Product Innovation Isn’t Everything

starbucks

This article was originally posted on Inc.com.

How was Starbucks able to build an empire in just 35 years by charging premium prices for what is essentially a commodity? The coffee purveyor’s legions of loyal patrons seem to find significant value in what it offers, to the point that it has become one of America’s most beloved brands. Others, meanwhile, are perplexed by the fact that someone would pay $4 for a cup of coffee, standing in a long line for the opportunity to buy something that could be created at home for much less. Starbucks founder Howard Schultz has said, “If I went to a group of consumers and asked them if I should sell a $4 cup of coffee, what would they have told me?“

So how does Starbucks pull it off? Because it offers more than just coffee. It prepares premium custom beverages made to your precise order, excellent customer service, and beautiful stores with comfortable chairs and free WiFi. For many, a trip to Starbucks is as much about the experience as it is about the caffeine. For others, it is a matter of convenience-they can always find one nearby when they need to connect to the Internet. All of these things add value beyond the coffee itself, which enables Starbucks to sell one of the World’s most commoditized products, at a significant premium. For those who value these benefits, Starbucks is contributing significant value, well worth the $4 per visit.

Amazon.com is a subtler example of what’s possible when we look beyond the commodity. It is not selling a premium version of a product like Starbucks, nor does it have a physical presence on every street corner. It does, however, contribute significant incremental value beyond that of its competitors. Most of us shop at Amazon.com because we know it has the world’s largest inventory, the fastest shipping, and one of the best return policies. And, because it is now the largest retailer in the world, it also has significant pricing power and is thus able to offer some of the best pricing.

If all of these benefits seem trivial, ask yourself if you would buy from a smaller online store you don’t know much about, even if the product is the same price. Perhaps you have a bias toward supporting the small businesses or the underdog, but that aside, would you pay the same price for a product from a store that has slower shipping and an unknown return policy?

In 1979, Harvard Professor Michael Porter introduced the concept of the value chain, suggesting there are multiple layers to your business, each of which contributes to the total value to your customer. Direct activities, including sales, clearly contribute to revenue, and activities such as IT and customer service provide indirect, long-term value. The presence of all of these services form an integrated value chain that makes some brands more professional and valuable than others. The investments these companies make in their infrastructure cannot only make them more efficient and bring down cost, they have the potential to add value for their customers by improving the purchase experience, reducing risk, and addressing other needs that the customer may have but are being ignored by the market.

Starbucks and Amazon.com have both built an empire around selling commodities, but they invested heavily in the indirect benefits surrounding their offerings, thus providing more value than their rivals. Put another way, their innovation is the value chain they wrapped around the commodity products they sell, not the products themselves. After all, innovation does not always mean technical wizardry or superior craftsmanship–creating a more valuable delivery or purchase experience can be fertile ground for innovation too.

How can you take a page from Starbucks or Amazon? First, you have to appreciate the irony of selling a commodity and yet become so differentiated in the process, that you rise above the commodity trap that plagues so many businesses. Therein lies a subtle, yet crucial, distinction. Everyone in Silicon Valley seems to be “innovating” a technology product, but not many are creating meaningful differentiated value that gives them a leg up on competitors. That is unfortunate when you consider that many technology products become commodities eventually.

The bottom line? If you spend all of your resources innovating a product that is bound to become a commodity, you won’t have a defensible market position down the road. In fact, all of your resources will have been spent fighting a battle you are unlikely to win in the long term, unless your successful at being acquired during market consolidation, which is unlikely. That’s why innovating the value chain around an existing commoditized product, rather than innovating the product itself, is sometimes a better strategy. That’s especially true if you’re entering a crowded space and lack the timing or resources to become a leader when the market matures.

Custom Development Costs Too High?

Small business has entirely different needs and expectations from technology than larger enterprise.  Okay, that is an obvious statement, right?  So then why are small businesses always so surprised to learn about the cost associated with custom projects?

 

 

First, a Little Background

There was a time 10 years ago, when the company I worked for would build websites for mid-size companies, and we could never quote less than $15-20k for a simple website.  In today’s world of WordPress and 1000s of templates to choose from at $30 a piece, that seems almost unbelievable but remember, frameworks like WordPress didn’t exist and neither did the templates, or even best practices for design in the early days.  As a result, you had to do pretty much everything by hand. You would write every function, connect it to the database, hand-code the HTML, and equally the designs were mostly original work that took time and research.  And so yeah, all-in, creating a WordPress equivalent website from scratch would have easily required 3-4 weeks of developer time, 40 hours from a designer, and another 40 hours for project management and requirements gathering.  All said, you’re talking about 6 weeks of work!

Fast forward 10 years and there are numerous companies offering to build a website for $500, or less!  By using an open source framework, free plugins, and by customizing an existing template for your design rather than starting from scratch, the website developer really only needs to snap peices together now – the pieces are built already, making it a relatively easy project to put together in days or even hours, rather than weeks.  No worries really about bugs either, since a lot of the logic is already written and revised from other projects.   Effectively, those problems have been solved now and we have commodity solutions to those problems.

