Hitotsubashi University
Institute of Innovation Research

Escaping the Red Queen Effect in Competitive
Strategy ‒ How Managers Can Change Industry
Rules by Sense-Testing their Business Models
Sven C. Voelpel
Marius Leibold
Eden B. Tekie
Georg von Krogh

IIR Working Paper WP#03-18

August 2003

Institute of Innovation Research
Hitotsubashi University
Tokyo, Japan
http://www.iir.hit-u.ac.jp

Escaping the Red Queen Effect in Competitive
Strategy – How Managers Can Change Industry
Rules by Sense-Testing their Business Models
Sven C. Voelpel
Marius Leibold
Eden B. Tekie
Georg von Krogh
August 2003
WP#03-18

Escaping the Red Queen Effect in Competitive Strategy –How Managers Can Change Industry Rules
by Sense-Testing their Business Models
bySven C. Voelpel
Harvard Business School
Soldiers Field
Boston, MA 02163, USA
svoelpel@fas.harvard.edu
Marius Leibold
University of Stellenbosch
Private Bag X17601 Matieland, South Africa
ml@sun.ac.za
Eden B. Tekie
University of Stellenbosch
Private Bag X17601 Matieland, South Africa
et@sun.ac.za
Georg von Krogh
University of St. Gallen
Dufourstr. 48
Ch-9010 St. Gallen, Switzerland
Georg.vonkrogh@unisg.ch

August 30, 2003

ESCAPING THE RED QUEEN EFFECT IN COMPETITIVESTRATEGY - How managers can change industry rules bysense-testing their business models
By Sven Völpel, Marius Leibold, Eden Tekie and Georg von Krogh1

How can smart managers change industry rules and thereby escape the straitjacket ofsolely improving efficiency and facing direct competition? By applying a sense-testing
tool in business model thinking and its reinvention.
Rationale of the Article
Most business models are based on traditional ways of strategy
formulation and implementation, leading to incremental and not disruptivechange in the nature of business and industry practices. The ‘red queen
effect’ refers to the red queen’s advice in Lewis Carroll’s Through the
Looking Glass in which she says that to stay in (competitive) place you
have to run very, very hard and to get anywhere you have to run evenharder. In today’s knowledge and mobile environments we know thatbusinesses cannot survive by just running harder, but especially byrunning different and ‘smarter’ than competitors. The article suggests a
sense-testing tool for managers to enable disruptive innovation ofbusiness models, through corporate examples and case study evidence.

1

Sven C. Völpel is a Professor and Visiting Fellow at Harvard Business School and Graduate School ofArts and Sciences, Harvard University. Marius Leibold is Professor in Strategic International Managementat Stellenbosch University, South Africa, and Professor of Strategy at Business School Netherlands
International. Eden B. Tekie is a senior research fellow at the Department of Business Management,
Stellenbosch University, South Africa. Georg von Krogh is professor of management and director of theInstitute of Management, and cofounder of the research center KnowledgeSource, at the University of St.
Gallen in Switzerland. Contact the authors at svoelpel@fas.harvard.edu, ml@sun.ac.za, et@sun.ac.za andgeorg.vonkrogh@unisg.ch.

1. Introduction
Despite increasingly fierce competitive landscapes, most managers assume that costcutting and other forms of improving efficiency will help them to counter directcompetitiveness challenges. Thus, their first reaction to discontinuous competition is to“work harder”, when what they need to do is “work differently”. Several observers havecommented that even though many companies work harder to improve themselves inincreasingly competitive environments, results improve slowly or not at all.i This is acharacteristic situation described as the “Red Queen effect”.ii It is a “comfort trap” where“running harder” is easier to do, it is of an analytic-benchmark nature, it shows short-term
success and is less risky in the near horizon, but ultimately holds long-term downfall.
Soon after 1995, Encyclopaedia Britannica, once regarded as the world’s mostcomprehensive and authoritative encyclopaedia with the most aggressive and successful
direct sales forces, was swiftly relegated to being sold at less than half of its book value.
All this despite focusing on traditional key success factors, established core competencies,
and working harder and harder, as if in response to competition from a traditionalcounterpart, rather than working different by responding to competition from a new rival– the CD-ROM. In less than five years, one of the greatest brand names in the Englishspeaking world, with a heritage of more than 200 years, was nearly destroyed by an
inexpensive, plastic disk.iii
In contrast, despite scepticism about the sustainable competitive advantage of theespresso-bar concept, Starbucks, in only 11 years, enjoyed phenomenal growth andbecame one of the great retailing success stories of recent history by making exceptionalcoffee drinks, selling dark-roasted aromatic coffee beans, and trendy coffee-making
equipment. The Starbucks brand is now regarded as one of the best known and strongest
brand names in America, and the company has firmly established itself as the dominantretailer, roaster, and brand leader of speciality coffee in North America.iv
Why did Encyclopaedia Britannica fail while Starbucks succeeded? Our research overmore than nine years has revealed the underlying principles. In hard times, most1companies fail because managers and executives focus on only squeezing out efficiencies
and working harder while our research revealed that, especially in a discontinuous (fastchanging, disruptive) environment, managers ensure survival or even prosperity if theywork different with their business model. But how can they accomplish this? Companies
need to change industry rules (the accepted way of doing business in the industry) by
fundamentally questioning industry orthodoxy of conforming to useful but outdated
traditional practices, lessons and experience.
The Red Queen effect is a situation where a company facing competition is more likely to
improve its current practices in order to adapt to the changing competitive environment.
However, in the current era of discontinuous change, solely achieving this will lead topoor performance while rivals that offer new customer value propositions bycontinuously changing their business models, thereby bucking industry rules, keep one
step ahead of the competition.
This article describes the charms and traps of the “Red Queen” in the conventional wayof analysing business strategy, and contrasts it with business model thinking and strategy
reinvention. Finally, this paper provides a practical sense-testing tool for developing,evaluating, and adapting new business models.

