Evolving Business Models: How CEOs Transform Traditional Companies

Management for Professionals

EvolvingBusinessModels

Christoph FranzThomas BiegerAndreas Herrmann Editors

How CEOs TransformTraditional Companies

Management for Professionals

More information about this series at http://www.springer.com/series/10101

Christoph Franz • Thomas Bieger •Andreas HerrmannEditors

Evolving Business ModelsHow CEOs Transform TraditionalCompanies

EditorsChristoph FranzRoche Holding LtdBasel, Switzerland

Thomas BiegerUniversity of St.GallenSt.Gallen, Switzerland

Andreas HerrmannInstitute of Customer InsightUniversity of St.GallenSt.Gallen, Switzerland

ISSN 2192-8096 ISSN 2192-810X (electronic)Management for ProfessionalsISBN 978-3-319-48937-7 ISBN 978-3-319-48938-4 (eBook)DOI 10.1007/978-3-319-48938-4

Library of Congress Control Number: 2017937747

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Contents

Introduction: Globalization and the Opening of New Markets . . . . . . . . 1

Thomas Bieger, Christoph Franz, and Andreas Herrmann

Transformation of Teaching and Research in a Globalized IT-Driven

World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Thomas Bieger

Banks Caught Between Regulation, Technical Progress,

and Profitability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Martin Blessing and Tobias Bange

Business Models in the Chemical Industry Amid a Changing

Competitive Landscape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Kurt Bock

Business Model Innovation: Some Key Success Factors at Bosch . . . . . . 61

Volkmar Denner

Environmental Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Jens-Uwe Fischer

Innovation for Health: Success Factors for the Research-Based

Pharmaceutical Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

Christoph Franz

Industry Expertise and Dynamic Challenges: Perspectives

of an Adopted Railwayman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

Rüdiger Grube

The Airline Industry: Flying on Its Own Is not Enough . . . . . . . . . . . . . 125

Harry Hohmeister

From Data to Business: A Paradigm Shift in Industry . . . . . . . . . . . . . . 141

Joe Kaeser

Engineering the Intangible: Strategic Success Factors in the Luxury

Watch Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

Georges A. Kern

v

Industry Expertise in the Digital Media Industry: Specialization vs.

Disruption of Online Business Models . . . . . . . . . . . . . . . . . . . . . . . . . . 181

Clemens Trautmann

Royal Dutch Shell in a Changing World: Navigating Uncertainty . . . . . 195

Ben van Beurden

Into the Future on the Digital Highway . . . . . . . . . . . . . . . . . . . . . . . . . 209

Dieter Zetsche

vi Contents

About the Authors

Tobias Bange Vice-President, Commerzbank AG, born

in 1960, studied German and sociology in Frankfurt. From

1989 to 1999, he worked as an independent filmmaker for

Hessischer Rundfunk and other public broadcasters. In

1999, he moved to Dresdner Bank and subsequently to

Commerzbank. From 2009 to 2013, he also played an active

role in the staff unit of the Government Commission Ger-

man Corporate Governance Code. Since 2008, he has

worked in the Public Affairs/Issue Management Department

of Commerzbank where his areas of responsibility include

issues relating to financial market regulation.

Thomas Bieger Prof. Dr. rer. pol., Full Professor of

Management with a special focus on the Tourist Industry,

President of the University of St.Gallen and Director of the

Institute for Systemic Management and Public Governance

at the University of St.Gallen (IMP-HSG). Thomas Bieger

has published, conducted research, worked in consultancy

and taught at various universities (among them the Univer-

sity of Innsbruck, the Vienna University of Economics and

Business, the Universita della Svizzera italiana in Lugano

and the University of Otago), with a special focus on service

management and network management, as well as desti-

nation management and location management. He served

as Chairman of CEMS (The global alliance in Management

education) from 2010–2014. Currently he is President of the

Chamber of the Swiss university presidents in within

swissuniversities.

vii

Martin Blessing President Personal and Corporate

Banking and President UBS Switzerland, UBS Group AG

and former Chairman of the Board of Managing Directors,

Commerzbank AG, was born in 1963; he studied business

administration in Frankfurt and St.Gallen. From 1989 to

1996, he worked for the management consultants McKinsey

for the last two years as a partner. From 2000 to 2001,

Blessing was Chairman of the Board of the direct bank

Advance Bank which at that time was part of Dresdner

Bank. On 1 November 2001, he became a member of and,

in 2008, Chairman of the Board of Managing Directors. On

7 May 2009, he was appointed Chairman of the Bank’s

Board of Managing Directors by the Supervisory Board of

Commerzbank.

Kurt Bock is Chairman of the Board of Executive

Directors of BASF SE, a position he assumed in May 2011.

Bock is currently responsible for Legal, Taxes and Insurance,

Strategic Planning and Controlling, Communications and

Government Relations, Global Executive Human Resources,

Investor Relations and Compliance. From 2003 until 2011, he

was Chief Financial Officer of BASF SE, and during that

time, from 2007, he was also Chairman and Chief Executive

Officer of BASF Corporation, based in the USA.

In 1985, Bock started his career with BASF in finance.

From 1992 until 1998, he held several management positions in

Germany and Brazil for the automotive supplier and electronics

company Robert Bosch. Bock returned to BASF in 1998.

Kurt Bock was born in Rahden, Eastern Westphalia,

Germany, in 1958. From 1977, he studied Business Admin-

istration at the Universities of Münster and Cologne as well as at Pennsylvania State University,

USA, and received his diploma in 1982 from the University of Cologne. In 1985, he earned his

doctorate in Economics from the University of Bonn. Kurt Bock is married and has three children.

Volkmar Denner has been chairman of the board of

management of Robert Bosch GmbH and a shareholder of

Robert Bosch Industrietreuhand KG since 1 July 2012. His

responsibilities include corporate strategy, corporate com-

munications and real estate and facilities. As chief tech-

nology officer, he also has corporate responsibility for

research and advance engineering, technology coordination

and new business areas. ln addition, he is responsible for the

subsidiaries Bosch Software Innovations GmbH and Bosch

Healthcare Solutions GmbH.

Born in Uhingen, Germany, on 30 November 1956,

Volkmar Denner is married and has three children. After

taking his university entrance examination in 1975, he stud-

ied physics at the University of Stuttgart, graduating in 1981.

After a research stay in the USA, he completed a doctorate in

physics (Dr. rer. nat.) at the University of Stuttgart in 1985.

viii About the Authors

He is a member of the managing board of the VDA (German Association of the Automotive

lndustry), a member of the executive board of BBUG (Baden-Baden Entrepreneur Talks) and the

chair of the Association of Friends of the University of Stuttgart.

Jens-Uwe Fischer studied metallurgy at the Technical

University Berlin (TU) and Economic Science at the Tech-

nical School Berlin (TFH). After working for 5 years as a

scientific assistant at the Institute of metallurgy TU Berlin,

he functioned in 1984 as the project manager of the German

Agency Technical Cooperation (GTZ) at the Technical

University Istanbul (ITU). In 1988, he received a Doctorate

in Metallurgy at in the Technical University Berlin. Since

1989, he worked as the general manager of the Group Berlin

Steelworks GmbH. In 1992, he was employed as the head of

the Department Business Development ABB Flakt Group

GmbH and appointed as the deputy environmental officer

ABB Germany and later as head of the PC paint application

of the ABB Flexible Automation GmbH. In 1995, he was

employed in the German Railway Association (Deutsche

Bahn AG) as the manager of Soil Remediation Department

and since 1997 as the head of the brownfield recycling management department till 2013. In the

year 2000, he was appointed as an honorary professor at the University Leipzig in the Economic

Science Faculty—Institute for Infrastructure and Resources Management—with the subject inte-

grative brownfield recycling management. Since 2013, he held several advisory positions as senior

expert for example as the chairman of the advisory board and as member of the executive board of

the ITVA (Engineering-Technical Society for contaminated Sites and brownfield recycling) and

since 2016 chairman of the advisory board immobilien-experten AG.

He is a member of the National Academy of Science and Engineering (acatech) and as well a

member of the soil protection Commission of the Federal Environment Agency (UBA).

Christoph Franz was born in Frankfurt am Main,

Germany, in 1960. After graduating from Darmstadt Tech-

nical University and the Ecole Centrale de Lyon in Indus-

trial Engineering, he earned his PhD in Political Science

from Darmstadt Technical University and worked as a post-

doc at the University of California, Berkeley.

Franz started his career at Lufthansa AG in 1990 and

joined Deutsche Bahn AG in 1994, where he was appointed

a Member of the Executive Board and CEO of the Passenger

Transport Division. He was then appointed CEO of Swiss

International Air Lines AG in 2004 and was later promoted

to CEO of Lufthansa Airlines in 2009. From 2011 to 2014,

Christoph Franz was the CEO of Deutsche Lufthansa

AG. He has served as the Chairman of the Board of Directors of Roche Holding AG since

4 March 2014. Further mandates include the boards of Stadler Rail AG and Zurich Insurance

Company Ltd. He is a Member of the Board of Trustees of Ernst G€ohner Foundation and of the

Advisory Board of the University of St.Gallen (HSG). Christoph Franz is married and a father of

five children.

About the Authors ix

R€udiger Grube Before joining Deutsche Bahn,

Dr. Rüdiger Grube had been a member of the Board of

Management of Daimler AG since 1 October 2001, where

he was responsible for Corporate Development including

Corporate Strategy, Mergers and Acquisitions, Industrial

Participations and IT; from 1 October 2004, he also oversaw

all of Daimler AG’s activities in North East Asia (including

the growing Chinese market). In addition, he served as

Chairman of the Board of Directors of the European Aero-

nautic Defence and Space Company (EADS N.V.).

Born in Hamburg on 2 August 1951, Dr. Rüdiger Grubecompleted his commercial and technical training in metal

aircraft construction and went on to gain a degree in automotive engineering and aircraft

construction from the University of Applied Sciences in Hamburg. He later studied vocational

and business teaching at the University of Hamburg. He lectured production and engineering at

the University of Hamburg from 1981 to 1986. Having gained his doctorate in the areas of

industrial science and polytechnology at the Universities of Hamburg and Kassel in 1986, he

went on to join Messerschmitt-B€olkow-Blohm GmbH (later Daimler-Benz Aerospace or DASA

in 1989).

Andreas Herrmann Prof. Dr. rer. pol., is Full Profes-

sor of Management with a focus on Customer Insight and

Director of the Institute for Customer Insight at the Univer-

sity of St.Gallen (ICI-HSG). Andreas Herrmann has

published on product and price management, on market

research topics, and on branding issues. He has directed

many projects in collaboration with collegues at MIT,

Columbia University, and Stanford University. Beyond his

academic work, he is very much involved in consulting

mainly for the automotive industry.

Harry Hohmeister is a member of the Lufthansa

Group Executive Board, where he is in charge of Hub

Management since January 2016. He was Chief Executive

Officer of Swiss International Air Lines from 2009 until

2015. Hohmeister has over 25 years of experience in the

airline industry. Having trained to become a commercial air

transport officer, Hohmeister joined Deutsche Lufthansa in

1988, where he held various positions and became Vice

President Planning with responsibility for the entire

Lufthansa network in 1996. In 2000, he joined Thomas

Cook Airlines, for whom he held various executive manage-

ment functions in Germany and the UK over the next

5 years. He came to SWISS in 2005, initially as a Member

of the Management Board and Head of Network.

x About the Authors

Joe Kaeser is President and Chief Executive Officer of

Siemens AG. He has over 30 years of experience at Sie-

mens, where he has held a variety of top management

positions in finance and strategy both inside and outside

Germany. Joe Kaeser began his career at Siemens in 1980

in the field of components and semiconductors. In 1999, he

joined the Corporate Finance Department. In 2001, he was

appointed Chief Financial Officer of the Information and

Communication Mobile Group. From 2004 to 2006, he

served as Siemens’ Chief Strategy Officer. Prior to his

appointment as CEO in August 2013, he was the company’s

Chief Financial Officer for 7 years.

