CIOs Can Help Their Companies Survive Industry Disruption

CIOs are learning some hard lessons about how industry leaders can be knocked off by out-of-the-blue competitors. Look at that quintessential business disrupter, Netflix. In 1997, the upstart launched a fast, convenient DVD-by-mail rental service that relied on highly efficient supply-chain systems, well-situated distribution centers and, of all things, the U.S. Postal Service. Mixing existing technology and service tools in a new way let Netflix create a fresh business model in video rental that eventually displaced Blockbuster, Hollywood Video and other stalwarts that relied on physical stores.

Today, however, Netflix struggles to maintain its supremacy. Lots of companies with streaming video have invaded its territory, including YouTube, Hulu and Cablevision. Perhaps the biggest threat, in part because there appear to be no bounds to its ambition, is Amazon. The $48 billion e-commerce company offers streaming and downloadable video for many devices–exactly the future Netflix imagines for itself.

Netflix is aware of these challenges and is trying to boost its streaming business and revamp for an all-digital market. But new pricing plans and an attempt to separate its by-mail and streaming subscriptions in 2011 got customers mad. The company admits in recent financial filings that it has seen “higher than expected customer cancellations” and that those customers aren’t coming back quickly. Churn for 2011 was 4.9 percent, up from 3.8 in 2010. Vehement customer reaction led Netflix to reverse changes to its subscription business, though it stood firm on its controversial pricing policy.

We don’t know how the Netflix story will end. But as so many business models in so many industries come to depend on IT, CIOs need to heed the law of the business jungle: Disrupt or be disrupted. It’s a familiar pattern–disrupter moves in, flies high, then becomes disrupted as markets and technologies evolve. Competitors emerge from unexpected places. Some customers vacate to more appealing companies while others resist your attempts to change. Every business model must eventually come to an end, but the trick is to recognize your own impending demise–plan for it, even.

CIOs who anticipate trouble can show colleagues how to avoid it, or fight it when it comes, says Gartner analyst Dave Aron. “You want to escape conventional thinking.”

To disrupt worn habits in a company or in an industry, CIOs have to recognize when a competitive weapon can be a weakness and develop peripheral vision to spot unlikely competitors. Also critical: Overcome the corporate diseases of myopia and inertia, which lead to certain death.

Weapon Becomes Weakness

Everyone wants to have a technology so innovative or a business approach so inventive that it pushes you to the moon. But competitive weapons wear out.

For years, Avon and its famous Ladies in pink have faced down forces trying to disrupt the classic direct-sales business model, notably e-commerce. While door-to-door encyclopedia salesmen have died out, Avon Products has hung on. But maybe not for much longer. Avon has spent $782 million on restructuring projects dating back to 2005, and still its profits, ominously, have sunk to their lowest level in recent years, even as total sales have increased.

“Avon has been putting out fires over the last several years, trying to manage disruptions as they’ve arisen, rather than getting out in front of the issues,” says Erin Lash, a financial analyst at Morningstar.

With Avon stock at its lowest point in five years, rival Coty attempted a hostile takeover last year. “It’s hard to imagine a U.S. company in worse shape,” according to financial research firm 24/7 Wall St., which predicts 2013 will be the year Avon falls.

CEO Sheri McCoy insists that Avon’s financial troubles do not mean we’re witnessing the end of the company’s business model. She and fellow senior leaders are trying to pull Avon into modern times without dismantling direct sales, where a representative visits homes, personally delivers catalogs to customers, or holds product parties. It’s not efficient, but it is how the 127-year-old company climbed to success. It’s also how McCoy, who joined a year ago, plans to conquer emerging markets, such as Brazil and Russia. There, cosmetics aren’t sold widely in retail stores and sales representatives are viewed as trusted sources.

Avon’s problem, McCoy says, isn’t its six million Ladies. Instead, it’s a combination of the wrong product mix in some regions, some ineffective pay incentives and, at various times, trouble with an ERP implementation that has so far taken eight years. As she recently told analysts: “The challenges Avon is facing developed over time, not overnight. We still have a tremendous amount of work to do to address issues Avon has wrestled with for years.”

Problems with a supply-chain module rolled out in Brazil hurt financial results there, the company has acknowledged; Avon has been working to implement a global ERP system since 2005 and expects the project to stretch into “the next several years,” according to its latest annual report. In the next three years, the company plans to spend between $150 million and $200 million on IT, including on systems for ordering and billing, analytics and mobile applications.

Donagh Herlihy, CIO and head of e-commerce, declined to be interviewed. But in a presentation at CIO‘s Leadership Event in 2011, he noted that reducing turnover among representatives is a major goal of his technology work. Improving the online ordering system will be lucrative for Avon, he said, because 15 percent of online reps order two or three more items when presented with tailored promotions on the screen. He also outlined plans to incorporate social networking into how representatives find and keep customers.

