Extending Your Business in the Digital Era: Do You Move Capability-Out or Customer-Back?

“There are two ways to extend a business. Take inventory of what you’re good at and extend out from your skills. Or determine what your customers need and work backward, even if it requires learning new skills. We do some of both.”

When Amazon’s Jeff Bezos said this nearly a decade ago, in a Fast Company interview, he cited the new Kindle business as an example of the customer-back approach: identifying under-addressed needs of existing customers and developing new capabilities to address them. Yet he acknowledged, too, that Amazon often extends existing capabilities to create new businesses.

In the digital era, both extension strategies are viable, but we will look at the choice from the point of view of non-digital-native companies who are incumbents in their industries. These are the established companies that have grown up before the digital era and whose success is not predicated on a digital business model. For these firms, we have seen that the customer-back model is typically more viable.

 

The Bigger Opportunities for Incumbents

There are two primary reasons for our view: first, the capability-out model requires the incumbent to compete on its digital technology capabilities, often around data capture and processing, and the non-digital incumbents typically don’t have distinct digital capabilities. Second, successful non-digital incumbents have access to and data from a large and proprietary customer base, and this customer and data asset is highly valuable in the digital era.

The real opportunity for non-digital incumbents is to develop digital business models that combine unique customer and data assets with established digital technologies. This approach gives incumbents a competitive edge versus the digital challengers who may have advantages in technology and may be faster business model innovators, but who don’t have ready access to large customers groups or associated data.

As Sunil Gupta points out in Driving Digital Strategy, customer access and customer data don’t appear on the balance sheets of companies, but they are some of the most valuable assets for incumbents. In many ways the race between the non-digital incumbents and the digital challengers is one where the challengers try to achieve critical mass in customer access and data, and the non-digital incumbents try to innovate the business model.

Or to paraphrase the philosophy of the VC firm Andreessen Horowitz: incumbents win if they get innovation before startups get distribution.

 

A Quick Review of Capability-Out

Before we turn to the customer-back model, it is worth examining how the capability-out model has been leveraged in the digital era. Companies such as IBM Watson, Weather Company’s WeatherFX, and Uber, have all successfully used the capability-out model to extend their business.

For IBM, the Watson supercomputer has the unique ability to process large data sets, to constantly improve its algorithms and thus to improve its analytical and predictive capabilities over time. It can be used, among other things, to diagnose cancer, fight cybercrime, personalize shopping and empower driverless cars. The Weather Company (now part of IBM) has leveraged its capabilities not just to predict the weather but also to consult retailers on how weather drives consumer behavior, to advise manufacturers on production schedules and stock management, and even to help shampoo producer Pantene promote their products through the Haircast mobile app that alerts users to “bad hair” days.

Meanwhile, Uber has expanded to Uber Eats, Uber Freight, Uber for Business and Uber Health that match drivers with service providers and end users. So this can work well.

 

The Power of Customer-Back

On the other side, the customer-back model has been extensively leveraged by digital incumbents such Amazon and Alibaba. These two companies serve their customers across retail, payments, entertainment, logistics, home and consumer electronics, and a multitude of other consumer related services.

Amazon’s consumer business model is a customer-back model that identifies new ways to serve its existing customers and creates powerful network effects based on its broad range of services. Amazon’s continuous and high value interactions with its customers and the ability to capture data from those interactions, uniquely positions it to extend its business by developing new product and service offerings.

As Bezos pointed out, “When we win a Golden Globe Award, it helps us sell more shoes.”

Similarly, Alibaba has pursued a customer-back strategy by developing a portfolio of complimentary products that are a combination of Amazon, eBay, PayPal, Google, FedEx, wholesalers, and related financial services. The company has constantly developed new technology solutions to address customer needs ranging from managing payments and logistics to distributing micro loans to Chinese SME’s that is enabled by the vast amount of data it has on these companies through its retail and distribution businesses.

As Ming Zeng, who joined Alibaba in 2006, pointed out in a recent HBR article: “Every transaction, every communication between seller and buyer, every connection with other services available at Alibaba, indeed every action taken on our platform, affects a business’s credit score.”

 

The Choice for Non-digital Incumbents

It’s surprisingly hard to identify non-digital incumbents that have successfully leveraged the customer- back model to develop scaled and profitable digital business models.

Airlines such as Australia’s Qantas have developed successful businesses around their loyalty programs that are digital platforms leveraging a customer-back approach. The Qantas loyalty program offers a large range of services and benefits to its customers and captures value through value added services it offers to retailers and other partners. As Angus Whitley pointed out in a recent article the model is simple: “partners buy Qantas points to reward their own customers for their loyalty. The cost to Qantas of redeeming a point is less than the money it’s sold for, so Qantas makes money on every point.”

As a result, Qantas leverages customer access more than customer data, but as the reach and scope of the program continues to expand, the richness and relevance of the data will increase commensurately

 

HOW TO MOVE VIA CUSTOMER-BACK VERSUS CAPABILITY-OUT

Industrial companies like John Deere have developed a range of value-added services related to precision operations, autonomous vehicles, environmental monitoring services and weather-related services that they offer to their customers. Its digital platform, MyJohnDeere helps agricultural producers optimize the management of production data, equipment information and farm operations. It has opened the platform to 3rd party software developers and aims to create a central platform for farm equipment hardware and software for agricultural producers.

By expanding its service offering far beyond the farm machinery, John Deere is significantly increasing the frequency and richness of its customer interaction and the associated data it can capture. In the future it is well positioned to develop new value adding services beyond selling and servicing farm machinery.

 

Changing the Basis of Competition

The customer-back model requires companies to develop new technology capabilities, but it does not require them to compete on those capabilities.

Rather by combining unique access to and data on customers, with robust (but not unique) technology capabilities, companies can successfully extend their business.

However, it is interesting to note that relatively few non-digital incumbents have successfully developed digital business models that extend their business by leveraging the customer access & data asset.

Instead, they end up with a winning equation that changes the basis of competition. The model of customer access & data + digital business model + (existing) digital technology requires companies to change the metrics they use in evaluating new opportunities and how they think about value creation in their business.

The implications cut straight to the heart of how incumbent companies will grow in the future. New service offerings that increase the frequency and richness of the interaction with customers and that generates data that can be captured must be viewed as inherently interesting. In the future, the companies that consider new profit formula by harnessing the customer back model will be the ones that create and capture value.