Georges A. Kern grew up in Germany and France. He

studied Political Science in Strasbourg, France, and subse-

quently obtained a degree in Business Administration from

the University of St.Gallen, Switzerland. He acquired his

first professional experience in the fast-moving consumer

goods sector at Kraft Foods Switzerland before joining the

Swiss watch industry at TAG Heuer (LVMH group).

In 2000, he joined the Switzerland-based luxury goods

group Richemont, and following the acquisition of A. Lange

& S€ohne, Jaeger-LeCoultre and IWC, he was active in the

integration of these brands into the company. In 2002, at the

age of 36, he became the youngest CEO within Richemont

when he joined IWC Schaffhausen. In 2017, he was

appointed Head of Watchmaking, Marketing and Digital at

Richemont.

Kern is also committed to charitable causes, serving as a member of the Board of Trustees of

the Laureus Foundation Switzerland, which promotes the use of sport as a tool for social change.

He is also a Founding Curator of the Global Shapers Community in Zurich.

Clemens Trautmann (born 1977 in Braunschweig)

has been President and CEO of Deutsche Grammophon

GmbH, part of Universal Music Group, since December

2015. He previously held various executive roles at Axel

Springer SE, most recently as Chief of Staff to Chairman

and CEO Dr. Mathias D€opfner, as well as Managing Direc-

tor and CFO of its online property portal, Immonet. In these

roles, he was responsible for a variety of strategic projects

focusing, for example, on digital transformation, new busi-

ness development, corporate acquisitions, innovative man-

agement methods and organisational culture. Clemens

Trautmann earned his doctorate in law while simultaneously

studying music, including at The Juilliard School,

New York. As a member of a European working group on intellectual property, he served on

the research staff of the Max Planck Institute for Comparative and International Private Law. He

has given solo and chamber music performances, for example, at Lincoln Center’s ‘Mostly Mozart

Festival’ and at the Berlin Philharmonic Hall in the ‘Debut on Deutschlandradio’ series and has

been awarded prizes by the Schleswig-Holstein Music Festival and the German Music Council.

About the Authors xi

Ben van Beurden became Chief Executive Officer of

Royal Dutch Shell plc in January 2014. He joined Shell in

1983, after graduating with a Master’s degree in Chemical

Engineering from Delft University of Technology in the

Netherlands.

Van Beurden’s career at Shell spans both the upstream

and downstream businesses. In January 2005, he became

Vice President, Manufacturing Excellence, based in

Houston, USA. In this role, he was responsible for oper-

ational excellence and initiatives in refining and chemicals

manufacturing.

In December 2006, Van Beurden was appointed Ex-

ecutive Vice President, Chemicals, based in London,

UK. During this time, he was appointed to the boards of a

number of leading industry associations including the International Council of Chemicals Associ-

ation and the European Chemical Industry Council.

In 2013, Van Beurden became Downstream Director and a member of the Executive Commit-

tee, with regional responsibility for Europe and Turkey.

Dieter Zetsche has been a member of the Board of

Management of Daimler AG since 16 December 1998 and

Chairman of the Board of Management of Daimler AG

since 1 January 2006. He is also Head of Mercedes-Benz

Cars. Prior to this, he held various positions in the company,

including President of Mercedes-Benz Argentina (1989),

President of Freightliner Corp. (1991), Member of the

Board of Management with responsibility for Commercial

Vehicles (1999) and CEO of the Chrysler Group (2000).

Dr. Dieter Zetsche was born in Istanbul, Turkey, on

5 May 1953. After attending school in Frankfurt, he studied

electrical engineering from 1971 to 1976 at the University

of Karlsruhe and graduated as an engineer. He joined the

research department of what was then Daimler-Benz AG in

1976. Dr. Zetsche completed a doctorate in engineering in

1982 at the University of Paderborn.

xii About the Authors

Introduction: Globalizationand the Opening of New Markets

Thomas Bieger, Christoph Franz, and Andreas Herrmann

The “new normal” of negative interest rates in the financial markets, the techno-

logical revolution of Industry 4.0, and the transformation of traditional business

models through the pressure of new digital providers, such developments, which are

challenging all industries, occupy the pages of popular media and management

literature alike. Imagine that you as a young person in this environment had to settle

on a career or that you had to purchase consulting expertise for your organization,

for example, in strategy or management. In light of these generic challenges, there

is much to be said today for deciding in favor of a cross sector, functional career, or

skill set.

As a result of intensified change, industry borders generally seem to be

dissolving. Sectors are merging, and in the wake of business transformation and

business migration, new cross-industry business models are emerging. In academia,

we find a corresponding development in research and teaching away from the

classical industry focused business administration toward a stronger functional or

thematic approach (e.g., gender, governance).

The question is whether traditional sectors and industries are still relevant as

points of reference for the development of career competencies or as objects of

study in academics. How useful to corporate management is the guiding concept of

“sector or industry” in meeting the challenges of today? This book explores these

questions. In the process it takes the reader on a journey through various traditional

sectors, from classical industrial production sectors such as the automotive or

chemical industries through service sectors such as transport, the media, the

consumer goods industry, and the financial sector to research and knowledge

sectors such as the pharmaceutical sector and finally universities. The authors are

Top Executives, CEOs or chairpersons of leading international companies and

organizations whose own careers and professional expertise have been shaped by

various backgrounds. In the fashion of a travelogue, these contemporary witnesses

T. Bieger (*) • C. Franz • A. Herrmann

University of St.Gallen, St.Gallen, Switzerland

# Springer International Publishing AG 2017

C. Franz et al. (eds.), Evolving Business Models, Management for Professionals,

DOI 10.1007/978-3-319-48938-4_1

1

offer a fascinating picture of the transformation of industry sectors that provides

insight into management’s mental map within and between these sectors: The

transitions between the individual sector maps are open and have many common

points of reference and triangulation. Yet, differences in the type of maps, their size,

and other characteristics remain. Differences extend not only to terminology but

also to reference models and finally theoretical approaches.

Sectors and industries have served as a tool for structuring the economy since the

start of the division of labor. Historically, guilds represented industries or branches

and their interests. Today in a time when integrated solutions rather than purely

individual services and products are of increasing importance industries are auto-

matically overlapping and being redefined. The enhancement of traditional services

and products with digital elements—for example, refrigerators that automatically

reorder milk—is reinforcing this trend. In their selection of contributions for this

volume, therefore, the editors have considered sectors characterized not only by

their output but also by their particular industry-specific service provision processes

and their specific economics.

On their voyage of discovery through the various sectors, the editors conclude

that various contextual factors impact the navigation through and across the sectors.

In total, the journey leads through 13 different maps that display remarkable

similarities vis-a-vis their network of coordinates but also show differences in

perspectives and descriptive focus.

• Thomas Bieger, President of the University of St.Gallen—education and

research

• Martin Blessing, former Chairman of the Board of Managing Directors

and Tobias Bange, Vice-President, Commerzbank AG—banking

• Kurt Bock, Chairman of the Board of Executive Directors, BASF SE—chemical

industry

• Volkmar Denner, Chairman of the Board of Management, Robert Bosch

GmbH—automotive industry

• Jens-Uwe Fischer, Honorary Professor at the Institute for Infrastructure and

Resources Management, University of Leipzig—environmental management

• Christoph Franz, Chairman of the Board of Directors, Roche Holding

AG—pharmaceutical industry

• Rüdiger Grube, former Chairman of the Board, Deutsche Bahn AG—transportation

and logistics

• Harry Hohmeister, Member of the Lufthansa Group Executive Board—aviation

industry

• Joe Kaeser, President and Chief Executive Officer, Siemens AG—large-scale

industry

• Georges Kern, Head of Watchmaking, Marketing and Digital at

Richemont—luxury goods industry

• Clemens Trautmann, President and CEO, Deutsche Grammophon GmbH—

media industry

• Ben van Beurden, Chief Executive Officer, Royal Dutch Shell plc—

petrochemical industry

2 T. Bieger et al.

• Dieter Zetsche, Chairman of the Board of Management, Daimler AG—automo-

tive industry

Overall, ten findings can be identified:

1. The articles highlight the authors’ current views on various themes and chal-lenges affecting their respective industries. Remarkably, similar issues and chal-lenges are found across sectors, albeit with differing intensities. The articles canbe grouped by their various thematic dimensions, in particular by customergroup (B2C, B2B, B2G), by the importance of the drivers of change (global-ization, regulation, digitalization, other technological innovation stimuli), or,according to the classical sector breakdown, by the degree of tangibility of theservice (physical goods, services, integrated solutions, knowledge services).Since the articles could be grouped by conflicting criterias, they were arrangedin simple alphabetical order by author’s last name.

The banking sector, for example, especially the growing field of private banking,

is primarily a B2C business and as a service industry shows similarities to the avi-

ation industry, among others. However, banking is especially strongly affected by

the deregulation/reregulation wave and thus has commonalities with the rail sector.

In terms of tangibility, banking involves abstract products such as consulting ser-

vices in asset management or private banking, which share similarities with

research services. Identifying such structural features helps observers to discern

cross sector developments, and it facilitates cross sector learning (Fig. 1).

2. All sectors are in the midst of a rapid transformation, which is being driven byglobalization, digitalization, deregulation/reregulation, and advances in tech-nological and scientific innovation. However, the focus and emphasis of thesedriving forces vary depending on the sector (Fig. 2).

Customers

B2G

B2B

B2C

Physical goods

Services

Integrated solution

Tangibility

Knowledge service

Globali-zation

Regula-tion

Digitali-zation

Other sources ofinnovation

Drivers of change

Fig. 1 Possible approaches to structuring the sector chapters

Introduction: Globalization and the Opening of New Markets 3

A sector’s exposure to the various drivers of change or metatrends mainly

depends on the sector-specific service processes, their conditions, and their risks

for the economy and society. Even though Industry 4.0 or digitalization’s potential

is relevant to all branches, it is especially salient in sectors that generate large

volumes of performance-related data, such as research and industry, or in sectors

that produce much consumer-oriented data, such as health care. Deregulation and

reregulation are highly significant for sectors that were previously heavily

dominated by the state, such as education or transport, or where large economic

or societal risks are perceived, such as the financial sector in the wake of the 2007

financial crisis. Globalization mainly affects industries whose service processes are

internationally relocatable and where new production facilities are being opened,

such as in the chemical and aviation sectors. Other sectors such as the pharmaceu-

tical industry or self-driving cars in the automotive industry are being influenced by

paradigmatic advances in scientific innovation. Naturally, these metatrends mutu-

ally influence one another. Thus, for example, globalization generates the need for

new regulations, or digitalization is itself further driven by advances in scientific-

technological innovation.

3. Regulation compels internationally active companies to develop skills fordealing with different regulatory systems (multiregulation management).Digitalization is leading to new core functions on both the customer and serviceprovision sides. The question is how data can be exploited and how processeslinked to customers or products can be reorganized. Globalization is leading tonew distributions of value activities across the world.

a) RegulationDespite supranational organizations and trade agreements, considerable regu-

latory differences persist across countries. These stem from differences in the

bases of the judicial systems (Roman law, common law) and the various political

cultures (more conservative or liberal) in these countries. Deregulation and

Sectors Regulation Digitalization Globalization Scientific/technological innovation

Education and research x x

Banking x x

Chemical industry x

Media and Internet x x

Automotive industry suppliers x x

Environmental management x

Pharmaceutical industry x x

Large-scale industry x x

Aviation industry x x

Transportation and logistics x x

Luxury goods industry x

Petrochemical industry x x

Automotive industry x x

Fig. 2 Perceived emphases of the transformation’s driving forces

4 T. Bieger et al.

reregulation processes overlap. This is partly because new markets are always

being opened as a reaction to tighter state budgets and to ensure efficiency, as is

happening in the education and transport sectors. Conversely, some areas are

being more strictly regulated to advance societal interests and to reduce negative

externalities. Reregulation is redefining conditions of competition and market

rules. This is creating an interesting convergence: Services once performed by

the state are being increasingly controlled by competitive elements. For exam-

ple, markets such as the electricity market are being liberalized, and services

such as security or even prisons are being opened to private operators. Con-

versely, traditionally private service areas such as finance or continuing educa-

tion are being increasingly regulated by the state. This is resulting in a tendency

toward the “middle.” More and more, management is moving between pure

market logic and a political-governmental administrative logic. Firms’ profit-

ability is increasingly being determined by the clever use of existing regulations

and to influence the crafting of future ones.

b) DigitalizationUnder the term Industry 4.0, digitalization is enabling the reconfiguration of

value chains. The Internet of Things is enabling the realization of streamlined

order processes. The management of production processes is becoming practi-

cally seamless, and robotics is also making it more independent of human

involvement. But digitalization also affects the customer interface. An ever

larger proportion of human activities are leaving traces on the Internet. Big

data systems allow to monitor customer behavior, to analyze it, and even to

anticipate it by calculating probabilities of occurrence of patterns, which is

revolutionizing marketing. Customers can also bundle services according to

their individual preferences. The transport sector offers an illustrative example.

