Start-up Strategy: To Change the Game, Change the Economics of How It's Played

(photo: laffy4k)

Several weeks ago, I found myself in the passenger seat of a car going nowhere fast.

My friend, Peter Sims, who had earlier introduced me to the Stanford D.School, was leading the charge into the unknown, hurtling us (hopefully) towards dinner in exotic Burlingame, where people from SF and Palo Alto compromise to break bread.

The “us” included Alan M. Webber, whom I’d never met. He sat behind me, and — as getting lost tends to promote — we ended up talking about nothing in particular and everything in general: publishing, the game of business, Mr. T, you name it. I didn’t know Alan, but it soon became clear that I should listen as much as possible.

Alan was co-founder of Fast Company magazine and former editorial director of the Harvard Business Review.

More specifically related to this post, Alan developed a very interesting habit more than 20 years ago, when he began to carry a supply of 3 x 5 index cards wherever life took him. He wrote down and collected the lessons and insights he gleaned from his experiences travelling the world and in his interactions with people ranging from CEOs and spiritual leaders to basketball coaches, novelists, and stars from dozens of other worlds…

His new book, Rules of Thumb, is a collection of 52 truths he’s culled from these notes specifically related to winning in business. I asked him if I could have an exclusive excerpt, and he graciously agreed.

Here is Rule #24, one of my favorites.

RULE #24 – If you want to change the game, change the economics of how the game is played.

Say what you will about the Grateful Dead, in my book Jerry Garcia was one smart businessperson. Here’s a guitarist who was missing a piece of a finger, played in several other bands besides his own, found time to sell paintings, had a line of neckties with his name on them, and even got an ice cream flavor named after him. He also articulated a competitive strategy for the Grateful Dead that put him at the top of my list of management gurus: “You do not merely want to be considered just the best of the best. You want to be considered the only ones who do what you do.”

The Grateful Dead principle of “being the only ones who do what you do” is what I decided to borrow when it came to devising Fast Company’s Web strategy. If you’ve ever been to a standard rock concert, you’ve heard the announcement they all make before the show: “No photography, no recording, enjoy the show.”

Except for the Grateful Dead. They had a different theory of the economics, which led to a different business model, which led to a different announcement before the show: “Tape all you want! Make all the bootlegs you want, trade them, swap them, sell them to each other.”

Their fans enthusiastically complied, creating one of the earliest versions of a social network focused on live bootlegs of their favorite band. Did the band object? Not at all. Because they knew the more traffic their fans created—even if they didn’t get a penny from it directly—the more tickets, T-shirts, stickers, CDs, and other Grateful Dead paraphernalia they would eventually sell. Give away the bootlegs, charge for everything else. By the way, it worked: the year Jerry Garcia died, the Grateful Dead was the highest-grossing rock-and-roll band in the United States.

Of course, Jerry Garcia wasn’t the first to change the economics of his industry this way. Cyrus McCormick did it with the reaper business in the 1840s.

McCormick is remembered for patenting a reaper in 1843—but that wasn’t his real innovation. McCormick had quite a few competitors, but at the beginning nobody was selling any reapers, including McCormick. The problem was farmers couldn’t afford the machines. So McCormick changed the economics: he invented an installment plan that let farmers buy his reaper and use the savings the machine produced to pay him back over a three-year period.

Once you start to look you’ll find companies in every industry that have changed the economics to change the game: from razors to cameras, computers to airlines, magazines to nonprofits. Companies that start by redesigning the economics of an industry often finish by redesigning the whole industry—and owning it.

So What?

The game today is all about changing the game. Competing head-to-head on products and services is table stakes. Innovators are looking for a new business model that will destabilize their rivals and produce a breakthrough opportunity. In fact, in a recent survey of top-level executives in established companies IBM found that the biggest shared concern is that somewhere in the world—in a garage or a dorm room— someone is coming up with a new business model that will overthrow their established way of doing business.

How do you do it?

Start by analyzing the status quo. What’s the standard economic model the industry uses today? When you pull it apart, how does it work? What are the assumptions that it’s based on? How and why has it become the industry standard? Take a look at it from the point of view of the customer. Exactly what is the customer paying for? And where does the business make its real money? Go back to Business School 101 and ask the fundamental question: what business are you really in?

After you’ve analyzed the standard business model, take a look outside your own industry. You may be able to learn some new tricks—or at least borrow some inspiration. What would Craigslist founder Craig Newmark do to your industry? What would happen if the whole business moved to the Web? If things that customers paid for now became free? Free, as the saying goes, is a pretty good price. What if you did a King Gillette and gave away the razor? What could you charge for? Take it one more step: are you hurting your business by charging for something you should give away free? (As daily newspapers watch their circulation numbers decline, some critics argue it would make more sense to give the papers away for free.)

After you’ve looked at the economics from inside the industry and from other industries, try looking at new platforms. Can you imagine new revenue streams that reflect changes going on in customer habits, customer experiences, or customer loyalty? Is emerging technology opening up new ways of connecting—or making customers pine for the good old days when things weren’t so high-tech? Don’t forget, everyone agreed that retail outlets were dead and all commerce was shifting to the Web. Then Steve Jobs opened up Apple stores with their Genius Bars. Counterintuitive can be a great economic model.

There are a lot of ways to reinvent an economic model. But most established companies are unwilling to do it because it would mean destabilizing their own operation.

Which is exactly what those innovators and entrepreneurs in the garages and dorm rooms are counting on.

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From Tim: I’ve included one of my other favorite rules — Rule #38: If you want to think big, start small (an interaction with Muhammad Yunus) — here on the experimental Tim Ferriss site. Rules of Thumb is now available at retail or through Amazon.

The Tim Ferriss Show is one of the most popular podcasts in the world with more than one billion downloads. It has been selected for "Best of Apple Podcasts" three times, it is often the #1 interview podcast across all of Apple Podcasts, and it's been ranked #1 out of 400,000+ podcasts on many occasions. To listen to any of the past episodes for free, check out this page.