2. Why Traditional Ways of Analyzing and Deciding on Business
Strategy Lead mainly to Incremental Change and “Comfort Traps”
The conventional process of environmental analysis, generating strategy options,formulating and implementing strategy, and gearing for contingencies, encourages
businesses to adjust to the future they anticipate rather than proactively reshaping andbuilding the future they aspire. In such a way, formal planning hinders organizationalchanges by promoting strategies that are repetitions of the past or copied from others in
the industry. This is an illustration of strategies converging and clustering around acertain “industry orthodoxy”, or generally accepted industry norms for doing business.v

2

Relative Stable Industry Conditions of the Past Era’s
Traditional approaches are useful for generating strategies for businesses experiencing
low levels of uncertainty. But such environmental stability of the industrial era has been
replaced by major discontinuities that have essentially altered many existing industry
structures, resulting in radically shortened life cycles of products/services and strategies.
As a result, conforming to defined internal and industry boundaries may cause a company
to ignore opportunities and threats arising in an interconnected, knowledge-intensivecompetitive environment.
Overall, traditional approaches to strategy-making are inconsistent and inappropriate withthe discontinuities that have taken place - and are taking place - in the businessenvironment. These approaches discount the voice of the people in the company who deal
with the daily business, and restrain the organization’s speed, flexibility andresponsiveness due to focus on analysing a static present situation and predicting thefuture. Conventional approaches to strategic management might be suitable and adequate
during stable industry conditions, but such constant and continuous state of theenvironment is exceptional in the present time where survival and sustainable
competitive advantage comes from thinking radically and by changing the rules of theorganization and/or industry.
The Impact of Greater Discontinuities
The new era of the knowledge economy and mobile society has resulted in industry
structures that are fundamentally different from traditional ones and challenge thecompetitive advantages that depended on such structures. vi Analytic approaches,
therefore, should complement the proactive and creative standpoint needed to overcome
the competitive pressures arising from the radical changes taking place in the businessenvironment. Employing industry systemic review as an ongoing process and integral
part of “revolutionary thinking” can enable organizations to create innovative andsuccessful disruptive strategies.

3

It is important to note that companies should not have a focus on singular strategies, as
the traditional approach has been fond to do. As already mentioned, it is difficult topredict the business landscape because of the diversity and complexity in the increasingly
turbulent environment. Consequently, managers should continuously exploit newopportunities through innovation and experimentation, seeing that the environment andcompetitors’ strategies constantly change. Having a set of multiple and diverse “robust
adaptive” strategies will provide companies to have the flexibility they need to choose
from a variety of options destined to keep them one step ahead of the competition.vii
The Need for Holistic Thinking in Today’s World
Successful businesses are those that evolve rapidly and effectively. Yet innovative
businesses have to attract resources, bringing in together capital, partners, suppliers, andcustomers to create cooperative networks. Accordingly, a company should not be viewed
as a member of a single industry but as part of a “business ecosystem” that operates
across a variety of industries. This implies that in a business ecosystem, companies work
both cooperatively and competitively to generate new products, satisfy customer needs,
and incorporate future innovations.viii
The competitive landscape is constantly shifting as a result of competitive or
collaborative moves. The shape and movement of this landscape therefore depends on theactions of an organization and those of the other organizations with which it interacts.
This implies that single moves can be ineffectual without proactive participation of thoseother organizations in a company’s business system. This is when co-evolution, in the
broader context of industry ecosystem activities, takes place. Business organizations coevolve competitively and collaboratively by adapting to and co-shaping theirenvironments, either by reacting to new business models or by proactively creatingthem.ix

4

3. The Attractiveness and Comfort Trap of the Red Queen Effect in

Formulating Business Strategy
A company facing competition is likely to initiate a search for ways to improve its
performance. Often, this search results in learning that is likely to increase the company’scompetitive strength, which in turn prompts learning in its rivals – consequently making
rivals stronger competitors and thus again triggering learning (search for improvements)
in the first company.