Transport modes can be independently mixed, switching between public trans-

portation and self-driving cars on demand.

Similar customer and service side effects of digitalization can be observed in

various sectors. In health care, diagnostic systems can be combined with infor-

mation systems for patients, thanks to inexpensive sensors. In the financial

sector, new payment systems, uncoupled from cash and thus freed from physical

transactions, are offering customers greater flexibility and lower transaction

costs. This enables optimized capacity utilization of hardware ranging from

automobiles to car parks, as well as warehouses and manufacturing facilities

in traditional production, while sharing models also allow more widespread

usage. Investments will thus also increasingly shift from hardware to software

or processes. The systematic identification of the beneficial, value-adding poten-

tial of digitalization is by this becoming a success factor in practically all

sectors.

c) GlobalizationThe creation of new markets in the framework of regulation and deregulation,

combined with digitalization, is expanding the potential for the reconfiguration


of value chains. For more and more individual elements of value chains global

markets emerge. For example, in research, services such as a literature review

can be tendered on the global market and procured through “crowdsourcing.”In

nearly all sectors, the increasing potential to separate and globalize value chains

heightens the potential, as well as the pressure, to globally reconfigure value

activities (Fig. 3).

4. As a result, traditional value chains are being reconfigured. On the productionside, cost and quality pressures are driving a focus on the use of technologiessuch as small batch (robotic) manufacturing and 3D printing. On the deliveryside, digitalization and the associated combination of physical and otherservices open up the possibility of integrating to meet customer needs. Therehas been a development away from deterministic “linear” value chains towardpartly situational and flexible value networks. The interdependence of firms andsectors is thus increasing.

The development toward value networks is leading individual production pro-

cesses with high scalability, for example the manufacture of chemicals, to be

consolidated and globally concentrated into a few centers. Conversely, new

technologies are allowing decentralized production directly at customers’ locations.

Just as with microbreweries previously, 3D printing is emerging as a new technol-

ogy for decentralized production example of spare parts. In such sectors as trans-

port, health care, and increasingly finance, integrators on the consumer side such as

IT platforms in the form of apps are enabling a situational, customer-side integra-

tion of part services into solutions. This concentration of the production of scalable

elements of the value chain the production side and the integration of services on

Fig. 3 Reconfiguration of value chains in global value networks

6 T. Bieger et al.

the customer side is associated with new business relationships across company and

industry boundaries. This reconfiguration of value creation remains the dominant

engine of change for business models. Consequently, knowledge and development

networks too are becoming more open.

5. The reconfiguration of value creation is not only leading to the transformation ofindustry business models and the sectors and industries themselves. Industryboundaries are shifting in the process of business migration (e.g., betweenpure transport and facilitating transport services). However, central valuechain elements (e.g., operation of rail networks, transformation of chemicals)or categories of customer benefit (e.g., health, education) have remained intact,and these still determine the core of industries. On the production side, cleareconomies exist (e.g., “economies of scale” in the chemical sector, “networkeconomies” in transport, and “economies of innovation” effects in technology).Around this core of industries, new business models with new revenuemechanisms are emerging.

New business models are emerging in particular in connection with transaction

platforms such as Airbnb or Amazon and other social media platforms like

LinkedIn that focus on careers and personal profiles. Because of the data they

generate and their networks, such platforms have the potential to develop to new

and powerful players in and across industries like career platform thus develop to

recruitment agencies and thus to compete with traditional headhunting or to become

transaction sites for continuing education that compete with training providers.

They may even provide salary comparisons and consulting, areas of activity

previously associated with traditional sectors.

Along with these new cross sector business models, new revenue mechanisms

are also emerging. When customers freely combine diagnoses and therapies or

transport networks, transparency and a results orientation ensue. This allows a shift

in value capturing from charging the cost of individual performance elements to a

customer value based perspective and by this a move in pricing from an input and

cost orientation to a results or success orientation. Transaction platforms likewise

enable service comparisons, for example, in the sourcing of research services. This

further increases the pressure on costs and utilization of economies.

The core of industry expertise therefore always has been and will be understand-

ing the needs of the customers, and/or the expertise in specific provision processes.

For example, in the automotive sector, passenger compartments can and have to be

designed around customers’ needs; in the chemical sector, production can be

optimized in form of capacity utilization.

6. The proper blend of general management competence and industry expertisedepends on the challenges a sector or firm is currently facing. Industry expertisetends to be more important the higher the cost and efficiency pressure, sector-specific regulation, or dependence on sector-specific fixed assets.


The transformation of business models across industry boundaries is creating the

need for “hybrid” management skills. On the one hand, industry expertise is neces-

sary for a specific customer orientation and for the “core,” the value chain element,

which is still rooted in the industry. Thus, specialized knowledge and solidly based

management experience in the respective industry is needed. For example, engi-

neering expertise is necessary in the insurance sector for the evaluation and

assessment of risks, and rail-specific operational know-how is required in the

railway sector. Running an expert organization too, for example, directing a

university, requires the manager to be rooted in the respective core sector, not

least to ensure the staff’s acceptance of his or her leadership. Nevertheless, in terms

of value networks, this expertise must be combined with general management

competence or expertise in additional sectors. For instance, IT skills are necessary

to transform a railway company into an integrated transport service enterprise. In

the future, corporate management teams may thus become more diverse in terms of

their industry backgrounds.

7. In the future, the challenge for management—and for governance—will includemore than just sensibly combining general management competence with indus-try expertise. It will also involve meaningfully shaping the transformation ofbusiness models and thus, within the same company, contending with the contra-dictions inherent in partly diverging business models and ultimately multipleindustry logics as well. This is especially so since the impetus for innovationfrequently originates externally, in other companies or other industries.

Industries also tend to distinguish themselves from one another culturally.

Examples include industry symbols (traditionally saints such as St. Barbara in

mining) or distinctive professional title structures as in universities. Specific termi-

nology and schools of thought also emerge from industries. This development is

reinforced by sector-specific continuing education programs. The advantages of

these industry cultures should not be viewed solely in the context of the evolution of

industry expertise and a focus on the economies involved in that sector’s value

creation. Affiliation with an industry also provides workers with an orientation and

a sense of meaning. For many, their industry also is an important source of identity.

Yet, in the context of newly structured, cross-industry value creation systems

and business models, the impetus for continued development and innovation in the

form of push effects (competition) or pull effects (e.g., new technological

possibilities) often arises from external sources, even ones outside the specific

sector. Balancing between concentrated sector rationality and permitting or partly

even enforcing the opening of structures represent a tightrope act for management.

Linking production culture in the industry with a digital design culture that has

entirely different quality requirements—and fault tolerance—is just as challenging

as combining traditional banking with e-banking. The process of transforming

business models is thus also to be understood in the proper sense as supporting

and shaping cultural projects. It requires management to contend with various

conflicting rationalities.

8 T. Bieger et al.

8. (Consolidated) industries are always dominated by large companies. The authorsof this book thus represent large companies, some of which are global leaders intheir industries. All are being confronted with the fundamental question ofhow they as incumbents should shape the transformation, which again requiresdealing with such contradictions as change and stabilize.

The authors of this book represent companies, which command significant

market shares in their respective industries. Large, established companies in the

classical sectors, so-called incumbents, use various means to integrate newcomers.

These range from the purchase of technology firms and their gradual integration

(as in the pharmaceutical industry), the development of innovation networks for

innovative teaching methods in universities, to the establishment of disruptive pilot

departments with innovative content within the companies themselves. In this

sense, the reconfiguration of value chains always raises the question of

reconfiguring the company and ensuring synergies across business units.

9. Corporate management in classical industries thus needs to be capable ofcontinuously and incrementally advancing the capacities and potential of thecompany creatively and with value orientation. At the same time, it must be ableto recognize disruptive changes (e.g., challenges by newcomers such as Airbnbin the hotel industry) and to assess their long-term effect and if promisingleapfrog and adapt to them in a revolution style.

If management puts too much emphasis on innovative trends, it runs the risk of

causing fragmentation into a multitude of ever-changing initiatives. Companies’

need to identify relevant “metatrends” with long-term influence on the sector and

adopt to them without loss of core competencies their industry. Examples include

the automotive sector or the transport sector as a whole, where new digital offerings

and new forms of coordination or information are arising in rapid succession.

10. The basic contradiction is between further optimizing existing business modelsand potentials, which continue to sustain companies, and on the other handvigorously implementing innovations. Navigating this contradiction representsa particular challenge for corporate management. Orientation (where does thepath lead through which stages, how to understand inconsistencies), sense-making (why must I/my department work on this now), and the formation ofculture (how can tradition and innovation be culturally shaped) are all crucialto winning the support of employees and other stakeholders such as investorson the path to new business models.

Overall, navigating contradictions or managing ambiguities constitutes a par-

ticular challenge for management in the age of digitalization. How can the virtues

of the traditional high standards of quality and reliability be preserved while


simultaneously maintaining openness to and experiencing with new digital

solutions from the Internet of Things? How can companies further develop tradi-

tional vehicles, while at the same time and in the same organization they are

developing new transport solutions with the cooperation of partners from

completely different industries? Such percieved contradictions must be addressed

and made transparent to employees, shareholders, and the public. Only thus can we

ensure proper orientation in times of change. This is absolutely necessary if the

transformation is to be achieved with the cooperation of employees and

stakeholders.

10 T. Bieger et al.

Transformation of Teaching and Researchin a Globalized IT-Driven World

From State-Dominated Hierarchical Structuresto Public-Private Open Network Approaches

Thomas Bieger

1 Chapter 1: Teaching and Research (The TraditionalParadigm as a Starting Point)

The focus of this contribution is on teaching and research, in particular their

symbiosis in research-based learning at universities. By this it deals with the function

of “teaching and research” in a specific “industry,” the university sector. The

university sector is very broad and includes different types of universities—rather

applied and college type of institutions of rather regional rank but also institutions

focusing on fundamental research with a global reach. This sector includes roughly

16,500 institutions worldwide, of which just the top 500 appear in the rankings (see

Rauhvargers 2011), and is fast growing in size as well as scope.

Teaching and research are activities that by their very nature allow people to

advance into new areas and to tread what is at least for them terra incognita and by

this constitute real experiences (for the definition and concept of experiences, seeSchulze 2005). For this reason, teaching and learning, as well as research, are not

just cognitive but also emotional and thus run deeper than other general or knowl-

edge services. Mental images of how one experienced teaching and learning, how

one achieved first research results as a young researcher and experienced discovery

and understanding, are thus formative for life.

In nearly all cases, at least those with complex content, research and teaching

require an interaction between various actors: students, teachers, or research

partners, as well as infrastructure providers or consumers and users of research

results. Teaching and research thus entail an extraordinary, interdependent system

of service provision. In addition, research activities usually produce open output and

operate in open systems. These features, the creativity required for research activities

as well as the particularity and number of the participants involved, mean that

T. Bieger (*)

University of St.Gallen, St.Gallen, Switzerland



DOI 10.1007/978-3-319-48938-4_2

11

research can only to a limited extent be actively managed as a discrete process to a

limited extent. This is in stark contrast to many other service processes, which can be

centrally managed and optimized as service chains.