The personal touch of modern Avon representatives depends on IT–they need it to place orders, track customers and settle finances, Lash says. Technology problems, she explains, are dangerous because many Avon representatives also sell other products. “They won’t necessarily push Avon products if they aren’t having a good experience with Avon.”

It’s easy for an outsider to diagnose problems. But insiders have to fix them, and sometimes that’s impossible, says a former IT executive at Circuit City, which once dominated the consumer electronics retail market, only to file for bankruptcy protection in late 2008. Circuit City was the original big-box electronics retailer–it was 60 years old at the time of its death-by-liquidation–and at one point it built a proprietary point-of-sale (POS) system that was used for 20 years. Senior leaders saw it as creative and not easily copied by competitors, says the former IT executive, who asked not to be named. The homegrown POS system did deliver competitive advantage for the first 10 years. Then it became onerous to support and slipped behind packaged POS systems in functionality, the executive says.

Meanwhile, rival Best Buy had upgraded its POS system and aggressively pursued a “grocery-store” approach to selling electronics, says Alan Wurtzel, son of Circuit City’s founder and a former CEO and then board member at the company. That is, while Circuit City relied on knowledgeable commissioned sales staff, Best Buy took a less expensive approach, letting customers shop by themselves, Wurtzel says. Although Circuit City eventually switched to a lower-cost sales method, it was too late. For too long, he says, senior leaders “stubbornly stuck with the old model. That did us in.”

As the former IT executive puts it, “We didn’t evolve fast enough into a very fast-changing and dynamic business.” He left the company a year before it fell. “It pained me,” he says. In bankruptcy, Circuit City, once a $12.4 billion company, sold rights to its brand and domain names for a scant $6.5 million to Systemax, an electronics retailer that runs e-commerce sites.

Now Best Buy, like other big-box stores, faces disruption from the “showrooming” effect, where physical stores become a place for consumers to play with products before buying from a different, usually cheaper, outlet online.

Avoid Corporate Diseases

Myopia and inertia can spread through overall corporate culture but also into the habits of individual CIOs. Many CIOs think of their job, aside from leading technology, as fixing and honing business processes, says Gartner’s Aron. But confining your scope that way, he says, guarantees an unremarkable tenure. If you’re concentrating on how to squeeze steps out of an existing process, you’ll never come up with an idea that smashes a spent business model or uncovers a brand new one. And best practices? By definition, they aren’t innovative; they’re tried and true.

One technique to shake away establishment thinking is to borrow from other industries. For example, GlaxoSmithKline (GSK), like other pharmaceutical companies, sees that the traditional drug-discovery model–years of expensive research to find a needle-in-haystack blockbuster medication–is too slow and costly to maintain. When a drug patent expires, the profits on that pill essentially dry up. If there’s no new drug to replace it, company earnings can fall off a so-called patent cliff.

GSK wants to interrupt that cycle by figuring out better ways of using analytics to find promising research paths in its gargantuan cache of scientific and consumer data. To jump-start its efforts, GSK looked outside the pharmaceutical industry to find a company that was good at handling big data problems, says Aron, who has studied GSK’s strategy. The unlikely partner? McLaren Group, a Formula 1 race car team.

McLaren puts sensors on its cars that transmit data about 200 metrics to members of the pit crew, who use real-time predictive analytics to help drivers make fast, nuanced decisions during races. The proprietary analysis tools also help engineers adjust the car for the next race. GSK wants to apply the same principles to decisions about inventory and pricing, for example. “GSK is using innovation that has already happened in one industry but may be new to its own,” Aron says.

Sometimes an upstart redraws an existing industry, the way Zipcar and Uber have used IT to claim territory in car rental and taxi services, respectively. Simple Finance Technology, a startup, aims to take on financial services with Web and mobile banking that bypasses mainstream banks. Disgusted by late fees and overdraft penalties, founder and CEO Josh Reich wants to give customers “constant situational awareness” of their personal finances. Customers ditch their current bank for an account with Bancorp, Simple’s partner. They also sign up to use Simple’s Visa card for purchases. Simple makes money on each Visa transaction and on interest margins that it splits with Bancorp.

A traditional bank doesn’t want to push such specific real-time data to customers, Reich contends, for fear of losing late fees and overdraft penalties by prompting customers to better mind their accounts and habits. “When you make money from fees or from customers making mistakes, you benefit when customers don’t understand their finances.”