In this way, organizations learn over time as a response tocompetition, which in turn intensifies competition in a self-reinforcing process.x
The “Red Queen” effect could have positive and negative impacts, or consequences.xi
Through an incremental but constant and self-reinforcing process, a company gains longterm advantages, especially of strategic capabilities and enhanced performance, andincreases its resilience in the face of direct competition and gain more in competitive
experience. However, organizations could face two major constraints because of the “RedQueen” practice. Firstly, organizations are constrained by their history, i.e. lessons
learned in the past. Organizations tend to respond to new developments using norms thatwere learned under previous and different environmental condition, hindering theirperformance by doing precisely what worked well under different circumstances. The
second constraint is when organizations are facing a group of rivals that do not share theorganization’s co-evolutionary history – history adapted from competition with others.
This prevents some forms of adaptation to its new rivals. Similarly, trying to adapt to new(indirect) rivals may require major alterations in responses to its earlier (direct) rivals.
Another important point is that after the emergence of a fundamental innovation,
people/organizations experiment with radical modifications to find ways to improve it.
As better methods or ways are found, it becomes increasingly harder to make further
improvements, so variations become more modest. Consequently, growth in that sector
slows down and markets become saturated.xii
Therefore, “Red Queen” thinking and practices can be detrimental under conditions such
as: new rivals entering a market (thereby increasing the variance in an organization’s

5competitive experience); limitations in improvement/modification (the rate of finding
improvements considerably slows as “peaks” of fitness are attained); and intense head-tohead competition (rivals have likewise adapted and become stronger competitors).
The Red Queen Effect as a Comfort Trap
In spite of discontinuity in the business environment, many companies (especiallyestablished ones) find it difficult to let go of industry orthodoxy, i.e. discarding
conventional beliefs and established ways of doing business. In such situations,companies find themselves trapped in a “catch-22” of solely improving themselves ratherchanging the “rules of the game”. While established (incumbent) companies struggle withimproving efficiencies, (mainly) upstarts and new entrants to an industry capture theirbulk of the customer base and niche of the existing (or new) market.
A classic example of a company wedged in such a trap was Encyclopaedia Britannica.
From being regarded as the world’s most comprehensive and authoritative encyclopaedia
in the early 1990’s, with the industry’s most efficient and successful direct sales force, it
was swiftly relegated to being sold at less than half of its book value. And all this due tonot competition from a traditional counterpart but a new rival – the CD-ROM.xiii Anotherexample is the MP3 phenomenon that has changed the record industry. As a freely
available technical standard for the compression and transmission of digital audio, it was
suddenly possible to download entire collection of pirated music and albums through theInternet. This cost the music industry in billion of dollars, and no matter how therecording industry scrambled to be in control again, the rules of the game had alreadybeen irrevocably changed. xiv Sears, Roebuck & Co., once one of the world’s largest
organizations and America’s leading retailer, is another instance of a company unable torespond early to the threats posed by discount department stores such as Wal-Mart, KMart, and Toys-R-Us. Sears was in the catalogue business (thereby extensively ignoring
online business for a long time) and had drifted to a condition of denial and complacency
reactions of “too small to worry about” or “not a problem in my region”. It was too little
too late by the time Sears included Wal-Mart and others among its competitor
benchmarks.xv

6

The above examples demonstrate situations where established companies failed toproperly respond not only to technological changes, but also to competitors andcustomers that at the time seemed apparently irrelevant to their respective businesses. It is
not easy for companies to pre-emptively “cannibalize” or destroy still profitable businessand cut off long-term relationships with their suppliers and customers -- Christensen’swell known “innovator’s dilemma”.xvi Nevertheless, it is a dilemma organizations must
address for their continued sustainability and long-term performance.
Hence, for companies locked in a “Red Queen” race, involving a head-to-headcompetitive pack, sustainable competitive advantage comes to those who move beyond
improving efficiencies/performance to radically changing their business models to stayahead. Critical questions that arise are: How exactly do companies and smart managers
successfully change industry rules? Does it always make sense for a company to break
the rules or are there other choices? How does one handle the tension between existingand new business models, and their divergent company requirements? Charitou andMarkides xvii indicate that if established companies are to respond by embracing
competitors’ radical strategies, they run the risk of jeopardizing their existing businessand strategies. Some companies respond by focusing on their existing businesses, othersby adopting the new strategy while holding on to their existing ones. Again there aresome that ignore the innovation or new strategy, whereas others completely embrace theinnovation. These authors point out that every organization needs to resolve its own
specific response depending on the unique circumstances confronting it.
While the one purpose of this article is to highlight the negative impact of the “RedQueen” effect in a highly uncertain and disruptive environment, the next sections provide
guidelines in changing industry rules for numerous companies and managers (including
leading and established organizations) that find it difficult to consider a different or even“radical” way of doing business. The box below indicates key questions to provide abasis for starting to consider how to escape the “Red Queen” effect.