Teaching and research can therefore be modeled and described with the help of a

systems approach (for activity systems, or generally for systems approaches using

the example of tourism, see Bieger (2010)). There is a debate within management

research over whether a high interdependence tends to lead to inertia in adapting to

new environmental conditions or whether this mutual dependence helps facilitate

an incremental adjustment process. In investigating this question, it is important to

find a suitable interplay between structures on the one hand and rules governing

cooperation on the other hand (cf. the discussion in Albert et al. 2014).

The traditional system of teaching and research, as most people likely still

remember it, can be viewed as rather hierarchically structured and molded by the

state. A lecturer, most prominently the full professor in Latin often called Amplis-simus, structures learning processes and mostly selects and processes the knowl-

edge he or she then transmits. Research processes are similarly organized: a senior

researcher structures a research project into research questions and coordinates the

knowledge gained. Humboldt’s model of academic chairs—still primarily domi-

nant in German-speaking Europe—perfectly captures this world (cf., e.g.,

Backhaus 2015). The full professor holds a chair, and, as still commonly provided

for in university bylaws, he or she heads a sub discipline at a university in teaching

and research. The system moved toward a “fragmentation” into a myriad of

subdisciplines (cf. Herrigel, p. 13, in Thoma 2012), driven not least by the full

professors who could thereby stake their claim in the demarcated disciplines. In

this hierarchy, the lecturers’, associate, adjunct and assistant professors are

hierarchically subordinate to the full professors, and under them are the assistants

and doctoral students.

In these classical scientific networks, the professors exchanged their findings

among each other. They were the real “hubs” of scientific work. Between these

hubs, implicit hierarchies were again established within the research themes and

cultural areas. In each country or language area, each discipline had its clearly

dominant researcher, whose findings would serve as a guideline for the others

and whom they would accordingly cite. Qualifying as a postdoc under these

prominent researchers increased the chances of being appointed as a full professor,

since these leading researchers were often members of advisory committees at

other universities. The full professors were (and still are) granted lifetime employ-

ment with the idea of thereby securing their academic independence and enabling

long-term-oriented research perspectives.

In this system, the owner and founder of the educational and research institutions

was the state. This had a threefold aim, first to keep access to the educational insti-

tution open to broad segments of the population through governmental access rule

and subsidies, second to keep teaching and research independent from private

money and interests to guarantee academic freedom, and third to also effectively

support the research disciplines and profit from the knowledge they generated. This

12 T. Bieger

was a dominant model in particular from the advent of the nation-state until the end

of the Cold War. Nation-states needed access to knowledge, for example, for the

development of their national infrastructure such as railway networks or the further

development of their institutional systems like school and legal system. This they

secured through the establishment of full universities since Bologna in the eleventh

century and specialized universities, such as the institutes of technology around the

middle of the nineteenth century. In Switzerland, for example, the Swiss Federal

Institute of Technology (ETH) played this role. Subsequently, at the end of that

century, business schools and universities of economics and social sciences were

founded, in Switzerland the University of St.Gallen (HSG).

Historically, public research funding of a wealth of large research areas—today

many of them classified as purely private sector research areas—was vital and

should not be underestimated. The emergence of the World Wide Web as well as

Silicon Valley as the cradle of the IT industry can so be traced back to the large

public (defense) research programs during the Cold War (see Lanz 2015). The

dominance of the state leads to various additional by-products such as reverse

selection in the admission process, by which public schools, for example, the

high school/gymnasium through the administration of the university qualifying

exam, had the power to decide who could enter the next level of education. The

universities, led by the same state, had to accept successful graduates of these

gymnasiums accordingly.

The emergence of typical research careers and life paths at universities can also

be largely attributed to public regulation of the sector. The career path from under-

graduate to master’s and doctoral student, postdoc, and habilitation through to

tenured professorship is a typical expression of this. Lifelong employment of

even nonprofessorial teaching staff, for example, “academic councils,” reflects

the influence of the governmental civil service.

The hierarchical structure of the activity system “research and teaching” (see

Fig. 1) clearly also contributed to important successes in a very specific contextual

environment:

• In the period of the nation-state’s dominance, the state was in the best position to

finance critical research budgets. This was particularly the case with the growth

of the public spending ratio in nearly all industrialized countries after WWI until

the end of the Cold War in 1990.

• In a period of technologies which just allowed point-to-point communication

using letters, telephones, or physical printed matter, communication between

system heads, like full professors as hubs, was often the only way to diffuse ideas

and findings over national and system boundaries.

• In a time of complex access to knowledge with limited space at universities and

labor-intensive search processes in physical card catalogs in libraries, it made

sense for the best informed people to select, process, and transmit knowledge.

The question is, to what extent has the environment changed and with it the

conditions for teaching and research? And to what extent does the activity system of

Transformation of Teaching and Research in a Globalized IT-Driven World 13

teaching and research have to adapt, to this new environment? And is it capable to

adopt?

2 Chapter 2: Changes in the Environment (Driversof a Transformation)

The St.Gallen Management Model conceives the environment/the context of an

organization as a resource space of options (cf. Rüegg-Stürm and Grand 2015). For

each organization or function, resources must be optimally configured to become

strategic success factors. A firm’s environment includes the natural, social, techno-

logical, and economic environment. Changes in these areas require a reorientation

to new strategic success factors and a reconfiguration of value-creation processes.

For teaching and research, the following developments are especially important:

1. Technological development: In the first phase from the mid-1990s, the Internet

enabled a global networking of researchers. Information could be exchanged at

virtually no cost directly from point to point, between individual researchers

worldwide. English established itself as the “lingua franca” in science; language

areas became porous. In this process, the classical star-shaped network structure

characteristic of the “professor” system was replaced by a grid network (see

Fig. 2). No longer did professors as hubs of their research groups channel in

some cases and even monopolize information streams. Opportunities to engage

in collaborative research and prepare joint publications became a common good

available to every level of an academic career. In a process of democratization of

information sovereignty, all at once it was possible for a doctoral student to

collaborate directly with a postdoc working on the same topic on another

Chair

System boundaries, e.g. language areas

Assistants

Postdocs

Fig. 1 Traditional activity system of teaching and research (own presentation)

14 T. Bieger

continent. Position as the key asset in academic research networks was replaced

by knowledge on specific topics.

In the second phase from 2010, huge quantities of data became available in all

economic and social realms affected by digitalization. For example, it was no

longer necessary to collect consumer data using representative surveys. Through

analyses of real demand data, such as purchases or information retrieval on the

Internet, one had almost instant online access to individual and collective behav-

ioral data. Empirical research moved from surveys and behavior lab experiments

to big data analysis. Data are thus no longer the exclusive province of univer-

sities, which they collect on sample basis at great cost. They are distributed

across company networks or purchasable on global search engines. Their analysis

requires advanced algorithms and large computing/coding capacities. This is

tending to increase the critical mass for research projects and is making new

partnerships necessary, often between universities and companies.

The general access to knowledge is also changing learning behavior of the

students. Students are increasingly learning from concrete tasks for which they

download the necessary knowledge directly from the Internet. By this role of

academic teachers is also changing. They not anymore select, channel, and

prepare knowledge; they rather coach knowledge acquisition processes. They

do not stand anymore between the students and the knowledge as quasi

gatekeepers. Like coaches for the tasks, they are structuring the learning pro-

cesses and moderating access to knowledge. Here too, network approaches are

Chair

Assistants Postdocs

Fig. 2 Modern activity system of teaching and research in a global network (own presentation)


becoming more important. Students work together on specific tasks, often with

colleagues from other universities and knowledge partners for practice from all

around the world. Collaborative learning (cf. Bruffee 1999) is becoming corre-

spondingly more important. A campus’ focus is no longer centered on research

offices and separate lecture halls, but rather on inspiring multifunctional meeting

rooms for students, instructors, and researchers, often in the form of labs like

design labs (cf. design thinking Brenner and Uebernickel 2016) or special

IT-supported learning environments such as trading rooms.

2. Socioeconomic environment: Because of globalization, competition is intensi-

fying not only in the real economy but also between places and finally with the

opening of markets for skilled labor for talents. High-cost locations in particular

are under increasing pressure to boost their productivity and deliver value added.

In the process of creative destruction (see Schumpeter and Seifert 1993) in the

interplay between innovation and imitation, firms must continuously increase

and enhance their competences. Only when firms using superior competences

manage to provide individual goods and services of better quality and/or less

expensively than other firms and other locations is their economic survival

assured.

It is evident that because of the importance of intangible knowledge, the

creative advancement of economic activities can be best pursued through per-

sonal exchange in clusters, supported by creative milieus (see Florida 2012). In

this effort, companies seek collaboration with the most capable people and thus

also locate their knowledge and research departments in places with strong

knowledge clusters. Consequently in an effort to strengthen their competitive

position places, countries and cities invest in the development of university

activities, for example, by founding new institutions or acquiring subsidiaries

of existing institutions.

This continuous improvement of their own capabilities as high-value and hard

working labor is also important for specialists and managers (see Harford 2015).

Thanks to the new information and communications technologies, knowledge

workers can become more effective, for example, by making their ideas or

concepts quickly accessible to a broader public and by achieving greater pro-

ductivity and ultimately high incomes. In the network society, the expression

“the winner takes it all” carries considerable weight (see Frank and Cook 1995).

Those who quickly and consistently dominate an area of knowledge or compe-

tence set the standards and often exclusively command the highest returns (see

Shapiro and Varian 2013) and productivity as well as salary differences increase.

In consequence, places, universities, and research institutions compete for the

most talented people and, symbiotically, research partnerships with the most

competitive companies or public institutions in their field. And talents want to

maintain their capability levels by having access to high-rated knowledge

streams and lifelong learning. Conversely, there are new markets in lifelong

continuing education and qualification for alumni.

In this knowledge economy, there are also huge self-reinforcing effects. Good

research partnerships make an institution attractive for outstanding researchers

16 T. Bieger

and teachers, which attracts especially talented students, who are then especially

valuable as new recruits to the corporate research partners in the field. A univer-

sity with good research partners as well as good researchers and students is

naturally also attractive in continuing education, in that good, reliable collabo-

ration in continuing education can generate new research collaborations (see

Fig. 3), which at the end also strengthens the attractiveness of the place itself.

Thus also differences between qualities of universities and attractiveness of

places with their respective clusters are growing.

As a result of intensifying competition and economic globalization, the posi-

tion of the state is also changing. With increasing financial constraints, the trend

toward the state as guarantor of services is ever more pronounced (see Schedler

2000). Public services formerly provided by the public sector and the public

administration increasingly are delivered also by private service companies.

Functions such as the provision of health care, education, transportation, and

even defense and security are no longer necessarily being fulfilled by the state

itself. The state is using performance contracts and other instruments to ensure

the corresponding functions are carried out. Services that in a state system were

previously more or less “ordered” by the state and thus hierarchically organized

are being at least partially opened to competitive bidding and are thus being

somewhat exposed to market mechanism. Conversely, ever greater numbers of

previously market-driven, purely private sector activities are now being increas-

ingly regulated (cf. especially the financial sector). As a result there is an inter-

esting convergence between the state/hierarchy coordination and market

coordination of economic activities.

3. Developments in the university sector

The university sector which for centuries was the center of research and

teaching activities was operating in a more or less stable structural environment.

Against the backdrop of the developments in the technological and

Quality of students

Quality of faculty

Rankings

Third-party researchfunds

Quality of recruiting companies

+

++

Quality of alumni

Fig. 3 Self-reinforcing effects at universities (Strategy paper, University of St.Gallen, 2014)


socioeconomic environment discussed above, however, new institutional

settings develop and research is provided more and more in countries, regions,

and topical areas which previously did not have access to higher education. In

many cases this happens through new and partly private providers. These include

private universities or nonuniversity research centers, supported by foundations

or other knowledge organizations. For example, consulting firms are supporting

the study of business administration by creating research centers and private

universities. These institutions all compete for research partnerships as well as

outstanding individual researchers.

