The Road Ahead in Technology

On June 4th I had the opportunity to open the Service Management congres 2014 in the Netherlands, with a keynote on the shifting paradigms in the commercial world: the Road Ahead.

The time we live in has been given many names; the Age of Complexity, Age of Data, the Age of the Customer, etc., and we can easily add yet another name, the Age of Disruption. In the past 10 years we have seen technological changes that have shaken large, reputable organizations. Roughly we can see two different types of disruption, each with its own dynamics, and drivers.  First category is disruption by technology. If I name companies like Kodak, Nokia, Blackberry, then you know what I mean with that. Companies (which are not limited to high- or near-tech industries) that miss one or two technological cycles, can see their market capitalization diminish from $200 billion to $5 billion in a matter of years (Nokia). And though I have good faith that what is left of Nokia, will at some point in the future again be very successful, many CEO's of global companies see this as one of the major risks for the continuity of their company. This is the main reason for the large cash reserves that many big tech companies maintain: If they would miss such a technological cycle, they will have the ability to buy themselves back into the game. 

A second category is disruption by operating model. 10 years ago our shopping areas were filled with bookstores, travel-agencies, record companies, video rentals, etc. They have all disappeared or are on the verge of disappearing. Not just by technological change, but because of a changing way we purchase services and products. What used to be a human to human interaction (advise on which book to buy, having it wrapped as a gift, etc.) is now a transaction that is fulfilled in software. And even if technological advances have given us e-books to read, we also still buy physical books, just not in a human to human interaction anymore. Marc Andreesen wrote about this in the article Software Eats the World, New York Times 2011, that has been referenced many times since publication.
Though this second category seems to play especially in Business-To-Consumer markets, it is exactly this disruption by operating model that we see happening in the Business-To-Business segments of the market.

In the past 17 years, PriceWaterhouseCooper has held a global CEO survey to see how CEO's are thinking about the future of their companies, and the markets they serve. Results are published on their website. In the 2014 edition, published in January, awareness of both types of disruption can clearly be seen by the top 2000+ CEO's of the world. 47% of all CEO's in the survey, are concerned with the speed of technological change (up from 42% last year), and 46% of the CEO's are concerned with new market entrants (with different business models).

Many books have been written on how changes are unfolding in Business-To-Business markets. An interesting view on what has happened in the past 10 years is narrated in the books published by J.B. Wood and Thomas Lah, resp. CEO and Managing Director of Technology Services Industry Association (TSIA).:

Complexity Avalanche, Consumptions Economics and B4B,
Technology Services Industry Association, J.B. Wood et all, 2009, 2011 and 2013

The predominant Business-To-Business model for acquiring technology, that has been around for about 125 years, is a Capex Purchasing model. Central in this model is the product or the service in itself, risk for introduction of this new technology lies mostly with the customer. In this model, suppliers often try to differentiate their products and services through feature-richness. This has steadily let to more and more complex products, with more and more possibilities. However, the ability of customers to consume this growing complexity is limited, leading to what is called the 'Consumption Gap'.

The growing Consumption Gap
Source: Complexity Avalanche, J.B. Wood 2009

In the picture to the left, the top line in essence represents the price we pay for new technology; the lower line is the value we derive from that same technology. The difference, the Consumption Gap, is one of the reasons that especially CIO's in the past years have been under heavy pressure with respect to the ROI achieved from new technology. 

This BtB model has worked fine throughout last century, but as products and services have grown in complexity, more issues began to arise with respect to the value derived from this technology. Testimony to this is the growing list of failed projects in the Catalogue of Catastrophe. Many projects that failed where large global projects, for the introduction of new technology. Though enormous amounts are spent for this technology, and the introduction into an operational environment, these projects never achieved the go-live status. These projects were stopped, as they grew to complex to manage, and were abandoned before completion, often by writing off tens of millions of dollars. Not so difficult to understand that the CEO's of companies that have experienced such a failing project (or probably their successors), will not start from scratch with a new vendor, but instead are looking for a different way to introduce new technology.
In the past couple of years we have seen the introduction of new, Opex based purchasing patterns, so-called (X)aaS models, or X as a service. The X stands for a term in a growing list of different types: software (as a service), database (as a service), etc. In below figures the difference between these two models is depicted for a typical purchase of technology of a total spend of $2m, over 4 years.