7

Does your strategy change industry rules?
1. In your company, where do you just “work harder” where you should “workdifferently”? Are there strategies that focus solely on improving processes andsystems while results show little difference or none at all (reaching a point ofdiminishing returns)?
2. Is your company committed to discovering new ideas and innovations? Does yourcompany continuously strive to create new customer propositions (newproducts/services/customer experiences)? Is offering new customer value number one
on your list in developing business models?
3. Does your company co-evolve collaboratively and competitively in creating (orresponding) to radical strategies? Does it network and configure itself with othercompanies and individuals (including customers) in search for value creation? Does it
react in time to what other firms, customers, etc. do, or even anticipate what they willdo, by engaging and co-evolving with important members of the business ecosystem?
4. Does top management have a mechanism that enables/encourages members of yourcompany to be creative and innovative? Does it listen to the “voice of the people” at
all levels of the company? Are employees encouraged to speak up without worrying
about reprisal from top management? Can they easily voice what changes are needed?
Do all employees contribute to the process of making your company a “better
company”?
5. Is there a diverse population of people of top executives and other members in yourcompany – those with various past experiences and perspectives, newcomers,
different age groups, etc? Does your company make sure it benefits from thesedifferent skills and knowledge?
6. Does your company have a diverse, but related, “robust adaptive” strategies? Does it
continuously explore and exploit new opportunities and ideas that it keeps in its
portfolio? Do the strategies evolve over time and with changes in the businessenvironment?
8

7. Is the portfolio of strategies closely monitored and decisions made in good time
regarding their feasibility (i.e. whether to commit to them or abandon them)? Do
managers make sure they are not a drain on resources (e.g. human and financial)?

4. The Necessity of Expanding Strategy to Business Model Thinking
It is essential to grasp the dimensions, perspectives, and core issues of business models if
one is to comprehend the creation of new business models and changing the rules of how
business is done in the (traditional) industry. Having a comprehensive and cohesive
understanding of a business model and its key elements can provide important sources ofcompetitive advantage. Several authors have attempted to define the term business model,
and its core dimensions.xviii Although different in perspectives and number of dimensions,
it seems that some consensus of the nature of a business model and the systemic thinking
under-girding it can be used for our purposes.
Nature of a Business Model
The term “business model” can be defined as:
The particular business concept (or way of doing business) as reflected by thebusiness’s core value proposition(s) for customers; its configurated value network toprovide that value, consisting of own strategic capabilities as well as other (e.g.
outsourced/allianced) value networks; and its leadership and governance enabling
capabilities to continually sustain and reinvent itself to satisfy the multiple objectivesof its various stakeholders.
This definition proposes the basic generic elements in business models to be:•

new customer value proposition(s);•a value network configuration for that value creation; and•leadership capabilities that ensure the satisfaction of relevant stakeholders.

9Creating and offering new customer value proposition is the basis from which viable andsuccessful business models can be created. Being first to offer such value will give anorganization “monopoly profits” by achieving high returns before competitors start
imitating and catch up. Being a first (or early) mover in responding to environmental
change can give a firm major competitive advantage by creating a critical mass.xix For
example, FedEx attempted to offer a new customer value proposition by offering
overnight delivery services. This strategy was feasible and succeeded to the point thatindustry incumbents were forced to adapt to the new industry structure and offer similar
services.xx“Systemic” Business Model Thinking
From a business ecosystem viewpoint, the strategy focus of an individual firm is to coevolve with the other players in the business community and to build co-opted
capabilities in the ecosystem. Such systemic thinking is the basis of a business ecosystemmindset, with an understanding of the phenomena within the context of a larger whole.
The co-evolutionary process of interdependently collaborating in co-shaping the businesslandscape has led to a shift to a new strategic management paradigm - “systemic strategic
management”. This is the co-shaping of organizational value propositions throughsystemic organizational capabilities.xxi Industry clusters, for example, illustrate groups ofcompeting, collaborating and interdependent businesses working in linked industries andother important entities (although concentrated in a geographic region, such as Silicon
Valley). Clusters attract innovation and investment; enable technology and knowledgetransfer; and foster opportunities for start-up companies.xxii

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5. Applying Sense-Testing to Your Business Model: a Tool toDramatically Reinvent Your Business Model – and to Change
Industry Rules
Andy Grove of Intel has used the term “strategic inflection point” to describe the point(timing, place, extent) of discontinuous change in industry structure, where businesses
subtly but discontinuously shift from the old business model to the disruptive new
business model, thereby fundamentally changing industry dynamics. xxiii In mostsituations, industry inflection points emerge initially too small to be discerned, but thenoverwhelm the industry in such a way that leaves it essentially altered (as evidenced by
Encyclopaedia Britannica and MP3). This is mostly due to the inter-connectivity andnetworked nature of the “knowledge economy”, and the emergence of critical mass overtime. How well a business anticipates and recognizes such a transition, and how soon it
adapts to the new rules, determines its future and sustainability.
In theory, it is easy to understand how the competitive landscape has changed and how
crucial it is to constantly and radically renew one’s business model. In actuality, however,
it is challenging for established businesses to sever existing lucrative businesses, physicalassets, customers and suppliers, and to “break the rules”. How do managers go about inunderstanding and “sensing” new business models for strategy inflection? – we propose asense-testing approach.
What is Sense-Testing?
Sense-making could be defined as the conceptual or constructed “mental frames” that areused as filters and references to interpret cues picked up from events and objects. For
instance, identities are constructed in the process of sense making. But since the “world”
is constantly in the process of reconstruction, identity construction is a continuous
activity whereby individuals look for ways and targets with which to identify.
Organizational sense-making has, therefore, come about as the result of the need to makesense of the complex and discontinuous changes in the environment, and the limitations11