Universities rely on research-based teaching. Thereby teaching itself also is

heavily influenced by digitalization. Students today have close to immediate

access to worldwide knowledge. Using MOOC’s (Mass open online courses)

they can acquire knowledge from around the world. Traditional universities

therefore have to create additional value through classroom teaching to legiti-

mate the cost of physical presence of lecturers and students. As a consequence

the role of lecturers is changing dramatically. Instead of lecturing knowledge,

they have to develop competencies of students in quasi flipped classrooms

(knowledge acquisition is performed outside the classroom by self-study) by

using role-plays, games, and simulations in a role of more a coach and trainer.

Hence quality of teaching depends on research quality and in addition the ability

to invest in innovative teaching methodologies and infrastructures.

This all is reflected in an increasing differentiation, which is also apparent in

other areas such as labor markets and locations. Qualitatively high-ranking

universities reach out ever further in global markets for outstanding teachers,

students, and research partnerships. On the other hand, there is a large group of

relatively interchangeable educational institutions catering to the regional mar-

ket and focusing on application-oriented research. Because of cost pressures,

they are increasingly obliged to purchase educational content from the global

marketplace in the form of MOOCs and in this way become dependent on large

institutions. New competition as well as cooperation between universities is

growing (see Huber 2016).

In summary, the following are the features of the process of transformation:

– Global network structures instead of regional hierarchical structures in

research

– With big data increasing cooperation between university and practice

– Larger critical mass for research projects

– New forms of teaching and learning with large requirements for investment in

new learning methods as well as physical and digital (e.g., IT in the form of

“blended learning”) infrastructure

– Increasing numbers of private actors in competition with traditional state actors

– Intensified competition for the best lecturers and researchers

– As a result a growing differentiation between top and normal institutions and

top and average places/locations in general

18 T. Bieger

3 Chapter 3: New Models of Teaching and Research(Networks Between State and Market)

On account of the developments described above, the success of a university and

indeed any teaching and research institution depends on its faculty and attractive-

ness to top students. The following elements are important in this regard:

– Assuring an attractive work environment and a cooperative culture for

researchers and students. This involves monetary compensation; as described

above, compensation for outstanding knowledge workers in the network econ-

omy is increasing disproportionately. But it also includes immaterial factors,

such as the physical work environment, the social and cultural environment in

which the university is embedded, as well as the university’s control and man-

agement systems, which must be geared toward a long-term culture of trust in

the context of an expert organization.

– The ability to develop situational and pragmatic forms of collaborations, espe-

cially in research, with other universities or partners in practice. Here basic

principles must naturally be upheld such as preserving academic freedom

through, e.g., the university’s retention of the right to personnel decisions and

avoiding strategic dependence on single partners by adequately diversifying

partnerships.

– In order to preserve academic freedom and a long-term orientation, uncondi-

tional basic financing must be secured be it in a form of long-term paying com-

mitments of the state or private partners or a significant endowment fund. Such

basic financing is important for university teaching. Students’ willingness to pay

has been demonstrated for direct, instrumental, usable knowledge and compe-

tences. However, direct users, the students or course participants, typically do

not display sufficient willingness to pay for a broader, socially oriented general

education that empowers them to anticipate long-term developments. In

research, solid basic financing is a guarantee for long-term employment

contracts, i.e., tenure, which still are needed in the competition for top talents.

As mentioned above, the university landscape can be expected to differentiate.

There is a growing discussion on generic types of universities, even business

models of universities (see also Aebischer and Escher 2016). Following generic

types of universities can be expected:

– Universities with regional scope to cover basic regional educational needs: Such

universities will continue to exist in the future. They will be dependent on a

larger share of public financing, but conversely, for the state they will serve as an

instrument for the pursuit of societal objectives like access to higher education

for broad parts of the population. This is currently evident in the USA where a

greater weight is being given to classical community colleges. These schools

benefit from a certain regional monopoly because of the limited mobility of their

students, who are often employed in outside jobs. But with public finances


increasingly under pressure, they have to improve their productivity and thus

will also increasingly have to use elements of IT-supported teaching and

learning. With shrinking resources research activities are bound to decline.

They therefore increasingly rely on inputs from external research networks.

– Research and educational centers with a large proportion of visiting faculty:

These institutions will benefit from either excellent locations or relationships

with companies or donors. Their strategic competitive edge is owed to their

flexible networking for faculty, students, and research partnerships. Their per-

centage of undergraduate training will be rather limited. Research can be signifi-

cant depending on their funding and partner networks.

– Faculty-oriented institutions: The largest share of the traditional quality research

universities belongs to this category. They have an interregional reach thanks to

their faculty’s performance and thus ensure for themselves a position in interna-

tional research networks and student or recruiting networks. Thanks to their

distinguished research and sought-after graduates, they are attractive for

partnerships with the private sector and can thus raise significant third-party

funds.

These three generic basic types span their own field over the three most impor-

tant strategic resources, access to students, location, and faculty (see Fig. 4). In any

case (competitive) position in networks is crucial. Classical central European

universities of the Humboldtian tradition face the question of how to shape the

transformation to a successful network organization in the interplay between

faculty, location/campus, students, alumni, recruiting firms, and private and public

research partners. This must take place against the backdrop of a stronger market

orientation as public finances continue to shrink.

Faculty/researchers

Location/cooperations Access to students

Network

Fig. 4 Strategic success positions in teaching and research (own presentation)

20 T. Bieger

4 Chapter 4: Outlook, A Regionally Rooted Faculty-DrivenUniversity with Global Reach (The Example of the HSG)

The University of St.Gallen was founded in 1898 as a classical commercial

academy by the city’s local textile firms, joined in a commercial board of directors,

today the chamber of commerce and industry, as well as by the canton and the city

of St.Gallen. Granted the right to award doctorates, it became a university in 1938.

It has always remained true to its specialization as a university of economics and

business while it has successively incorporated related disciplines such as law,

social science, political science, cultural studies and humanities.

As a specialized university, it has always needed an interregional reach in order

to achieve a critical mass. It introduced a foreigner quota of 25% as early as the

1960s as a means of managing the high demand from abroad. Today, the University

of St.Gallen, the HSG, ranks among the ten leading business schools in Europe (see

Financial Times Business School Ranking 2015). In Switzerland it represents the

third type of a university, the university of economics and social sciences, along

with the classical full universities and the institutes of technology (the ETH in

Switzerland) that emerged in the middle of the nineteenth century. Similar schools

were the previously founded London School of Economics and Political Science

(1895), the Stockholm School of Economics (1909), and the Vienna University of

Economics and Business (1898).

Located near large economic centers and geared toward an interregional reach,

the HSG follows the above-described, faculty-driven model. It has always

structured itself as an expert organization and has always maintained a high degree

of autonomy with distinctive self-administration by the professors. As with other

expert organizations, the assembly of partners, the professors in the senate, remains

an important decision-making body for policy issues.

With increasing internationalization and globalization, the University of St.Gallen

has gone from being one of the leading business schools in the German-speaking

world to one of the leading European business universities. As today in particular, the

market for outstanding researchers and lecturers is global, and at least some of the

university’s activities must have global reach. Vision 2020 reads accordingly:

As one of the leading business universities in Europe, we are known worldwide as an

academic hub for current problems in the economy and society as well as for the promotion

of integrative-thinking, entrepreneurial, and responsibly acting people.

To advance from a regional institution to one with international and even global

reach, the University of St.Gallen must pursue a balanced development on various

levels (see Fig. 5). With the internationalization of its teaching, it creates the

conditions necessary to attract outstanding students from Switzerland as well as

the international student market. The internationalization of its teaching is also a

requirement for the internationalization of the faculty and vice versa. Important past


development stages in this regard were the building of international exchange net-

works, Joint degrees, a bilingual campus, and representations abroad.

Excellence in research is an important requirement for developing a profile.

Early on, the University of St.Gallen organized its research activities in institutes.

Since the early 2000s, crosscutting institutional high-profile areas with European

reach, so-called “lighthouses”, have been developed. The definition and support of

such lighthouses were in the meantime handed over to the departments, while the

university as a whole concentrated on developing global high-profile areas,

so-called areas of thought leadership. This effort is being supported by the intro-

duction of new chairs with international faculty.

An important requisite for modern forms of teaching, a good working environ-

ment for the faculty as well as an internal and external identifying icon is an

attractive campus. In 1963 the HSG was the beneficiary of the first modern campus

in Switzerland, a Cite Universitaire, as a closed research and learning space.

Although since then it has been expanded more than once, today this campus is

too small and no longer meets the needs of modern collaborative learning in all

areas. Following this logic, currently one of most important strategic projects is the

expansion of the campus from a capacity of just 5000 to upto 9000 students. This

expansion is more than just an infrastructure project; it is an innovation project for

teaching and research.

As a precondition for the formation of research focus areas and the development

of global high-profile areas, as well as for funding a modern campus, the univer-

sity’s financial standing must be strengthened. Traditionally, the HSG has

Development levels

Time

Exchange networks

Joint Degrees

Double Degrees

Operations/ Institutions abroad

Teaching quality Bologna Bologna

improvement Teaching innovation

International research Research foci Profile areas Global profile

areas

Accreditation Ranking participation Ranking excellence

HSG as public university with governmental revenues significant Financial automony

Alumni Foundation HSG Foundation Culture of Giving

Campus renewal Additions, temporarystructures

Campus 2023/Expansion of campus

- New requirements Working environment(second machine age)

- Increased competition among universities

> Greater critical massresearch

- IT- MOOCs> Teaching innovation

Fig. 5 Dependency of strategic development projects at the example of HSG (Strategy paper,

University of St.Gallen, 2014)

22 T. Bieger

reached one of the largest proportions of third-party funding. As early as 1963, a

third of the costs of building the campus were raised in a national fundraising cam-

paign. An important forerunner of this tradition of self-financing was the creation of

entrepreneurial entities in the form of financially autonomous research institutes at

the end of the 1930s. The founding of the Executive School at the start of the

twenty-first century established another important pillar. Most recently, the devel-

opment of an HSG Foundation is an important step for fundraising. The university

also moved away from being included in the governmental annual budget to being

granted comprehensive financial autonomy based on a four-year performance

mandate with the right of equity capital formation.

A strong alumni organization is of highest importance for the university’s inte-

gration in sustainable research networks, as a basis for a loyal customer base in

continuing education and as a basis for funding. The HSG has one of the oldest

alumni organizations in the German-speaking regions with over 23,000 members

currently. The establishment of professional offices in 1998 and the introduction of

international alumni conferences were important steps in its development. In the

future, the synergies between the university and the alumni organization should be

strengthened.

Executive education is not only an important instrument for financing. It also

helps embed the university in practice and research networks. Many collaborative

projects with practitioners come about through relationships with participants in

executive education. Important steps in the development of executive education at

the HSG were the first seminars offered from HSG institutes as early as 1938, the

founding of the continuing education in 1968, the construction of the Executive

Campus HSG (Holzweid) at the end of 1995, and, as mentioned, the establishment in

2007 of the Executive School that offers important degree programs like the full-

time MBA and executive MBA programs. In the future, the Executive School

should be even more firmly targeting “C” level top management. Here an increasing

convergence between consulting, research, and executive education in networks

with partners from practice is becoming apparent. Often, research results are

directly applied in divisional strategies of corporate clients, which then require

implementation through executive education.

The ability to attract excellent researchers and teachers to a single university

requires competitive offers and an inspiring working environment. The University

of St.Gallen has a model for involving its professors in the success of its research

units. In recent years, the possibilities for market-driven salaries have been

expanded, in particular through activities in executive education. The Research

infrastructure has also been strengthened by the construction of a central institute

building, which will be followed in a few years by a second major center in the city.