Capex based Purchasing Pattern
Source: Consumption Economics, J.B. Wood et al

In the first (Capex based) model, by the time the maintain phase starts, and the customer can start deriving value from the investment, already 70% of the total value has been transferred from customer to supplier, with usually a strong lock-in for the remaining 30%. Quite clearly, the risk associated with such projects is with the customer.
In the second model, the OPEX purchasing model, risk has shifted significantly to the supplier side, who has the upfront

Opex based Purchasing
Source: Consumption Economics, J.B. Wood et al

investments, and in whose interest it now is to make sure that the customer will actually consume the product in itself, as this will drive the value transition from customer to supplier. To an extent, the supplier is shouldering the risk with respect to deriving value from the investment.
Companies like Salesforce.com, RackSpace and more and more show stellar revenue growth, and are steadily growing their penetration by employing such an Opex based technology model.
Conclusion from this might seem simple. Everybody to the cloud, and we have our new BtB model, right? Well, no, there seems to be more going on. Take a look at the following picture, taken from TSIA's book B4B, where the last 3 years of Revenue growth are shown against the operating margin of a number of companies; traditional tech companies, typical software companies as well as new Cloud based companies (Xaas).

Operating Margin vs Revenue growth
Source: B4B, J.B. Wood et al

One thing quite clearly stands out. Though companies like Salesforce.com are able to show impressive revenue growth numbers, quarter after quarter, and year after year, it is clear that going to a specific consumption based type of model in fact represents the trade off between revenue growth, and operating margin (from top left to bottom right). You can imagine that if the companies in the top left corner would opt to fully transform to a (X)aaS model, their shareholders will not always be applauding.

In the picture to the right, these companies are in the top left quadrant, in the Status Quo. They know that product and software margins are under such pressure, that innovation alone will not be enough to sustain their current healthy operating margins. They face commoditization, hardware and software erosion, etc. Some companies have taken the brave move to the bottom right quadrant, which is a step in the right direction. However, all companies would like to be in the top right quadrant, with healthy margins, and high(er) growth. But what type of a model are we then talking about? 

Many articles have been written, proposing what such a model would look like. Though they are different on key features of the model, they mostly share one thing in common. This new model will not be about the product or service in itself (old Capex model) and not about the consumption of this product alone (new Opex model). This model will be about the outcome, the outcome for our customers. Suppliers will start to become responsible for the success of their customers, and will only be able to sustain healthy margins, if they are capable of helping their customers to derive maximum value out of their investments. We see this across the industry segments. Obamacare, the new healthcare plan in the United States, is built on an outcome based model. Doctors and hospitals in the future will not be paid on a by procedure basis, but on the basis of the outcome of such procedures. I.e. they will be paid on the basis of cured patients. If along the line a patient would be re-admissioned to hospital, this will not trigger a new payment, but the related cost will have to be absorbed by the hospital (or medical specialist). You can also clearly see it in the messages that companies sent to their customers. A few years back, when the Dutch energy markets were opened up, much of the communication was on lowest possible prices. Today, we have seen a shift, where all these companies now want to help me to achieve better results. Insight into my energy spending, new thermostats, energy saving appliances, etc. 
These new models are being experimented with as we speak, especially by start ups. Important to understand that this does not simply mean taking all products and services offered combined, and then changing the pricing methodology only, as we usually see in traditional Managed Services deals. Completely new services will emerge, that start from the challenges our customers face, and where suppliers will take a significant portion of the risk associated with solving these challenges. Those companies who will be able to increase the outcomes for their customers, will be the successful companies of the future. This in itself will lead to a transformation on how companies interact. Many of our customers will have customers of their own, and their success will in turn depend on their ability to help those customers to be successful. The results will be a much closer integration of companies and their customers, leading to a chain of dependencies that together server a certain portion of the market.
As predictions are always difficult, especially when they relate to the future, it will be interesting to see which products / services in the future will be successful. Time will tell, but I am quite sure that if we look back in 10 years time, we will see all sorts of solutions in the market,that we currently have not even begin to think about.
This transformation of operating models does not happen standalone. There are a number of underlying trends and technologies that accelerate the transition to new, outcome based models. In the next Blog post, we will dive into how Big Data is one of those drivers for a fundamentally new way for companies to interact with their customers.