of conventional strategies and managerial approaches to “doing business in theindustry”.xxiv
A systemic sense-testing tool (see figure below) helps companies grasp the concept ofadapting and creating business models for strategic inflection. This tool enables managers
to discern if the rules of the game could be dramatically changed, and, if so, if they can
become the ‘new industry’ leader in actually changing the “rules of the game”.
The four key dimensions described in the sense-testing tool affect the development of apotentially reinvented business model. These are: sensing reinvention of customer value
propositions; sensing the impact and/or reinvented utilization of technology; sensing thereinvention of industry value chains and/or business system infrastructure, and sensing
the sustainability of the potential reinvented business model.
•

Customer sensing: Research indicates that the creation of dramatically new
customer value propositions and/or sensing potential breakthrough change incustomer behaviour are the initial driving forces behind sound new businessmodels. Does the value proposition dramatically improve/satisfy customers’
needs and wants, or does it create new customer segments? And if it does so, iscustomers’ ease of transition/acceptance slow and difficult, or fast and swift?

•Technology sensing: This indicates the relative strength, direction and impact oftechnology on new customer value propositions and the business network. Is theavailable technology still efficient in communicating and delivering new customer
value propositions? Or is it becoming obsolete, and perhaps even a new and better
technology is being developed (e.g. the Internet replacing catalogue and mailorder)? When a new business model is proposed, does the available or proposed
technological infrastructure enable quick organizational reconfiguration? (see thenext point about reconfiguration).

12•Customers
Sensing potential for change inCustomer/User Behaviour and
New Customer Value Propositions

Favourable
Economics/
Profitability
Sensing the
economic
feasibility andprofitability of the
proposed businessmodels•••Economic
payback
Incentives
to switch
Profitability

Poor

•
•

Improving customer
benefits & success
Ease of transition
Persuasion requirements

Simple, Fast
Difficult, Slow
Technology
Sensing thestrength, direction
and impact oftechnology

Business
Model
Reinvention
Rigid,
Traditional

Old,
Entrenched

Responsive•New,
Diffusing ••New customervalue
New efficiencies
No rapidobsolescence

Business System Infrastructure
Sensing the potential for value system(re)configuration, includingorganizational structure(s)•••New business network roles
Improved business network
effectivenessGuiding and leading the network

Figure: Sense-testing Key Elements of Business Models for Industry Inflection•

Business infrastructure sensing: The business environment is a “networked
economy” consisting of various business systems, where a company co-evolves
with selected organizations (suppliers, competitors, etc.) and individuals(customers, employees, etc.) in creating/responding to new business models. Is
the company (internally) reconfigured and organized in such a way that enables it
to offer new value propositions? Is the (external) value system configured with
the necessary suppliers, customers, even competitors and other critical13

stakeholders? Simply put, this sense-testing refers to the relative responsivenessof the traditional business network to reconfiguration, or the options forreinvention of business systemic infrastructure (internal and external).
•

Economics/profitability sensing: The proposed strategy/strategies should be
evaluated as sustainable and relatively inimitable by competitors. They should be
economically feasible if they are to sustain the company and support otherstrategies get under way. Economic payback is also needed to make it possible forthe company to experiment with opportunities and innovation without shortage offunds. The proposed strategy may not be groundbreaking and a particularly
lucrative undertaking, and every model may not turn out to be economicallyfeasible in the end, and that is why it is important to have a diverse (robust) rangeof strategies to minimize the risk of unsustainable strategies.

Looking at the four sense-testing dimensions in conjunction, the higher the acceptancepotential of the value proposition that appeals to a larger customer base, the higher theacceptance of new technological standards and business infrastructures, and the greater
the sustainability and profitability of the new business model, then the greater the
likelihood of the success of a new business model. These four elements can be used bymanagers in determining which business models from the pool of strategies are feasible
and possess acceptable success probabilities.
There are numerous companies (mainly start-ups and new market entrants) that haveredefined their businesses in a radical way and successfully “transcended” traditional
industry competitors. These include: Dell Computer (structuring a “direct sales” value
chain of build-to-order manufacturing), Amazon.com (creating virtual stores that offer
millions of new, used and collectible items), Starbucks (America’s speciality coffee
retailer, see the box “Starbucks – Redefining Customer Experience” below), Cisco
Systems (manufacturing and selling scalable, standards-based networking andcommunication products that cover a wide range of customers’ networking needs), IKEA
(a global leader in a wide range of modern home furnishings and accessories), Nokia