The research capacities have been expanded through the creation of new posts for

mid-level faculty as well as a new fund for supporting conferences. Junior

researchers have been detached from the chairs and are now directly assigned to

the schools which reflect their independent position in internal and external

research networks.


In the future, it will be increasingly challenging to combine practice-based

research with the requirements of basic research. Both areas require increasing

specialization. The key is developing internal work networks of both research-

focused and practice-focused people who are firmly rooted in their respective

networks (scientific community, practice).

In order to realize this, the university’s management model must be continuously

adapted. Here a balance must be struck between creating the capacity to develop

strategic focus areas, which requires performance monitoring and central manage-

ment, and avoiding the emergence of a transactional controlling culture, which

would destroy internal cooperation.

The basis for this is being firmly rooted in the region. Further development

requires achieving legitimacy in the region, for example, securing basic financing

from the canton and the necessary acceptance of expansion projects. It also requires

creating opportunities for research and learning nearby and contributing to an

attractive residential and living environment for faculty and students. In the end

also a university is relying on a well-functioning regional cluster. Thus, one of the

basic strategic principles of the University of St.Gallen is to combine international

reach with strong regional roots.

5 Conclusion

Knowledge organizations in research and teaching are undergoing a transformation.

This is being driven by technological—mainly digitalization—and socioeconomic

changes, primarily the new role of the state. In this process of transformation, the

traditional strengths of the classical universities will erode. What is needed is an

orientation toward a clear strategic factor for success. As the example of the University

of St.Gallen shows, an aligned progress on different dimensions of development is

needed.

References

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strategic renewal in activity systems. Academy of Management Review, 40(2), 210–234.Backhaus, J. G. (2015). The University according to Humboldt: History, policy, and future possi-

bilities. Heidelberg: Springer.Bieger, T. (2010). Tourismuslehre—Ein Grundriss. Stuttgart: UTB GmbH.

Brenner, W., & Uebernickel, F. (Eds.). (2016). Design thinking for innovation: Research andpractice. Cham: Springer.

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a.M.

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Shapiro, C., & Varian, H. R. (2013). Information rules: A strategic guide to the network economy.Boston, MA: Harvard Business Review Press.

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Banks Caught Between Regulation,Technical Progress, and Profitability

Martin Blessing and Tobias Bange

1 Confidence and the Banking Business

“In the beginning was the credit” is a concise way of describing the origins of the

banking business. Lending money over a period of time remains the basis and the

focus of the business activity of banks. The credit—derived from the Latin credere(to believe, entrust, place trust in)—is based on the lender’s confidence that the

borrower will meet his obligation to repay a loan. Confidence is therefore essential

to the banking business. This applies not only to banks as lenders, but just as

much—if not more so—to the customers who entrust their savings to a bank, confi-

dent that these deposits are secure and that the bank will be able to meet its con-

tractual obligation to repay the funds.

Confidence is the common denominator for money, credit, and all financial

products. The precondition for all of these is the confidence that they will retain

their intrinsic value. Hans Christoph Binswanger,1 long-standing head of the Insti-

tute of Economics at the University of St. Gallen, has highlighted this point in

relation to money in his study of Goethe’s “Faust”2:

In “Faust”, the Emperor gives Mephisto the task of printing money:

We’re short of gold, well fine, so fetch some then.3

M. Blessing (*) • T. Bange

Commerzbank AG, Frankfurt am Main, Germany

1Hans Christoph Binswanger was a professor of economics at the University of St. Gallen from

1969 until he was appointed emeritus professor in 1994.2Binswanger, Money and Magic: A Critique of the Modern Economy in the Light of Goethe’sFaust. 2. Revised version, 2005.3Johann Wolfgang von Goethe, Faust: The Tragedy, Part Two—Chapter 4 (translation by

A.S. Kline # 2003).



DOI 10.1007/978-3-319-48938-4_3

27

However, only the confidence that paper money has a real value gives the basically

worthless paper its own intrinsic value and thus an exchange value. The printed

paper therefore carries the assurance:

This paper’s worth a thousand crowns, or so.

As a secure pledge, it will underwrite,

All buried treasure, our Emperor’s right.4

The confidence invested in the banks and financial markets is also their lifeblood.

For the business activity of the banks and events in the financial markets are to some

extent abstract and difficult to grasp. They rarely relate to physical objects—such as

the sale of gold coins or bars—but generally to credits and financial products, which

“only” exist on paper and which often do not represent any particular value, but are

associated with risks and opportunities.

This is why confidence that credits and financial products will retain their value

and that the associated risks are transparent and manageable are such important

factors for the financial sector as a whole. If risks which have become unmanage-

able can no longer be absorbed in the financial markets, this confidence is lost. And

such a loss of confidence may lead to a general undermining of the stability of the

financial system. This was made painfully evident by the financial market crisis of

2008, the impact of which is still being felt today.

2 Regulation of the Financial Sector

The financial market crisis has led to radical regulation of the financial sector at

national, European, and international levels. The new measures are aimed at

restoring lost confidence in the stability and functionality of the financial system.

In the event of a crisis, taxpayers will no longer have to bail out the financial

institutions.

However, the stricter and more exacting controls being applied to the banks

compared to businesses in many other sectors are not a new development, but have

always been regarded as necessary, based on the particular risks in the banking

business. Banks assume risks which have a major impact on the real economy and

thus carry out a key economic function. They exert an influence on investment

activity and the overall economic trend in many ways—particularly by making

loans to companies. This means that banks bear a high level of social responsibility,

which can be illustrated by a simple example from everyday business practice.

When deciding to make a loan to a company, a bank faces a difficult conflict, in

both business and also moral terms, if the company which is applying for the loan is

gradually becoming embroiled in a crisis and is at risk of becoming insolvent. The

lending bank carries a heavy responsibility here, on the one hand in relation to jobs

4The Chancellor in Johann Wolfgang von Goethe. Faust: The Tragedy, Part Two—Chapter 13

(translation by A.S. Kline # 2003).

28 M. Blessing and T. Bange

and thus potentially for the economic stability of a whole region. These are impor-

tant reasons for maintaining a business relationship in order to ensure that the com-

pany survives and that jobs are not lost. On the other hand, the bank may not

repeatedly extend or even increase a loan to such a company if, in so doing, it

neglects its own interests in relation to the repayment of the loan. If necessary, it

will have to call in a loan early in the interests of its depositors and owners, in order

to safeguard at least part of the sum which is owed. The bank must also avoid

helping to delay insolvency proceedings by extending the term of a loan. In such a

situation, the bank must act responsibly and give careful consideration to the

alternatives when reaching a decision.

Given the importance of and the responsibility borne by the banks for the eco-

nomy as a whole, regulation of the financial sector has always therefore been

regarded as necessary. Consequently, banking transactions and financial services

must only be carried out by suitable individuals and companies. For this reason, the

fundamental constitutional right of economic freedom for the financial sector is

restricted to a fairly significant degree by the German Banking Act. Written permis-

sion is required from the regulatory authorities to operate banking business and

financial services.5 As a precondition for obtaining this, the professional abilities of

the management are monitored just as closely as the sustainability of the business

plan which is presented.6

The intensified regulatory activity since the financial market crisis is in contrast

with the previous phase of deregulation, when the aim was to give financial insti-

tutions more flexibility and to encourage innovation. The international financial

markets have become increasingly important for the financing of companies as a

result of globalization. The classic corporate loan has been supplemented with

capital market-based types of financing. The banks have created an interface here

between companies seeking credit and the financial markets. Banks were no longer

merely lenders but also intermediaries for the capital market. This also changed the

refinancing methods used by the banks. While banks had previously financed their

capital needs mainly with equity capital and customer deposits, in other words

they accumulated deposits as borrowed capital on the liability side of their balance

sheets, they now had increasing opportunities to refinance in the capital market.

In Germany, the scope of financial institutions was considerably extended,

mainly as a result of the four Financial Market Promotion Acts which were passed

between 1990 and 2002. These facilitated, for example, the development of new

financial products, trading in financial future contracts, investment in money market

funds, and securities lending. On the one hand, this extended the profit potential on

the lending side of the balance sheet. However, the total assets of German banks and

their leverage ratios also increased. The gap widened between equity capital and

borrowed capital raised in the capital markets. The Bundesbank has established that

5§§ 32 ff. German Banking Act (KWG).6Freedom to engage in business and to practice a profession is also restricted in other sectors which

are dependent on particular suitability and reliability.

Banks Caught Between Regulation, Technical Progress, and Profitability 29

both the expansion of business areas and growth in balance sheets were all the more

marked, the larger the bank’s original size. It attributes this, for example, to the fact

that larger banks can increase their leverage ratios more easily, since they are more

likely to be active in the capital market; however, this was not a phenomenon

limited to Germany, but was a global trend in the development of bigger banks.7

The financial market crisis highlighted the fact that too high a level of risk

tolerance, short-term financing instruments, and a high leverage ratio led to unex-

pected shortfalls of capital and liquidity in a time of crisis. This inevitably led to

extensive legislative activity, aimed at preventing a repetition of the crisis. The final

communique of the G20 summit in Pittsburgh in 2009 stated that “no product, no

participant, no market and no territory may remain unregulated and unsupervised.”

The new rules which were applied internationally were to be introduced gradually

and implemented by the end of 2012.

Essentially they sought to:

1. Identify and limit risks at an early stage.

2. Take precautions in order to make financial institutions stable enough to with-

stand any risks which might occur.

3. Finally strengthen banking supervision in order to monitor adherence to the

abovementioned measures.

3 Risk Management

One of the key aspects of the regulation of financial institutions today is therefore to

improve risk management by developing a viable risk strategy and an appropriate

risk culture within those institutions.

3.1 Requirements Under Corporate Law

The restriction that companies should assume only manageable and controllable

risks applies not only to banks but also to the economy in general. For some time,

legislators have therefore required all listed companies to take precautions with

regard to risk management. An important step in this direction was taken in 1998.

This was triggered by some spectacular company failures in the 1990s, which high-

lighted serious deficiencies relating to the management and control of listed com-

panies. The Corporate Control and Transparency Act (KonTraG) passed in 1998

was intended to bring about improvements here. Listed companies were obliged to

7Deutsche Bundesbank, Monthly Report April 2015, p. 37.


introduce a so-called early risk warning system.8 This was intended to identify at an

early stage risks which posed a threat to a company’s survival. The main focus of

this assessment is of course classic business risks, which may lead to the insolvency

of a company.

The requirements under stock corporate law concerning the early warning

system to be implemented have been fleshed out further and supplemented over

time, specifically by the German Accounting Reform Act of 2004 and the German

Accounting Law Modernisation Act of 2009. For example, new determinations

under corporate law and in the German Commercial Code obliged limited com-

panies to publish in their annual reports statements concerning the probable trend at

the company, identifying the main risks and opportunities and providing details of

internal control and risk management systems.9

3.2 Risk Strategy in Financial Institutions

The general rules on risk management under corporate law are today being super-

seded by much more specific and tougher special regulations under banking super-

visory law which apply to all financial institutions, irrespective of their legal form.

New rules for the extensive risk management and control of financial institutions

have been regulated by the German Banking Act (KWG) since January 2014.

Some of the risk management requirements for financial institutions specified by

the Federal Financial Supervisory Authority (BaFin)10 have now been included as

legal obligations for the business managers of a financial institution.11 The core

element is the obligation for a manager of a financial institution to ensure that the

institution’s business strategy is geared to its sustainable development, with a consi-

stent risk strategy, as well as processes for calculating and safeguarding its risk-

bearing capacity.12

The risk strategy is intended to cover all the main risks to which the institution is

exposed. The institution must not only be aware of the extent to which it can assume

risk. It must also take a conscious decision concerning its willingness to take on risk

in order to meet strategic targets. The institution’s risk tolerance, or “risk appetite,”

must be determined precisely. This is the basis for the strategic risk guidelines

which define the maximum risk which can be assumed by the bank.