Wal-Mart, too, sees room for itself in financial services, in a case where a giant in one industry disrupts another. In recent years, Wal-Mart tried to enter financial services through established channels by applying for a bank charter and trying to acquire a bank, but it was denied by regulators. After its attempt to run a tried-and-true play met with failure, the retailer was spurred to be more inventive. Late last year, Wal-Mart launched Bluebird, a financial service with American Express that lets consumers make deposits, withdraw cash and pay bills. It is also seeking patents for mobile-payment technology.

Develop Peripheral Vision

For all the talk of how companies can use IT to create new business models, nothing new actually gets created unless the company has an entrepreneurial spirit, says Paul Stamas, vice president of IT at Mohawk, an 81-year-old, family-owned paper manufacturer. It also helps, he adds, to experience crisis.

Mohawk has seen a perfect storm of developments: people using far less paper because of digitization, strong and growing environmentalist trends favoring living trees over dead paper, and the migration of paper-making to other countries. “We had to do something radically different or we’d be out of business,” Stamas says.

The company brainstormed about new business ventures that would stimulate demand for its core high-end paper. In 2010, Mohawk and a design firm called Rosebrook, Peters, Funaro launched Pinhole Press, a small online photo gift company akin to Shutterfly. Pinhole uses Mohawk’s expensive specialty papers to produce items such as wedding albums. For two years, Mohawk helped grow the business and learned about selling online, then sold Pinhole last year for more than the original $1 million it spent to start it.

Mohawk, which has also invested in a small software company and a paper distributor in Germany, plans to incubate more businesses, Stamas says. “The CEO has looked to me and said, ‘Start thinking about what’s next. Institutionalize this.'”

Apart from an entrepreneurial culture, Stamas credits a smart approach to experimentation for Mohawk’s successful diversification. The key, he says, is to augment what works (specialty paper) with related businesses (such as photo printing). “You can’t walk away from who you are or what you did,” he says, “but you need to evolve.”

One way to compete when your position is threatened is to focus intently on a project to distinguish your company. At OfficeMax, that’s omnichannel retailing, where physical, Web and mobile shopping systems are integrated. The goal is to let customers interact with the company any way they want while systems share pertinent data in the background. “It’s really key to our future,” says Randy Burdick, OfficeMax CIO. “We want to be best-in-class.”

The decision to concentrate on omnichannel expertise came from the company’s CEO and board of directors, Burdick says. OfficeMax comes in a perpetual third in the three-player market for office supplies, behind Staples and Office Depot. Meanwhile, competition from nontraditional outlets such as Target and Amazon has intensified, says Jim Barr, chief digital officer. “We take a broader view of the competition,” Barr says. “We’re all just a click away from each other. We have to pick our game up.”

It Gets Complicated

Although business disruption is as old as business itself, one development that makes the current wave especially difficult to handle is the interdependency that has sprung up between many companies, says Jim Spitze, executive director of the Fisher CIO Leadership Program at the Haas School of Business at the University of California Berkeley. Some dependencies, he says, may need to be broken for a company to advance.

Mohawk, for example, used to turn over its paper products to distributors and had little or no interaction with end customers. Distributors don’t or can’t tell you about nuanced changes in the market, Stamas says. Without the ability to sense and respond to customers, “you’re doomed to failure.” The company decided to gut its distribution model so it could build closer relationships with customers and find out what they want, he explains. “We needed to learn.”

Netflix has created a complicated relationship with Amazon as partner and rival. The very technology Netflix has bet on–cloud computing–is supplied by Amazon. By the end of this year, Netflix expects to be Amazon’s largest cloud customer, after Amazon’s own retail operations. In its most recent annual report, Netflix calls out its IT relationship with Amazon as a critical risk factor. “[W]e run the vast majority of our computing on AWS [Amazon Web Services]. Given this, along with the fact that we cannot easily switch our AWS operations to another cloud provider, any disruption of or interference with our use of AWS would impact our operations and our business would be adversely impacted.” Indeed, Netflix streaming service was disrupted Dec. 24 due to an AWS glitch. Netflix declined to make executives available for interviews. (For more, see “Who’s Disrupting Who?”)

Netflix adds an optimistic note for worried investors: “While the retail side of Amazon may compete with us, we do not believe that Amazon will use the AWS operation in such a manner as to gain competitive advantage against our service.” Still, the video company knows that competitors can get in a snit, as it explains in that same filing. In 2010, Comcast, which is both an Internet service provider and a video competitor to Netflix, raised prices on Netflix technology partner Level 3 Communications for access to Comcast’s network. “Given that much of the traffic being requested by Comcast customers is Netflix data stored with Level 3, many commentators have looked to this situation as an example of Comcast either discriminating against Netflix traffic or trying to increase Netflix’s operating costs,” the filing says.

“The intertwined nature of business models now will make the future interesting,” Spitze says.

Kim Nash is a senior editor for CIO Magazine. Follow her on Twitter @knash99.

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