14

(world leader in mobile communications – services including mobile telephony design tothe manufacture and installation of broadband and multimedia network equipment).
Case: Starbucks – Redefining Customer Experiencexxv
Starbucks has recreated the “Italian espresso-bar” experience. From a local company it
grew into a national success by concentrating on creating customer value proposition
around freshly brewed espressos, cappuccinos, lattes, and a wide selection of other fancy
beverages. It also offers a variety of fresh pastries and other food items, sodas, juices,teas, and coffee-related products and equipment. Its ever-growing customer base includes
young, tech-savvy customers to moms with strollers to people who were combining workand a coffee break. Its stores accommodated a stream of over 5 million customers per
week by 1998. Loyal customers patronized a Starbucks store 15 to 20 times a month,
spending up to $50 monthly. Some customers were Starbucks fanatics, coming in daily.
By 1997, Starbucks’ success was prompting a number of ambitious rivals to scale up
their expansion plans. Starbucks’ closest competitor is Second Cup. Other small local andregional chains that aspired to grow into rivals of Starbucks include New World Coffee,
Coffee People, Coffee Station, Java Centrale, and Caribou Coffee. In addition, numerous
restaurants were picking up on the growing popularity of specialty coffees and started toserve a range of coffee drinks to their customers. The company also faced competition
from nationwide coffee manufacturers such as Kraft General Foods, Procter & Gamble,
and Nestle.
The company was constantly engaged in efforts to develop new ideas, new products, andnew experiences for customers that belonged exclusively to Starbucks. Senior executives
emphasized the importance of always being open to re-inventing the “Starbucks
experience”.
The company’s efforts to greatly increase its sphere of strategic interest via its joint
ventures, its move to sell coffee in supermarkets, and the possibility of marketing fruitjuice drinks and candy under the Starbucks label represented an ongoing drive tocontinually reinvent the way Starbucks did business.
In order to sustain the company’s growth and make Starbucks a strong global brand,
Senior executive Howard Schultz believed that the company had to challenge the statusquo, be innovative, take risks, and alter its vision of who it was, what it did, and where it
was headed. Under his guidance, management was posing a number of fundamental
strategic questions: What could Starbucks do to make its stores an even more elegant“third place” that welcomed, rewarded, and surprised customers? What new products andnew experiences could the company provide that would uniquely belong to or beassociated with Starbucks? What could coffee be - besides being hot or liquid? How
could Starbucks reach people who were not coffee drinkers? What strategic paths should
Starbucks pursue to achieve its objective of becoming the most recognized and respected
brand of coffee in the world?

15

Business model thinking, and application of the sense-testing tool in reinventing abusiness model, is aptly illustrated by how a major Australian wine company, BRL
Hardy, reinvented its business model, thereby changing the rules of the global wine
industry (see illustration box below).
Illustration: Applying the Sense-Testing Tool - How BRL Hardy reinvented its
business model from a wine exporter to a global wine brand companyxxvi
The Australian wine company BRL Hardy increased its 1991 international sales of
US$31 million to US$178 million in 1998 when they realized the opportunity to build up
a global wine brand, something previously unimagined in the highly-fragmented global
wine industry. The Old World (European) wine industries of France, Spain, Italy,
Germany and others are so fragmented in producers, cultivars and brands that it confuses
consumers and retailers alike. A large supermarket store in Europe sells hundreds ofdifferent types and brands of wine made by a huge variety of producers, from the Old
World and New World wine producers. The New World wine producers are fromcountries such as the USA, Australia, New Zealand, Chile and South Africa.
In most Old World wine countries, wines are labeled according to region, sub-region, andeven village. In addition to that a vineyard in France can be further categorized according
to its historical quality classifications such as the Premier Grand Cru, the (ordinary)Grand Cru, and so on. The world famous wine region Bordeaux alone has over 12,000
producers. Italy has over a million separated wine-growing units in private ownership. In
Australia on the other hand, just four companies dominate 80% of the local wine
industry, making for a more consolidated industry. It is this power of larger scale thatallows New World wine producers to build up brand strength and distribution capability.
The major wine importing countries are the United Kingdom and Western European
countries such as Germany, Holland and Sweden, where the range of wine brands haveproliferated five-fold in the past ten years.
In the early 1980’s BRL Hardy found itself “trapped” in the shrinking market of thelower quality and price segment of the major wine importing markets, especially the UK.
The business model was an “export company” model, built on significant quantities of
low-margin wine products, with the large supermarket chains in the UK having the power
to dictate wine styles, quantities, timing and prices. In world terms, BRL Hardy was a
relatively small and entrepreneurial entity. Steve Millar, the managing director at thetime, decided that the only way out would be to “change the rules of the game” and tocome up with a new business model. He sensed that wine consumers were frustrated
with the proliferation of wine brands and their lack of knowledge of relative wine
qualities and service. He further sensed that there was no real global wine brand, whilethese were commonplace in soft drinks, beer and some high-alcohol spirits. He surmisedthat a global wine brand would make things easier for suppliers and customers, and could“free” him from the stifling power of large retailers.