8§ 91, para. 2 German Companies Act (AktG) “The management board must take suitable

measures, specifically by setting up a monitoring system, to enable developments which pose a

risk to the company’s future survival to be identified at an early stage.”9§§ 171 para. 1 AktG; §§ 289, 315 para. 2 German Commercial Code (HGB).10German Federal Financial Supervisory Authority; Circular 10/2012 of 14 December

2012—Minimum Requirements for Risk Management—MaRisk.11§ 25c paras. 4a and 4b KWG, inserted as a result of the legislation on protection against risks and

the planned restructuring and resolution of financial institutions and financial groups, of 7 August

2013, BGBl I p. 3090.12§ 25c para. 4a No. 1 and No. 2 KWG.


The precondition for a viable business strategy, and thus a consistent risk stra-

tegy, is in any case that the institution’s main risks, particularly counterparty credit

risk, and risks relating to market price, liquidity, and operational matters are identi-

fied and defined regularly and as required within the framework of a risk inventory

(total risk profile); the risk inventory must also include the monitoring of risk

concentration as well as potentially significant negative factors which may have

an impact on the institution’s assets, profits, or liquidity.13 Risk management and

control processes are to be integrated into a joint profit and risk management system

(“overall bank management”).14 The core of overall bank management is to achieve

a balance between the premises established in the risk strategy and those contained

in the operating strategy. Care must always be taken to hedge risks with sufficient

liquidity and capital provision.

Adherence to these criteria is no longer simply controlled by the banking regu-

lators, but also carries penalties. Under the new criminal offense in § 54a of the

German Banking Act (KWG), the manager of a financial institution may, under

certain circumstances, be liable to prosecution if, in violation of previous BaFin

regulations, he or she has not taken sufficient care to meet the legal requirements for

risk management, resulting in a risk which jeopardizes the institution’s survival.

However, even if the institution’s survival is not at risk, deficiencies relating to risk

management may lead to losses for the company and possibly also form the basis

for a criminal charge of breach of trust against the responsible manager.

3.3 Risk Culture

However, these legal requirements relating to risk management and the relevant

details contained in the German Minimum Requirements for Risk Management

(MaRisk) by BaFin are not in themselves sufficient. Another integral element of the

corporate governance of a financial institution is the development and promotion of

an appropriate risk culture within the company. Managers and individual

employees should become risk-aware, leading to responsible action on a daily oper-

ational basis. It is evident that deficiencies in this area have been partly responsible

for some banks assuming excessively high and, in some cases, unmanageable risks

in the past. The Capital Requirements Directive IV (CRD IV) therefore requires the

development and promotion of a solid risk culture at all corporate levels of financial

institutions and investment firms as part of an effective risk management process.15

13§ 25c para. 4a No. 2 a and b KWG.14MaRisk AT 4.3.2 No. 1.15Recital 54 of Directive 2013/36/EU of the European Parliament and Council of 26 June 2013 on

access to the activity of financial institutions and the supervision of financial institutions and

investment firms.


BaFin intends to impose obligations on managers here in the future by means of

corresponding new rules within MaRisk. It is in the process of drafting specific

guidelines for an appropriate risk culture. Risk management will consequently be

firmly anchored in the corporate culture of institutions. Institutions will be obliged

to develop a code of conduct for their employees, stipulating which risks may be

assumed and which may be not.16

3.4 Remuneration Policy

Another important element of risk culture as reflected in the responsible manage-

ment of risks by employees at all levels of the financial institution is that no finan-

cial incentives may be offered which encourage the assumption of excessively high

risks. The financial market crisis demonstrated that high-risk and ultimately loss-

making transactions were also, to some extent, encouraged by remuneration struc-

tures which favored the assumption of extremely high levels of risk. Such a

remuneration policy runs counter to appropriate risk management. Misplaced

incentives created by an inappropriate remuneration policy may constitute risks,

not only to the stability of individual companies but also to financial stability in

general.

As early as 2009, the 20 most important industrialized countries therefore agreed

at the G20 summit in Pittsburgh that inappropriate financial incentives may no

longer be offered by financial institutions. Variable remuneration poses a particular

danger if it is geared to short-term results. For a remuneration policy which is

geared to short-term parameters and which unilaterally rewards success, without

sufficiently punishing failure, may detract from the long-term and sustainable

success of the business. Overall, remuneration policy should therefore be geared

more strongly in the future to the long-term interests of the financial institution.

Excessively high risk tolerance is to be avoided, specifically by obliging finan-

cial institutions to set an upper limit for the ratio of fixed to variable elements of

overall remuneration. This obligation is now enshrined in law. The details are regu-

lated in the German Banking Act17 and in the Institution Remuneration Ordinance

which came into force on 1 January 2014.18

16Further details: Steinbrecher, Risk culture, BaFin Journal August 2015, p. 20 ff.17§ 25a para. 5 KWG.18Ordinance on the regulatory requirements for the remuneration systems of institutions of

16 December 2013, BGBl. I p. 4270.


4 Capital and Liquidity

The lesson learned from the financial market crisis was that risks must not only be

controlled better but also hedged more successfully. For, during the crisis, it

became evident that the combined effect of excessively high risk tolerance,

market-based financing instruments, and high leverage ratios had led to dangerous

shortfalls of capital and liquidity. New regulations on the capital cover and the

provision of liquidity for financial institutions have therefore been enacted at the

national, European, and international levels, aimed at preventing a recurrence of the

financial market crisis. This also dates back to a decision taken by the G20 summit

in 2009. Today, banks are obliged to create a risk buffer which can be used to

absorb unexpected losses by increasing their capital and liquidity. Raising the

capital requirements for financial institutions is intended to further enforce the

validity of the central principle of the market economy—the unity of property

and liability. In the future, taxpayers will no longer have to bail out stricken

banks; instead, the owners and creditors of financial institutions will assume more

liability.

True, the rules introduced under Basel II before the financial market crisis

already differentiated between higher-risk and lower-risk loans. Depending on the

risk weighting (risk-weighted assets), the level of capital cover required is based on

the default risk calculated for a loan. Specifically, this means that a bank has to

provide less capital cover for lower-risk positions but conversely is obliged to

create larger capital buffers for positions at risk of default.

However, the G20 countries supported the introduction of a new, nonrisk-based

gearing figure (the “leverage ratio”) as an additional measure to Basel II. The

“Basel III” package of reforms agreed by the Basel Committee on Banking Super-

vision therefore sets higher criteria for the volume and quality of capital held by

financial institutions and investment firms. In addition to the risk-based approach

which has been applied so far, a mandatory upper debt limit will be introduced from

2018, based on the ratio of total assets and capital (the leverage ratio). During the

transitional period, the banks are obliged, from 2015, to disclose their leverage

ratio. Discussion is currently still under way concerning the technical details of how

the leverage ratio is to be calculated and where the upper debt limit is to be set. It

has to be borne in mind here that a bank’s business model typically implies a high

level of debt, and the proportion of capital to a bank’s total assets is therefore very

much smaller than for companies outside the financial sector; the proportion of

capital for the German banking system is only therefore about 4% on a long-term

average.19

The tougher capital requirements are being supplemented by stricter criteria for

the liquidity of the financial institutions. For the financial market crisis also led to

liquidity problems because interbank lending had ground to a halt based on fears

that the other bank might get into financial difficulties. Minimum standards are

19Deutsche Bundesbank, Monthly Report April 2015, p. 40.


therefore intended to ensure that internationally active banks have a sufficiently

large portfolio of highly liquid assets to be able to withstand potential liquidity

problems.

5 European Banking Union

Creating a banking union in Europe is one of the most politically ambitious

projects to emerge from the financial and sovereign debt crisis. The first two

pillars—uniform banking supervision and standardized rules for the orderly

restructuring and, if need be, the dissolution of banks—have been completed.

Insolvency and market withdrawal must also be possible for banks in a market

economy. The “too big to fail” objection should not be an obstacle. In the future, it

will also be possible for large financial institutions to be wound up if they fail.

To prevent this from happening, and to enable countermeasures to be taken at an

early stage, the supervision of financial institutions has been intensified. To this

end, a new European banking supervisory mechanism has been created, based on an

EU directive, and located at the European Central Bank. The purpose of this mecha-

nism is to identify problems in the national banking sector at an early stage and to

correct them before they cause risks for the whole Eurozone. This will help to

ensure the security and solidity of financial institutions and the stability of the

European and international financial systems.

The core of European banking supervision is the Single Supervisory Mechanism

(SSM). This is a new banking supervision system, composed of the ECB and the

responsible national authorities in the participating countries. The supervisory

mechanism will set uniform standards for banking controls in all the participating

member states.

The ECB has been given a number of powers to perform its supervisory function.

If necessary, it can also intervene directly in the business activity of individual

institutions. The independence of the ECB must of course be safeguarded. Mone-

tary policy and banking supervision must be clearly separated from each other

organizationally. Since November 2014, all large and systemically relevant banks

in the Eurozone have been controlled on a uniform basis by the ECB. 120 major

banking groups are currently subject to supervision. Based on assets, they represent

82% of the banking sector in the Euro area. Consideration needs to be given to the

question of whether this supervision should be extended to all banks in the

Eurozone, irrespective of the size or business models of the individual institutions,

in order to avoid regulatory gaps between individual banks and financial centers.

To protect bank customers in the event of insolvency, the European Commission

also plans to establish a joint European deposit guarantee system. This project is

currently still politically controversial. Critics argue that national deposit guarantee

systems have proved effective so far and have been sufficient.


6 Regulation and Profitability

The extensive regulation of the financial sector, which is far from complete, has a

major impact on the banks’ business models and their profitability. The stricter

criteria relating to capital and liquidity will potentially weaken the profitability of

the banks. Many transactions will therefore no longer be worthwhile in the future

for certain financial institutions or financial groups. Some financial institutions

will be forced, as a consequence, to adopt different strategies, in order to meet

the legal requirements and also operate profitably.

This is particularly evident from the parameters for capital provision. Different

methods of assessment may lead to a change in business strategy. If the level of

capital cover is based solely on the risks relating to transactions (risk-weighted

assets), an institution could, for example, decide to offer more construction financ-

ing. For, because they can be collateralized by real estate liens or other securities,

mortgage loans are less risky and less capital cover is therefore required for them.

The same applies to other well-secured loans, for example, in the area of corporate

financing. If, on the other hand, the leverage ratio is used as a benchmark for an

institution, every loan—regardless of its respective risk—has a negative impact on

the leverage ratio. For only equity capital and total assets are compared here. More

capital cover is required for new loans as soon as the permitted debt limit has been

reached. This can result in an institution withdrawing from loan transactions, even

if loans are lower-risk because sufficient collateral is available. For, irrespective of

whether credits, for example, mortgage loans, are secured or not, they will remain

in a bank’s balance sheet for years.

This example shows that regulatory targets pose a major challenge to the future

business models of banks. When coordinating the risk and business strategy within

the framework of the overall management of the bank, managers have to evaluate

the relative risks and profit opportunities under the specific regulatory conditions

and achieve an appropriate balance. When taking these strategic decisions, a bank

must always be guided by the question of which transactions are no longer possible

for regulatory reasons, or are no longer worthwhile, and what profitable transactions

or services remain for the bank.

7 Digitization

While endeavoring to continue to work with profitable business models, banks must

not fall behind in terms of technological development, but must set benchmarks

themselves as innovation drivers. They must disprove the malicious claim that the

only innovation which they have invented is the cash dispenser. Digitization

provides new opportunities for the innovative optimization and expansion of the

banks’ business activity and is the top priority for all companies today on a cross-

sectoral scale. The availability of data and the associated possibility to exchange

and combine information at any time provide companies with new opportunities

throughout the whole value-added process. Digitization today affects all areas of a


company. Specifically for banks whose products are largely “abstract,” digitization

offers major opportunities, not only for cost cutting but also in terms of expanding

their business. From product development to sales and to customer relationships,

almost all processes can be digitally mapped or optimized. The same applies to

risk management and overall bank management.

