Modularized Business Models in the Service Sector

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Platform business models are becoming established in response to the upheaval in current market structure. However, decisive heightening of flexibility comes only from modularization.

Customers expect from providers a high degree of flexibility (e.g., through customized offers and services) as well as low prices and excellent customer service, especially in the service sector. 

Linking with the digital world has become a feature that is taken for granted: select, order, book, buy, pay, check-in, chat, review, collect points, share, and post. Anyone who does not offer these functions need not bother to open the store at all. Consumers always want to interact with providers quickly and easily and on terms they have themselves determined.

Traditional companies under pressure

Large process-oriented service companies with a long tradition have long struggled to keep up with these customer demands, and in many cases they still have issues. In retail trade, once-illustrious names such as Kaufhof, Karstadt, or Sears are fighting for their survival, while others such as Quelle have already given up the battle for customers’ favor. Online mail-order companies such as Amazon and Zalando are more or less counted among the incumbents and are under attack by new startups such as Outfittery and About You. In the financial services sector, more and more branch banks are being closed while in the meantime every large insurance company has initiated a digitalization program. In this area, PayPal is already one of the established digital providers while startups such as N26 or Chinese giants such as Alipay/Ant Financial are vigorously pushing their way onto the markets. The new players are more successful at addressing customers who are interconnected with one another and who, as members of the always-on society, use mobile devices for their financial transactions as they move effortlessly between online and offline channels.

The handicap holding back many traditional service companies is that, as a rule, they are strongly infrastructure-based and therefore asset-intensive. Utilities, transportation and telecommunications companies as well as banks and retailers with a network of branch businesses covering a large area share the common trait that their business operations are oriented to a wide-area physical presence that ties up capital; in comparison with the new, largely internet-based companies, they find themselves under increasing pressure to cut costs and obtain the financing they require. To put it more abstractly, these companies have, over a period of more than 100 years, developed highly integrated vertical business models in which they have rigidly tied the industry or business infrastructure, the product and service world, and the customer interfaces to one another.

Upheaval in market structure

A striking characteristic of the digital age is that these vertical business models are breaking up and that horizontal market roles are developing. These roles are specifically:

  1. The manager of the customer interface who understands the customer’s language, develops an intense relationship of trust with the customer, and includes the customer in the creation of the service.
  2. The platform provider who assumes the role of coordinator in the added-value network.
  3. The infrastructure operator who merges industry infrastructure and ICT infrastructure into one and provides the basic services for the other providers. We can point to brick-and-mortar businesses and logistics in trade, energy grids and railroad networks, or transaction banking as examples of industry infrastructure.

Because of the assets they hold and the related sluggishness of their actions, traditional companies can quickly find themselves pushed into the role of the industry infrastructure operators. In many cases, it is unlikely that this part of added value will be able to offer much in the way of growth potential; it is characterized by high pressure to raise efficiency and scaling effects. If they hope to participate in growth markets, companies will have to look closely at where added value will be generated on their markets in the future and what additional roles they want and are able to assume. There are essentially two directions in which companies can move if they want to break out of standard business, i.e., the role of the industry infrastructure operator, and to keep pace with market developments: One is for service companies to develop into a market role which takes care of the operation of a platform; the other is for them to strive to fill the role of manager of the customer interface.

Manager of the customer interface

Many of the requirements that we discussed in the previous article also apply to this latter role: customer proximity, customer understanding — acquired from data — and customer trust are the decisive success factors for building a strong, long-lasting customer relationship and for repeatedly generating anew the customer’s enthusiasm. Traditional service companies are, by and large, in a good starting position with respect to customer trust, but must frequently work intensely on changing over from thought patterns and processes oriented to supply to procedures oriented to demand and customers.

Challenge of platform operators

Many companies have been striving to fill this market role, and not just since platform business models became the talk of the town. Service companies that have long been established often experience extreme difficulties in achieving precisely this goal. They frequently oversee a business and product structure that comprises many pillars existing parallel to one another. In the past, existing offers were usually retained while new ones were added. Offers are linked to IT systems that were often implemented as independent system solutions. Over the course of time, this has created complex service portfolios, realized on numerous parallel IT islands next to one another, for many providers. When operating on slowly changing markets, companies can be successful by continuously optimizing the offer segments and the corresponding IT systems. But as market dynamics begin to accelerate, these business models suffer from inflexibility, growing complexity, a lack of interconnectivity and integration, ultimately becoming highly vulnerable to disruptive changes. This has prompted increasing numbers of service providers to follow the example of other industries and to divide their service portfolio and production platforms into modular units. By doing so, they improve their mastery of the system complexity while simultaneously enhancing efficiency and flexibility.

