Vicenç Hernández / Economist. PhD in Economic Psychology. CEO of Tecnotramit and Treshabitat.
Innovation involves much more than applying technology to a particular internal or external process. Technology is a means, not an end, and for its implementation to be disruptive it requires a pre and a post. The pre is a change in the company’s organisational culture, the post is a change in the business model, which describes the basis on which a company creates, provides and captures value. Digital technology makes it possible to generate new business models which, in turn, create a new type of customer value in a new way.
According to behavioural economics, people perceive value in two different ways.
- Acquisition value.
- Transaction value[1].
Acquisition value is based on standard economic theory and is comparable to what economists call “consumer surplus”. This term indicates the difference resulting from measuring the satisfaction of the object obtained and subtracting the opportunity cost of that which has been renounced. For a cold person, acquisition value is everything. A purchase will produce an abundance of acquisition value if, and only if, the buyer values the purchase far more than the money he has had to spend in return, thus providing satisfaction or meeting a need.
But people in general also tend to value another aspect of the purchase: the perceived quality of the transaction. And that is precisely what the transaction value measures, which is defined as the difference between the expected purchase price or reference price, and the final price at which a product is eventually purchased.
Here is an example. Suppose you are at an amusement park and you buy a product that turns out to be identical to the one you usually buy in your usual shopping basket, only in this case it costs three times as much. The product itself satisfies you, as always, but your feeling is that the transaction has been a disaster, as the high purchase price produces a negative transaction value. This is what we usually know as a scam. If, on the other hand, the price is below the price you are used to, i.e. your reference price, then the transaction value is positive, i.e. a “bargain”.
The reality is that the place of purchase should not be a relevant factor, since our happiness should come only from the acquisition value, but our competitive mind makes us value a good or service not only for the satisfaction it provides, but for the satisfaction of having made a good purchase.
Because of this way of thinking on the part of consumers, sellers have incentives to manipulate the perception of the reference price and create the illusion of having made a good purchase by making it seem like the best possible price. This is called the price trap[2]. Products promoted in this way usually share two basic characteristics: their acquisition is rare and their quality is difficult to evaluate or has a high degree of subjectivity.
On the one hand, the low frequency of purchase means that consumers do not realise that such products are always on sale. And on the other hand, when the quality of a product is difficult to measure or has a high component of subjectivity, the recommended selling price can do a double service: suggest that the quality is high (and thus increase the perceived acquisition value) and insinuate the presence of a positive transaction value, since the product is discounted.
According to the DBT Centre[3], the main values provided by start-ups that differ at a technological level are 3; cost value, experience value and platform value.
The cost value is the one that leaves the most notable competitive consequences and as its very name makes clear, it is the capacity to offer the product or service to the final customer at a lower price. This is possible thanks to the virtualisation and dematerialisation of the different products and services that allows these disruptors to improve cost efficiency, and therefore to put a more competitive selling price with the same or higher margin.
Their two main characteristics are that on the one hand they can offer more for less due to the use of analytical tools that allow them to create, analyse and exploit the available information by optimising the management of their operations based on it. On the other hand, they take advantage of technological tools to manage their workforce and supply chain in an unconventional way, improving their operational performance by reducing costs and therefore becoming more competitive.
One of the major forces behind cost value is the impact it has on the market when the disruptor performs the intermediation task. Many platforms exert indirect price pressure on the respective industries by providing the possibility to compare prices in order to favour the end user and by restricting the ability of companies that advertise to set prices that are too high.
The value of the experience is to offer the end customer more facilities or control over their purchasing decisions. This value is maximised at a time when the offer is increasingly digitalised, since as the physical disappears in favour of the digital, the offer can be fragmented, allowing the customer to take only those parts that really interest him without the need to acquire the entire product or service offer. This quality allows the customer to choose only those products or services that he values and not the rest.
This virtualisation of the offer has been the stepping stoner for start-ups that have been able to detect small market niches within the value chain of traditional companies, and all through digital channels that allow for greater personalisation and a lower cost. This allows for a superior experience value that exceeds the brand or quality values that traditional companies can offer.
But where something really new is added is in the platform value. After all, trying to be competitive through cost – and therefore price – or experience is not something that has emerged recently. But the great contribution of digital disruption comes from the creation of a platform or playing field completely different from what we were used to and whose main characteristic is its exponential capacity. The platforms originate a network effect where the number of users and their typology greatly influence the final value[4].
