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Price*, is the key part of a great experience and fundamental to Customer Experience (though hardly ever part of the design phase). It also indicates a fundamental shift in the underlying business model, especially when the price point shifts significantly for the good/service due to a digital channel being adopted.

At its core, digital disruption is caused by the resetting of price due to a change in distribution models as the customer’s point of purchase evolves.

In economics talk:

Price changes are led by an increase in supply (which has been pent up with no access to market) due to a rapid increase in distribution options without a rent seeking gatekeeper (oligopoly/monopoly), restricting access to the market. The supply side increase pushes down the price to the demand side, creating a groundswell of support for the new distribution channel and increasing demand beyond the new supply levels. Demand, once increased, in turn promotes additional supply often at a lower cost. After a few years the new distribution model benefits from a network effect and gains traction. It attracts significant external capital at a low cost to build a momentum moat. The rest, as they say, is a post-modern rags-to-riches overnight success story of ivy league drop-outs.

Shorter distribution lines = lower price to customer at same margin

From an Economics 101 perspective, it’s a little bit backward, as high prices should attract more suppliers and low prices reduce suppliers into a market. Digital disruption fundamentally changes this assumption due to the lower cost base enjoyed by new entrants, due to newer technologies and reduced distribution channels which reduces the price to the customer. The new supplier’s marginal profit and Return On Equity (ROE) is equivalent or higher than the incumbents, at a lower price point.

Before you leave a comment in BOLD saying that better CX through customer centricity and systems thinking is the reason for this – I agree with you. The disruptors come into the market focusing on the customer and building a ground up experience based on today’s points of purchase and new pricing ,while the incumbents are stuck supporting the old distribution.

When your channel is more important than your customer…

I know this sounds either bizarre or obvious, but many incumbents spend more management time on their channel to market than their products. The channel is where the margin sits and where power comes from – it’s their competitive advantage. This distribution focused myopia leads to good decisions (i.e. focus on the ‘fat middle” of your customer base) killing you over time, because the market you see is the market you have created. You cannot see the size of the outside edges of your customer distribution curve.

False quality signals

Incumbents often limit access to their channels using a “quality” argument. This quality is either legislated, supplier power driven or decided by management. The decisions are focused on the “core customer”, which are often the later adopters or the market segment most serviced by the current offering. It is hard to innovate when you cannot see the problem and have investors screaming for margin improvement.

Walmart, with its “fast, faster, fastest” delivery option is a clear case in this. A complicated offering driven by their internal distribution model limitations rather than trying to build a product for the customer.

Why do incumbents die while their industries boom when they are filled with smart, capable executives?

Some basic examples:

  • Music – there is more music being made today then ever before, and more consumed, and more musicians – but music labels died because they were invested in physical production of music
  • Movie rental?  Blockbuster vs Netflix (selection and long tail vs latest releases focus, physical location & complex late fee structures)
  • Bookstores – remember those? Though Kindle is the real disruptor versus just buying books online (that impact is still coming)
  • Investment Management – financial services industry made up of middlemen is beginning to get a fright. Nutmeg, Motif and a number of other low cost investment managers are gaining traction.
  • Travel was disrupted ages ago (who really uses a travel agent?) but its continuing with accommodation (Airbnb) and transport (Uber/Driverless) as this segment continues to change.

These are industries that are booming, but the traditional middlemen/aggregators are dying, died or starting to have some significant health concerns.

The maths is on the side of the disruptors

A successful digital disruption occurs when there is sufficient momentum in these new distribution models that less than 2% of industry spend moves into these new channels (Google, Amazon, Netflix, Uber, Transferwise, AirBnB all became market disruptors at a fraction of market share, getting free PR that further fuelled their growth). While the percentage may seem small, it is enough to create a significant competitive force in any sizeable market. Disruptors attract far cheaper capital than incumbents, giving them an incentive to grow and no fear of destroying established value.

What is also interesting is that this 2% may not have been traditionally served market by the industry i.e. unmet demand or customers with unique (but trending) usage patterns. AirBnB is a great example of this, as was Amazon, Netflix, Spotify etc..

Does my middle look fat in these jeans?

This is where the focus on the fat middle can really impact incumbents, as they are focusing on a limited audience view led by the products they sell, the channel that they have etc. versus a larger market opportunity – which they literally cannot see from where they are.

Who is prone to digital disruption?

Large industries with convoluted value chains based on distribution, versus the quality of the end product are most at risk. At its core, the internet has changed a couple of fundamental elements:

  1. the product/service is now delivered digitally – this means that different things are good/bad in its design versus previous models of product/service delivery.
  2. high margin value chains:- where there is a lot more money in the value chain versus in the creation of the product/service, keep an eye out for disruption
  3. legislative barriers to entry i.e. restrict competition to manage “quality” – i could write a novella on the myth of legislated quality, but I won’t. These industries have often become legislated to keep competitors out rather than make customers happy.

What do you do as an incumbent?

Transformation is often undertaken as an inward gazing exercise, which is not a terrible approach, especially if you can impact your price point and distribution chain… but a more challenging approach is to find the edges of your customer base and start building products that will meet their need. It’s a very hard ROI discussion to have, and I have personally killed a number of these projects when i was on the side of the incumbent figuring out transformation strategies – so i think the complexity of doing this is under-rated.  Even if you kill the projects at the end, looking at new customers is highly valuable as it gives you ideas into what is coming, versus focusing only on what you have.

Enough rambling from me. Always curious as to what other people think, so please share your thoughts…

*Price does not mean cheap, price speaks to the magic mix between perception and quality that creates “value” in a consumers mind.

By Nevo Hadas – Nevo is the Founding Partner of &Innovation, now DYDX