Modularization of products and production platforms

Modularization is always accompanied by standardization. To this extent, the modularization of services always represents as well a path to a portfolio of standardized and prefabricated service building blocks. These kinds of building blocks exist on various levels such as types of service, supplementary offers, quality levels, and billing models. One good example of this can be seen in the fare structures of the aviation industry, especially of the no-frills airlines, which have in the meantime become highly complex. The pooling of core services into only a few types of services paves the way to scaling effects and the related cost advantages while the supplementary offers are frequently used as a means of driving total revenues upward. The bottom line is that modularization leads to significant improvement in profit margins.

Flexible business architecture

If a modern service provider is to be aligned completely with the principles of modularization, its entire business architecture must be adapted to the appropriate design rules. This encompasses all elements of production as well as the service building blocks (products). The former include the infrastructure — planes, branch offices, network elements, for instance — and all processes for service performance such as provision of the service, performance of the service, and billing as well as the IT supporting operations.  Moreover, a common data model for all divisions must be created as an element of the architecture.

Without this holistic architectural approach encompassing the entire company and unifying the separate perspectives of products, infrastructure, processes, and IT, it will not be possible to exploit in full the advantages of modularization.

Integrated portfolio management (or architecture management)

At the heart of a modular business architecture is the portfolio concept that incorporates the product modules, infrastructure modules, process modules, and IT services. Owing to the high dynamics of the market, the portfolios are subject to constant change. The structural competitiveness that is created by the modularization must therefore be complemented by a dynamic form of portfolio changes. As in the case of the integrated business architecture, the decisive point here is the coordinated or integrated portfolio management.

A modular architecture permits innovation processes at various levels:

  1. Existing modules can be changed or various features can be emphasized in new variants.
  2. Existing modules can be combined in different or new ways.
  3. Modules can be added or removed (end-of-life management).
  4. The design of the modularization can be changed significantly (remodularization).

Along with reduction in complexity, the great competitive advantage of modular architectures is that changes in modules and even the combination of modules become possible quickly and simply. As a consequence, market or technological innovations (for example) can be easily integrated into the overall system without endangering its stability.

It is decisive, however, that there not be any departure from the general architectural framework. This is the reason it is important to define an innovation process that can incorporate new ideas from as many directions as possible and includes coordinated management of the linked portfolios. In this way, service companies can achieve high innovation capability that goes hand in hand with short innovation cycles. Past experience indicates that in many cases the time to market can be cut by more than half.

Opening of the platform to the business ecosystem

From the starting point of a modularized business architecture, the path to an open platform is not a long one. Partners’ modules can very easily be integrated into the overall added value and a business ecosystem can be created without major expenditures of time and effort.

Company ReBuilding as a fundamental principle of transformation

Many branches of the service sector were affected by the rapid development of new technologies at an especially early stage, a situation that turned them into pioneers of digital transformation. One striking feature is that technology is no longer restricted to enabling efficient provision of services, but has expanded in scope to become a decisive element in the perception of the service and the customer interaction. If service companies approach the challenges of the digital world by regarding themselves as customer advocates on the one hand and significantly heightening their platform flexibility through modularization on the other, they have a good chance of finding their role and securing their survival in the new horizontal business world. The objective — completely in the sense of the “Company ReBuilding” concept — is to transport past experience, competencies, and assets into the new world in such a way that they contribute to customer understanding and performance flexibility, thereby giving rise to new capabilities.

 

#RebuildingEuropeMagazin

The world is currently going through a so-called technology shock. The digitalization as the trigger redefines the parameters of economic action and changes whole societies. The drivers of our global economic system deal with it in different ways. The Silicon Valley model from the USA is based on creative destruction, i.e. digital platforms with a global reach are emerging in competition with established companies. The Chinese model, on the other hand, is based on a domestic market massively protected by the state and is currently proving to be particularly competitive in economic terms. The distribution of Fortune 500 companies shows significant growth, especially in Asia, while the number is declining in the USA. A shift to the East can also be seen in technological competence, including standards.

How do Germany and Europe move between these two dominant digital models? There are signs that a "European path" of its own is developing. In our view, cutting-edge technology and leapfrog innovation, originally the foundations of our established industry, are once again the key competencies in which we must invest all our resources. The "European Approach" requires ecosystems and a digital reengineering of established businesses for global relevance.

Our customers and business partners also confirmed this orientation at the premiere of the Detecon Red Carpet Event in September 2018. We have compiled the essence of this "European Path" for you in the magazine Rebuilding Europe.

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