this case, Dow Corning, a highly innovative and service oriented organization, needed to find a way to better serve the “price seeker” segment. This segment knew what products they needed, how to use them, but didn’t need all the high value services bundled into the price of the product. They simply wanted to purchase their standard silicones at the lowest possible price.
Don Sheets, current CFO, worked to develop and implement a new business model that would tackle this customer segment. He knew that he couldn’t capture the price seekers merely by cutting prices. Charging less for the same goods would result in unacceptably low margins and make the model unattractive to Dow Corning in the long term. Instead, he had to ensure profitability by coming up with a business model radically different from the high-end, value driven model of the company’s core business.
Though innovation is too often thought of as a moment-of-inspiration thing, success is far more likely when the new opportunity is approached methodically, through a process of testing the most important assumptions one by one. So Sheets and his team carefully considered the four critical elements that make up any business model: key resources, key processes, a profit model, and a customer value proposition (CVP).
Because the CVP typically determines how the other three elements are configured, it’s critical to get it right by answering this question: what is the job that customers are trying to get done and how will the offering help them do it? Dow Corning’s CVP for these price-driven customers was to offer them products in a more direct, simplified fashion—with fewer services and at lower costs. This was potentially disruptive to Dow’s existing business, but if the revenue model, resources and processes were realigned to support this new CVP, the potential was great.
In keeping with the CVP, Sheets and his team determined that cutting services alone wouldn’t do it. There also needed to be a new price point that was lower than any of Dow Corning’s offerings at the time. This new venture had to have a much lower cost structure given these customers were much more price sensitive. For the most part, thought Sheets and his team, this customer segment knew what products they wanted and how to use these products. There were certain services they wouldn’t need. In order to build efficiencies into the model – so Dow Corning could afford to sell these products at lower prices and still like the profitability – standard operating mechanisms would be instrumental. In this case, business rules were designed and built into the model.
Rules such as minimum order quantities and order lead times were enforced. These alone created efficiencies in the supply chain, logistics and in the warehouses where less inventory is managed. Also, standard credit terms of 30 days were offered with the option of purchasing different terms at a premium. Prices are market-based and set at the time the customer places their order. All of this required a shift away from Dow Corning’s hands-on, service approach to one that was low-touch, standardized, automated and web-enabled – as close to an on-demand operation as possible.
A critical point in its development came when the management team sought the reaction of the organization as a whole. It’s an important step when an innovation requires radical new ways of thinking and operating. Not surprisingly, the idea was not particularly warmly received initially–it was alien compared with its core operations. Such reactions often lead companies to tie a potentially transformative business too closely to the core, binding it to the same cultural norms, incentive plans, and processes – a critical mistake that has sabotaged many an otherwise innovative offering. So Dow Corning created an entirely new brand – XIAMETER® – a business model under the Dow Corning corporate umbrella, yet operate independently, with its own identity and culture.
The remaining challenge was to fit this new entity to the overall organization. Because automating as much of the customer transaction as possible was essential to keeping down overhead, the Xiameter brand was designed from the start as a web-enabled business model. The customer would place an order with no human interaction, requiring far fewer staffers than a traditional Dow Corning business unit. Because those staffers needed to be much more comfortable managing business differently, the Xiameter organization sought out people at Dow Corning who could act differently with customers – a much more transactional approach than a nurturing approach. While still needing to be team players, they had to be experts who were comfortable making fast decisions. One test of this was how quickly they decided to accept a position with the Xiameter team when asked to join the new business model.
Most new businesses need time before their success can be fairly gauged. Not so in the case of the Xiameter business model, which quickly delivered on its promise, sometimes in unexpected ways:
- Dow Corning earned back its investment in just three months.
- New orders allowed better use of under-utilized manufacturing capacity.
- By utilizing market-based prices, it drove more demand for silicone products, in some cases drove up prices, which in turn increased profits for Dow Corning as a whole.
- Prior to the launch of www.xiameter.com, the company had no online sales but now over 30 percent of Dow Corning’s sales are online – nearly three times the industry average.
- Despite worries that the new model would cannibalize the existing customer base, a majority of the new business was driven from new customers.
In the nine years since the Xiameter brand launched, it has transformed dramatically, while still staying true to its core business model. It now offers more than 2,100 standard silicone products, compared with just 400 when it launched. Originally, it was just for large-volume customers. It now also serves smaller volume customers through transparent tiered pricing so customers can now choose the pricing most appropriate for them based on the volumes they need. And while www.xiameter.com still maintains a minimum order quantity business rule, they have added the option of purchasing through local distributors for customers seeking flexible order options or customized services. Discounts are available for purchasing multiple items within a product family, and customers can lock in price and volume commitments through an online supply agreement. And the Xiameter business model has been able to maintain its efficient cost structure by implementing and automating all its business rules within www.xiameter.com which links directly to SAP.
Improved offerings are a natural outcome of innovation. It’s good for both customers and companies. Customers get better products; companies get higher margins or greater revenue. The trick is knowing when and how to make the next change. Like Dow Corning’s core business and the life cycle evolution of products, the Xiameter brand will also have to continue to evolve. When that point comes, Dow Corning, practiced in applying a methodical and repeatable process of business model innovation, should be ready to once again turn their world upside down.