16

A key issue was the eventual realization by BRL Hardy that the major knowledgeable
wine customer need, or customer wine value proposition, was made up of three elements:
well known global image; consistency of quality and availability; and “value-for-money”,
including affordability and competitive pricing. Once it is was clear that something had
to be dramatically changed, it was important to have the necessary prerequisites toengage in disruptive change. In 1991, for example, Christopher Carson, an experienced
international wine marketer, was appointed managing director of the company’s UK
operations. Over the next 18 months, he pruned three-quarters of the items in the
fragmented product line, replaced half his management team, and began building aculture around globalism, creativity and innovation, and global value chain configurationand management. It was realized that dynamic new organizational capabilities wereneeded, and Hardy embarked on a targeted strategic alliance building with companies in
Italy, Spain and the USA. These alliances added essential expertise, infrastructure andfinance. Several mistakes were made in the process, but nothing survival-critical, andthese eventually contributed to the learning experience and overall value-added of the
new business model.
The company started to focus on integrated wine production, supplementing their
Australian product line by sourcing and supplying wine from around the world. By
breaking the tradition of selling only its own wine, Hardy was able to build the scale
necessary for creating strong global brands and negotiating on equal basis with large
retailers. The advantages of global sense making to Hardy have been clear and powerful:
The company’s range of wines – from Australia as well as France, Italy and Chile –responds to supermarket companies’ need to deal with only a few broad line suppliers.
Simultaneously, the scale of operations has supported the brand development so vital totransforming products from the commodity range.
A radical corporate strategy, as in the case of BRL Hardy, is to introduce new businessmodels that challenge an industry’s established rules of competition, or ways of doing
business. Results have been outstanding. In Europe, the volume of Hardy’s brands has
increased 12-fold in seven years, making it the leading Australian wine brand in the huge
UK market, and number two overall to Gallo in the United Kingdom. Hardy has evolved
from an Australian wine exporter to a truly global wine company, utilizing global scopeand scale economies and drawing on knowledge and skills from many parts of the world.
How did BRL Hardy escape the “Red Queen” trap of working harder and harder, but withlittle or no growth in product margins and profitability? In essence, utilizing the sensetesting tool described above:••

Sensing potential for change in customer need satisfaction, and testing for ease of
acceptance, persuasion requirements, and particular combination of overallcustomer value propositions.
Sensing the direction and impact of technology on wine styles, wine qualities,
customer communications, wine value chains, packaging and marketing, andtesting for new customer value, new efficiencies and new perceptions throughexpert use of relevant technologies.

17

•

•

Sensing the potential for disruptive value system reconfiguration, which would
eventually destroy its old business model, and testing for new business network
partners and roles, and what leadership qualities would be needed for global wine
business ecosystem leadership?
Sensing the economic feasibility and profitability of the new business model, andtesting for economic payback on investment, incentives for distributors, andoverall ROI and long term shareholder growth (with various risk assumptions).

From the above illustration and case examples a number of key managerial lessons
emerge, as discussed below.

6. Key Lessons for Managers in Applying the Sense-Testing Tool
Six key managerial lessons in applying the sense-testing tool for development of
disruptive new business models emerge:
1. They often arise in entrepreneurial entities or ventures
It is a matter of fact that most disruptive innovations whether according to products,
services, processes or business models have been made by small, young starting
companies rather than by the larger incumbents. This is true for any industry if it is Dell(computer), Amazon (book retailing), BRL Hardy (wine) or, for example, Ryanair which
has been turning the airline industry upside down since the late 1990’s. It seems that theentrepreneurial thinking that is very often the strategic basis for doing business in thosecompanies fosters unconventional, creative solutions in order to survive in the presenceof the larger established competitors, or to enter a tough and saturated market with asignificant advantage over incumbents.

Larger incumbents mostly lack the kind of

thinking and the flexibility to incorporate such an entrepreneurial flair, and need tolaunch entrepreneurial incubators and experimental ventures.
2. They disruptively change the way of doing business
Once a disruptive new way of doing business has proved to be successful it will force
other competitors to rethink both their strategies and business models in order to keep up
with the development of a more challenging environment. While Amazon has been a18