Expectations Mismatch

The availability of lower-cost solutions is a great thing, but it creates a mindset of cost expectation that often isn’t realistic when you begin to look at custom coding work.  For example, even just adding a functional interface with JavaScript and AJAX to optimize user experience or validate a form, might not already exist and will require custom development.  On the surface this statement seems reasonable to a developer, but what if it is 8 hours of work and costs as much as the initial website itself? Will the client/customer still find this reasonable?

As businesses go deeper into custom work, there are fewer templates and fewer frameworks and technology stacks upon which they can stand to accomplish their task and as a result costs and time requirements will begin to scale exponentially. There is afterall, a reason why Amazon.com employs 1000s of people and yet you can have your own ecommerce site built in a day.  This dichotomy seems to always be an issue for the non-technical person to accept, not just at the small business level, but any time a businesses tries to go a layer deeper.  I’ve seen the same issue among mid-size businesses as well, when looking at going into deeper systems integration work.  One company in particular  I observed, went from using PHP/LAMP technology for their website in,  to deciding it was time to go deeper. They embraced an enterprise Java stack to begin developing the business logic and work on other systems integration work, and were stunned to realize their time estimates were less than a third of what was now required to do the work.

Development Value Pyramid

Lessons to be Learned

A lesson here, is both for developers to realize the paradigm that businesses are coming from when their expectations are challenged, and also for business owners to understand the reality behind why costs scale exponentially as we go deeper into systems.   When a business owner is use to $500 price points, a $5-20k price tag for the completely custom project they asked for is going to be scary and will invoke trust issues.  But that doesn’t mean the developer should work for less to appease a client, or that they’re necessarily wrong for proposing a higher cost for what the client asked for either.  The problem to be solved, is one of expectation management.

Advice For Developers

For developers, this is going to be a larger challenge the higher up on the pyramid you go, where the most commoditization has occurred.  If you’re trying to operate one layer below templated solutions, you’re going to have the biggest challenge convincing clients that you should be charging so much more, if they cannot see tangible value as a result, compared to just using a template.  In this case, you’d better align yourself with clients who have a lot of money to spend on branding design, rather than technology.  And if you’re offering customized app or interface development solutions a layer down, you’re going to see more and more frameworks trivialize what you do over time, and push you further toward commodization.

Indeed, it would seem a developer is better off specializing as low as possible on the pyramid, if they’re going to offer custom solutions.  Businesses however will continue to find opportunity to push value further up the pyramid and further commoditize and productize the solutions for the small business consumer.  This is why the SaaS business model is so poignant, since it promises to make available solutions that have real value for smaller businesses, who could never afford them before. So if there is any lesson to be learned here at the bottom line for developers, perhaps it is to be realistic in understanding who your audience is, and who is willing to pay for custom work versus a customized commodity. If you’re going to address the commodity audience, find a away to productize and scale it as a business.  But if you’re going to focus on skills and custom work, go as deep into the value pyramid as possible…and stay there!

Systemetize Your Intelligence

One of the biggest criticisms I hear about services businesses is that they are not scalable.  Profit margins are low, clients are demanding, and you are highly dependent upon high-cost employees with specialized skills, who could leave at any time.  In fact, this is the way most small consulting companies run.  But it doesn’t have to be this way.

There is a quote that I have heard attributed to Ray Kroc in the past, though I cannot find reference to it now.  The quote is something like this: “Build a business in which the intelligence is in your systems, not your people”.   Let’s take the restaurant industry as an example.  If you subdivide the various tasks and automated as much as you can, you don’t need a team of Michelin chefs to run your restaurant.  In the case of McDonalds, you could have a moderately paid manager and a small army of teenagers doing the work.  Sure, you may have that high-end chef help you to define the “program” and oversee it, but you do not need n-number of them to scale the business or operate day by day.

The problem with a typical consulting company is that the engagements are too open-ended, meaning there is constant inefficiency and you try to cover special case scenarios, and the business cannot systematize their own operations sufficiently.  At first this is okay because your hourly rates are high and clients tolerate the inefficiencies since there is no other choice, but eventually those skills become commoditized, the client begins demanding more for less, and you’re left still paying for the high-end talent and seeing your margins compress.

Instead, imagine taking the opposite approach.  Taking something that is already nearly commoditized, and building value around it.  What value can you offer to augment the commodity?  Apple did this well by turning commodity technology into a work of art, that happened to be a computer for example. What they’ve essentially done is spin gold out of straw.  They’ve taken a commodity, added value all around it, “programitized” their efforts and now it is scalable and controllable.

Let’s take Starbucks as another case.  They basically are just selling coffee – a commodity.  But they created a hook in that it is a great place to hang out.  They added value by making it a gourmet product (lattes with infinite choices) and nice cushy chairs.  They invested heavily into their value chain to make sure they could reliably and efficiently reproduce the experience and provide the product to the consumer.  And because they made the investments into consistently replicating the experience and product, they were able to scale worldwide with relatively low-priced and easily replaced workers.

Of course Apple and Starbucks are essentially product companies, but Starbucks in particular is partly a services company.  There are other examples that lean toward services more heavily like H&R block for taxes, and GeekSquad for computer repair. In both these instances, they provide relatively high value to customers at relatively low costs. Because knowledge is systematized within the organization, training costs are low, and the value proposition of the company is otherwise contained within the value chain of the business, not in the skills of a few all-star team members.