These network effects are common in our daily lives in both positive and negative ways, such as the dissemination of news and/or knowledge, social networks, financial contagion in times of crisis, etc. In fact they are the perfect seed for many gregarious behaviours in the economic and sociological field. This network effect occurs when a large number of users can connect to each other in such a way that a binding effect of energies (also known as synergies) is generated, where the whole is greater than the individual sum of the parts. And this is where platforms have the intrinsic quality of being able to increase value by generating greater benefit to the end customer.
In addition, these platforms generate a truly dominant competitive force since, due to their nature, once they achieve a certain success, it is exceedingly difficult to dethrone them from their winning position. This peculiarity ends up leading to situations of absolute victory where the leading platforms such as Facebook, iTunes, Twitter or Google can amass great benefits.
The growth of digital density is generating a strong reduction in transaction costs, leading many sectors to move from organisational environments centred on linear value chains to new models where the focus is on data. This data is essential to meet the new needs of customers who were previously served only through traditional value chains.
These traditional chains were based on models where physical assets were necessary for the creation of a value proposal, so meeting the needs of a new client generated fixed operational costs resulting in linear growth. This growth was achieved by increasing production capacity in proportion to the costs and investments required. Additionally, this effect increased a hidden risk within the company by increasing the lack of agility as it had a structure focused on fixed costs. But the appearance of information platforms has generated a new habitat where growth is exponential and the capacity to serve a new client has a decreasing marginal cost in cumulative terms, since the main asset of this type of platform is the grouping of data from all the members of the value chain.
As IESE International Graduate School of Management[5] points out, in a scenario where the centrifugal forces of digital transformation are much stronger than centripetal ones, there is a tendency for the market to consolidate around information platforms, creating a progressive commoditisation of the traditional value chain and a greater difficulty in capturing value.
If these two forces manage to balance out, the traditional value chain may not disappear by combining its linear component with the exponential growth part of the platform because its intangible assets combined with an information platform model open up the range of services for customers. This combination of forces creates new challenges in terms of reliability, privacy and security, as well as opening the door to the emergence of new data exchanges with the aim of obtaining more automation, personalisation and prolepsis.
Obviously these three values of cost, experience and platform do not necessarily occur individually as on many occasions the power of disruption comes from the combined strength of these three elements or value generators. So when the three values converge to give rise to new business models and the capacity to generate exponential profits, we speak of combinatorial disruption.
Throughout history, technological homogenisation and competition have led to the combination of different technologies giving rise to new innovations, so that different business models can be intermingled and result in revolutionary combinations of cost, experience and platform values. Combined disruption is not only beneficial to the end customer but also to those companies that are able to differentiate themselves by providing a higher level of value.
In short, although the war for price and quality has always existed, digitalisation has managed to take a step forward by allowing an explosive combination by adding the competitive advantage of platform value. These new platforms allow for a red carpet for new business models that in many cases are derived from a more core model in addition to a combinatorial disruption that favours a large number of end customers in an exponential manner. These disruptive start-ups are having the ability to generate new value for the end customers by making them stop looking at the more traditional companies in many cases.
Only those companies that are able to combine a balanced situation between pipelines or linear value chains and appropriate information platforms will be better prepared to capture and generate value.
[1] According to classical economic literature, one speaks of “utility” instead of “value”. In its broadest concept, utility is the interest or benefit that is obtained from the enjoyment or use of a particular good or service. It is also assimilated to the concept of happiness. As a result, the greater the usefulness of the product, the greater the desire to consume it. In the context of this article we prefer the term value, which is more adapted to the common business language.
[2] “Finanzas personales para Dummies”. Hernández, V. Planeta (2012)
[3] The Global Center for Digital Business Transformation (DBT) is located in Lausanne, Switzerland and is an initiative of the International Institute for Management Development (IMD) where corporate and academic leaders are joining the forefront of digitalisation to explore and solve the major issues facing business and society today.
[4] Network effects are usually associated with Metcalfe’s Law (named after the technologist Robert Metcalfe), according to which the value of a telecommunication network increases in proportion to the square of the number of users of the system, causing non-linear changes. Examples can be found of various types and not only in reference to telecommunications, such as the telephone, a social network or a certain operating system, where each one of them by itself has no value but as the number of users grows its value in the market exponentially.
[5] “Las fuerzas centrífugas y centrípetas que inciden en la transformación digital de los sectores”. Zamora, J., Tatarinov, K. and Sieber, S. Harvard Deusto Business Review. Planeta de Agostini Formación, S.L.