positive example in regards to customer satisfaction and offers, it can be imagined thatthe effects of Ryanair might put larger airlines under even greater pressure (e.g. in regard
to prices and overall customer value propositions) in future than they already have. BRL
Hardy has disruptively changed the boundaries of global collaboration and knowledge
sharing in the wine industry, away from only country-specific competition, brandproliferation and retailer power. The “rules of doing business” in the industry have been
reinvented, with a new basis for competition – besides the old business models.
3. They are guided by visionary leadership
The role of visionary, creative and strong - but not limiting leadership - cannot beemphasized enough. Whether we are talking about entrepreneurs like Bill Gates, or to
stick with the example above, like Michael Dell and Steve Millar. In any phase of theorganisational life cycle, the right enabling and guiding leadership is essential if theorganisation would be able to achieve ambitious goals, especially to disruptively change
the way of doing business.
4. They posses an “open enterprise” mindset
Original, creative and fresh ideas do not always come from within the single organization.
Sometimes the radical “new-new” thing arises from external sources. Companies ready to
be open to new influences from outside are those with the necessary mentality andcourage to engage in necessary collaboration across borders, e.g. with customers, partners
and even with traditional competitors.
5. They are hard to imitate
The question is what stops other computer manufactures to switch their business model tothat of Dell’s business model when it proves to be so successful? Why does the way of
doing business of a disruptive model usually not become a model for the whole industry?
In some cases this might happen, but more often the incumbent still stick to their oldmodel and prefer only slight modifications. There might be several reasons for not doingso. Some are related to the entrepreneurial thinking and flexibility that thoseorganizations might be lacking. But more often it is simply not possible to move out of
19the old structures even if they would like to because of existing contractual relationships
and bargaining power of suppliers. Some industry players, e.g. retailers and evencustomers, might prevent a change in the business model and provoke retaliation if done
against their will. On the other hand, the company might find it quite easy to distinguishthemselves from the new competitor by their own way of doing things and benefit fromthe increased demand.
6. Business model change opportunities appear only very seldom (sometimes
only once during the “lifetime” of a organization)
It is astonishing that most companies, whether small or big, young or old, seem to be able
to do this “leap into the unfamiliar”, the revolutionary way of doing business, just once intheir existence or for a very limited number. There might be the danger that a former
leader of innovation becomes a laggard and a victim of more innovative companies itself.
On the other hand, this doesn’t necessarily have to happen. The major lesson is to be able
to perceive the business model change opportunity, and to be able to grasp it while it isstill possible to do so. Continuous sense-testing of possible reinvention of an existing
business model needs to be done.

7. Conclusion
Companies often respond to uncertainty by imitating other, usually competing,organizations. However, in an increasingly discontinuous environment, questioning thefundamental makeup of conventional mindsets is crucial for survival in the present, andespecially to advance strongly in the future. For instance, had Sears, Roebuck & Co.
fundamentally questioned their business model, they would possibly have succeeded in
out-innovating their rivals such as Wal-Mart and Toys-R-Us. Best business practices andefficiency approaches and practices become vulnerable when the industry environment isripe for dramatic reinvention, and companies should strive to be alert to take a possible
lead in this, or at least be able to interpret such imminent changes for rapid adaptationand co-shaping of new customer value with other companies. Corporate survival in
today’s world depends on being ahead of the competitive pack in business model
thinking and adaptation.
20

The “Red Queen” effect illustrates that companies could easily lapse into a dead-end
street which brings them faster to failure if they just work harder or try to improve
traditional industry key success factors. This need not be a terminal situation, however.
Managers and executives can use numerous means to come up with creative and new
strategic ideas by continuously challenging what their company is doing and why it isdoing it. By doing so, they will be able to discover new ways of doing its business –reinventing its business models in timely, appropriate ways. Constantly searching forsomething new through experimentation with new ways of doing business, andreinventing old ways, will provide a wide range of options to choose from in dealing withthe uncertainty of the environment.
Having a broad view of the business landscape and the company within, companies canco-evolve and co-shape customer value propositions that reinvent the company’s andindustry’s rules. The sense-testing approach provided in this paper assists managers andexecutives in identifying, developing and evaluating the key dimensions of a future
reinvented business model. This tool can help evaluate the chances of a proposed new
business model making it or failing.

21

About our researchThis study’s conclusions are derived from two interrelated research streams.
First, a seven-year quantitative and qualitative research study of more than3000 interviews in collaborative studies and 64 expert interviews with leading
authorities to, on the one hand, map patterns of the red queen effect and on
the other hand purposeful managerial strategies to change industry rules.
These studies include executives from firms such as Accenture, BCG, Cap
Gemini Ernst & Young, DHL, McKinsey and Siemens, as well as scholars
from institutions such as the Harvard Business School, Hitotsubashi
University, IMD, MIT and the University of St. Gallen and a detailed casestudy of Siemens, one of the world’s largest companies in terms of people.
Second, this study is grounded in our case research over the last nine years inlarge and small companies headquartered in North America (Accenture,
Boston Consulting Group, Cap Gemini Ernst & Young, DHL, McKinsey),
Europe (Bayer, BrainsToVentures, DaimlerChrysler, Infineon, Novartis,
Roche, Siemens) and Asia (Motorola, NTT DoCoMo, Sony).
Case studies from a wide range of industries were used, including those fromestablished organizations to new entrants into a market/industry, and fromvirtual, web-based companies to bricks-and-mortar and bricks-and-clicks
ones. These comprise of IKEA, Old Mutual, Encyclopaedia Britannica, Dell,
Wal-Mart, Amazon.com, e-Bay, Quicken, Microsoft, Xerox, Sony, Canon,
Holcim, BP, GE, BRL Hardy, Kuoni Business Travel International, Unisys
Switzerland, and Skandia Insurance.
Our focus was on strategy taking in today’s rapidly changing, highly
competitive business environment. The issue of the red queen effect and theneed for companies to adapt their business model to change industry rules
emerged from our research as the decisive factor on the edge of companies’
success and failure.

22

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