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I recently spoke with Stacy Coughlin and Kristina Bobrowski about Dow Corning and their experiences with business model innovation in the creation of Xiameter. The story is a great case study of how an established, successful firm can still improve their innovation efforts.
The story has been told by others pretty well already – Xiameter has been made into a Harvard Business Review case study authored by Clayton Christensen, Mark Johnson and Henning Kagermann. Kay Plantes and Jeffrey Phillips have also written excellents posts on this case after speaking with Stacy. Here is how Jeffrey describes the advent of Xiameter:
Traditionally, Dow Corning has provided silicone to a range of clients, but wrapped that product in a lot of information, service and support. It became evident to individuals within Dow Corning that a large segment of the potential customer base didn’t want or need anything except the silicone product itself, so Xiameter was launched to offer a radically different business model and distribution of the product to those customers who didn’t want, or need, the service or support associated with the sales and distribution by Dow Corning.
I won’t recap too many details of the case, but I’ll use it to make some points. This is how the introduction of Xiameter changed Dow Corning’s position on The Innovation Matrix:
Prior to Xiameter, Dow Corning was a Fit for Purpose innovator. They have been a market leader in the silicon industry since its inception – and their strategy was built around providing the best possible product. Consequently, all of their innovation efforts were put into sustaining this market-leading position. They had substantial investments in R&D, significant resources sunk into customisation for lead customers, and a high level of commitment to continuing to build market-leading products.
But at the end of the 1990s, they noticed that a large part of the market didn’t want or need this level of service and support. For many applications, silicone was becoming a commodity. The environment around Dow Corning was changing.
Xiameter was developed in response to this.
It represented an increase in Innovation Commitment in two ways. First, it had very clear support at the CEO level, and this was reinforced by the allocation of resources – people, time and money. Second, the economic investment was significant.
Xiameter also helped Dow Corning increase their Innovation Competence. In addition to their skill at product and service innovation, the development of Xiameter built a business model innovation competence as well. Also, this increased the scope of Dow Corning’s innovation portfolio – this was a clear Horizon 2 investment.
This case illustrates several important points:
- Your position on The Innovation Matrix is dynamic. I’ve made the point before in talking about Procter & Gamble – you control your position on The Innovation Matrix, and it can change over time. Shaun Coffey makes this point in a comment on that post:
The emphasis on the dynamic nature of a firms position is important, and often misunderstood. Many firms do not recognise that a business model exists at a point in time – and, like all complex systems, every time you act in the market you perturbate the system and a new configuration of the business model emerges. It is simply too easy to conceptualise this once, and then stick with a fixed model until is is so disfunctional that you are in crisis mode.
This is exactly the problem that Dow Corning avoided by undertaking this initiative.
- A new business model often requires a standalone division. This has some interesting interplay with points raised by Ralph Ohr in his last post. Big companies have some significant advantages in building new business models – in particular, they have the resources to do so. Constantinos Markides has written about this too – and he outlines the factors that lead to success in new unit spinouts designed to support new business models.
- Separate business models work best when they share resources. This is where it helps to be big. Plantes outlines one of the key issues in the success of Xiameter:
Product line managers oversee product category platforms, determining where products are in the life cycle and deciding which products fall under which brands, all with an eye to balancing capacity and brand mix to maximize overall profitability. Everything else except sales and marketing – in other words manufacturing, governance, sustainability and C-level management resources – is shared by the two brands.
“We also have a highly integrated SAP system utilized in real time, allowing us to offer two brands without adding operational costs, which also adds to efficiency” Coughlin notes.
Stacy made the point to me when I asked why the Xiameter model hadn’t been copied by competitors. Her response was that they were all running multiple instances of SAP. This is actually kind of mind-boggling. The inability to integrate back-end data is preventing them from achieving economies of scale – and this is one of the keys to successfully implementing the multiple business model strategy.
- To succeed over time, you have to risk cannabilisation. There definitely appears to have been concern internally about the potential of Xiameter to cannabilise the core Dow Corning customers. Here is how Phillips discussed this:
But there are several factors at play here. First, Xiameter was introducing a business model to serve unserved or underserved customers who had chosen not to interact with the existing business model, so they were additive to the customer base. Second, Xiameter is more than willing to co-exist with a high-touch, high service business model that Dow Corning provides. In this case, and I suspect in many cases, business model innovation expands the pie and attracts new customers. It does not have to be a zero sum game.
There are still issues here. One is that Xiameter achieves its lowest total cost position by taking advantage of resources within Dow Corning, and this can have negative impacts on incentives within the parent firm. Managing this issue is very tricky. But overall, the business model innovation undertaken by Dow Corning expanded their addressable market – it didn’t just replace existing customers with new ones.
Dynamics are critically important – even if you are just executing a currently successful business model with increasing efficiency, you are rarely standing still. And over time, this approach can be dangerous. Your market may be turning into a commodity as the silicon market was for Dow Corning.
The Innovation Matrix is a tool for you to evaluate where you currently are, but more importantly, it is there to help you figure out how to get to where you want to go. You can use it to plan the innovation moves that will transform your organisation.
Student and teacher of innovation - University of Queensland Business School - links to academic papers, twitter, and so on can be found here.