To this end, all information and processes within the bank must be digitally

networked. The synchronization and exchange of data are a prerequisite for the

digitization of all of a bank’s internal operating procedures. This will facilitate the

development and provision of needs-based products. In the future, in addition to the

services provided by branch networks, contact between banks and their customers,

and vice versa, will be easier, faster, and more customer oriented via corresponding

Internet applications (apps). The possibility to provide a large number of financial

services and products online too has already revolutionized classic banking busi-

ness. There is no sign of this trend coming to an end.

Many banking transactions can already be carried out online today. These range

from opening an account digitally—a process which can be completed in a few

seconds—to investing in fixed term deposits, which are transacted in an “end-to-end”

process. This means that all accounting processes are now automated. All stages of

processing are digitized from the placing of an order, via processing, to posting. The

transparency of processes plays a crucial role here for customers. Customers can

thus inform themselves at any time online about the processing status of their order.

Many customers are now managing their banking business online. Surveys show

that 80% of all customers access account information online and that more than

60% carry out transactions via a smartphone or computer.

Loans can also be issued online, without the need to visit a branch. A credit

review process can be carried out today within seconds, as soon as the customer

data required for risk scoring is available online. The precondition for developing

classic banking business further in this direction is that the customer agrees to

provide the relevant personal and financial information online. Once the customer

has given permission, this data can be used to offer other banking products. Data

analysis then makes it possible to provide tailor-made advice and identifies the

appropriate products.

The competitive environment is also exerting pressure on traditional banks to

change. Banks are currently facing challenges from large companies from outside

the sector, e.g., Google, PayPal, and Apple, which have successfully developed

electronic payment systems in recent years. It is only a matter of time before these

companies evolve into fully fledged financial services providers. However, banks

are also facing growing competition from young FinTech companies which are

using state-of-the-art technologies to develop innovative financial services solu-

tions. This also nevertheless provides potential for productive cooperation. Banks

are in a good starting position here.


8 Commerzbank

After a lean period lasting for some years due to the impact of the financial market

crisis, Commerzbank is now back on the road to success. It is in the process of

scaling back risks again and optimizing its capital resources. The risks bundled in

the noncore asset segment (Deutsche Schiffsbank and Commercial Real Estate) are

being reduced in a value-preserving manner. This will release the capital tied up

here, which can then be used to generate growth in the core bank.

Commerzbank is also continuing its strict cost management. Thanks to a high

level of cost discipline, it has managed to maintain a stable cost base despite higher

wage settlements and increased material costs, for example, as a result of more

stringent regulatory requirements. Commerzbank is also investing in new products

and services in order to increase its profitability. The bank has significantly

enhanced its earnings power in recent years with these measures. The main focus

of its business model is retail business, as well as services for small and medium-

sized companies in Germany and abroad which are provided by its

Mittelstandsbank. Commerzbank has strengthened its market position further in

both areas. As a result of the close links between the Mittelstandsbank and

Corporates & Markets—Commerzbank’s investment banking arm—practical

solutions have been developed here for customers for the hedging of currency,

interest rate, and commodity risks. Commerzbank also provides its corporate

customers with access to the capital markets.

In terms of digitization, Commerzbank is benefiting from Comdirect, and also

mBank, the group’s Polish subsidiary. As a universal bank, mBank provides its

customers with retail, corporate, and investment banking services. For years it has

been making a significant positive contribution to Commerzbank’s group profits.

One of the strengths of mBank is the further development of digital solutions for

online and mobile banking. This is connected with the fact that Poland has a

younger and thus more Internet-savvy population than other European countries.

mBank has developed many new applications in the mobile banking sector, which

have then been transferred to Commerzbank business in Germany and other coun-

tries as “best practice.” In 2013, mBank received an award as the best bank for

online and mobile banking.

Despite growing acceptance of online banking, investigations show that tradi-

tional bank branches are still in demand. As soon as banking business which

requires more intensive professional advice is involved, such as pensions, asset

creation, or large loan agreements, after carrying out the corresponding online

research, most customers still seek the personal contact and individual advice avail-

able in a branch. Based on a survey carried out by the management consultancy

Roland Berger, 55% of respondents have confidence in innovative branch con-

cepts.20 Branches will therefore continue to feature at Commerzbank in the future,

20Digital Revolution in Retail Banking; chances in the new multi-channel world from a customer’s

perspective; Roland Berger Strategy Consultants, February 2015 p. 15 ff.


at least for more complex financing questions, although they will be increasingly

integrated into the digital universe.

In addition to its own business, Commerzbank’s subsidiary Main Incubator

GmbH also promotes young FinTech start-ups which are driving forward inno-

vations in the digital banking sector. Commerzbank is also benefiting from this

alliance by helping to structure the evolution of the financial services sector by

promoting groundbreaking ideas, creative concepts, and innovative solutions.

“Banking is necessary, banks are not”—Bill Gates caused a stir many years ago

with this assertion, long before the financial market crisis. The crisis and the discus-

sion which it prompted concerning the misconduct of banks seem to have proved

him right. However, the restructuring of the financial sector in the postcrisis years

has opened up new prospects for the future. Today, it is generally true to say that

banks are still needed to fulfill their important economic function of arranging and

transferring finance. Their actions must reflect the heavy responsibility which they

bear as a result. Over and above all the new technical developments, this is the main

task faced by the banks in order to regain the confidence which was lost during the

financial market crisis. For without confidence, banking business is not possible.


Business Models in the Chemical IndustryAmid a Changing Competitive Landscape

Kurt Bock

1 Introduction

Running a venture always leads to the question which business model fits best. This

article provides a high-level overview of the basic business models applied in the

chemical industry and their success factors, especially amid a continuously chang-

ing environment.

Answers to the following questions are given:

• Which trends are shaping the chemical industry?

• What do business model archetypes look like?

• What factors lead to a successful application of a business model?

• How will the digitalization affect the business models in the chemical industry?

After presenting some key facts on the chemical industry, especially with regard

to size, dynamics and customer structure, the most important trends are highlighted

laying the basis for a better understanding of the competitive forces shaping the

chemical industry’s landscape.

The main business models are then described in detail: basic chemicals,

application-oriented solutions, and product innovation-driven specialties. Exam-

ples show how these business models work in practice. Starting from a portfolio

management view, the success factors for each model are outlined, with an assess-

ment on how business models might change, especially with a view to the

most significant, upcoming change—the digitalization of the industry. Finally, a

short conclusion is given.

K. Bock (*)

BASF SE, Ludwigshafen, Germany



DOI 10.1007/978-3-319-48938-4_4

41

2 A Brief Overview of the Chemical Industry

The chemical industry is based on a limited number of raw materials such as oil,

natural gas, and coal, which are converted into roughly 20 building blocks. Starting

from these elementary products, the entire “universe” of conceivable products is

derived (Vogel 2012).

The large variety of chemical products is sold to an exceptionally broad spec-

trum of customer industries, which in turn is linked to all other manufacturing

industries—including rubber, plastics, construction, automotive, paper, packaging,

as well as nutrition and agriculture. As a consequence, the chemical industry is one

of the most diversified industries in the world (Fig. 1).

All the customer industries use chemical products and solutions to manufacture a

wide range of products such as dyes, detergents, chemicals for household cleaning,

plastic materials, fibers for functional wear, paints, and vehicle parts, which impact

on virtually all areas of our lives. Without chemistry, it would not be possible to

construct ever taller buildings, tablet PCs would not work, wind turbines would not

rotate, and batteries would not provide cars with electrical power. According to

Cefic, the European Chemical Industry Council, 95% of all manufactured goods

are dependent in some way on the chemical industry (Cefic, online 2014).

Fig. 1 Broad portfolio of the chemical industry (Source: Eurostat 2014, BASF SE)

42 K. Bock

The chemical industry substantially contributes to the prosperity and competi-

tiveness of economies around the world:

• In 2014, the total production value of the global chemical industry amounted to

$3.9 trillion, of which global value added1 was $1.1 trillion, thus contributing

1.5% to global gross domestic product (GDP). This share has been growing,

however at a somewhat lower rate than the information and communications

technology industry (Feri Chemdata 2015; IHS Economics 2015).

• Worldwide, the chemical industry is an important employer, providing a total of

at least 11 million jobs growing annually at 2.5% worldwide (Feri Chemdata

2015).

• Between 2000 and 2014, growth in chemical production has been faster than in

global GDP—increasing on average by 3.5% compared to a GDP growth of

2.7% per annum. This growth has been driven by emerging economies that have

high global market shares and grow strongly. China, in particular, has increased

its share in the chemical market significantly, from 8% in 2000 to 37% in 2014.

Its growing middle class is driving demand for high-quality goods in areas like

housing or transportation, where chemical solutions play a decisive role. All

projections assume that the chemical production will further shift to emerging

countries during the coming years (Feri Chemdata 2015; IHS Economics 2015).

From a business model perspective, the following conclusions can be drawn

from this:

• As chemicals are sold into a broad spectrum of industries, the degree of addi-

tional support and services offered together with the chemicals strongly varies.

An example for this variation: Typically, customers of basic chemicals are

price buyers, requiring limited or no additional support and services, whereas

application-oriented solutions, e.g., lightweight materials for the automotive

industry, require technical support and services and are valued by the customers

based on the performance in the application. This must be reflected in the busi-

ness models.

• With the rise of demand in emerging markets, offerings may well need regional

adaptations. Customers in a mature market, for example, may not expect addi-

tional services for a specific product, while customers in an emerging country

may ask for such a support—at least for a certain period of time—or have differ-

ent needs to be addressed. Business models must be flexibly designed to cater for

such differences.

1Global value added: production value minus intermediate inputs.

Business Models in the Chemical Industry Amid a Changing Competitive Landscape 43

3 Trends in the Chemical Industry

3.1 Changing Landscape: Rise of Emerging Markets

Since 2000, a major shift has been taking place in the landscape of the global

chemical industry as new competitors from oil- and gas-producing countries, and

the high-growth developing markets of China and India enter the scene (Budde,

McKinsey & Company 2011). These new players, including state-controlled major

corporations such as Sinopec, ChemChina, and PetroChina, are challenging the

market position of Western companies. “New competitors not only play a dominant

role in their home markets, but also heavily tap into the mature markets to advance

their technological skills” (Roland Berger 2011).

Competition is heating up. Players from the emerging markets have grown faster

than their Western competitors, often with double-digit rates. Furthermore, over the

last decades, the emerging and mature markets have become strongly connected via

chemical trade. This also contributed to increasing competition (Fig. 2).

Looking ahead, it is expected that chemical production will continue to grow

faster than global GDP until 2025. Asia Pacific will remain the largest chemical

market. The pace of growth will continue to vary from region to region, with

emerging markets being the most important growth drivers, even though their

economies will be less dynamic than they were over the past 5 years due to macro-

economic imbalances and geopolitical tensions. China will remain the most impor-

tant market, in terms of size and growth. Without China, global growth of chemical

production would be around 1.5 percentage points lower (Feri Chemdata 2015; IHS

Economics 2015).

Fig. 2 Emerging markets driving chemical growth (Source: Feri Chemdata, IHS Economics,

BASF SE)

44 K. Bock

As a consequence of this globalized competitive landscape, it is estimated that

by 2030 five to eight of the global top ten chemical players will come from Asia and

the Middle East. Only a few multinational companies from established markets are

likely to stay in the top ten (A.T. Kearney 2012).

3.2 Regional Diversification: A Special Challenge for Europe

Parallel to this development, the raw material landscape is diversifying with major

implications on basic chemicals: Each region has its specific raw material base that

is driving its value chains.

In North America, the shale gas and oil boom has led to the revitalization of the

continent’s chemical industry, improving the cost position especially for producers

of base chemicals and leading to increased investments. According to the Associ-

ation of the American Chemistry Council (ACC), roughly 246 chemical industry

investment projects valued at $153 billion had been publicly announced until

September 2015 (ACC 2015).

China, by contrast, is counting on a renaissance of coal-based chemistry, mainly

to produce basic chemical products such as ammonia, methanol, and olefins. Such

plants have an enormous cash cost advantage due to the extremely low price for

coal, especially in Western China. However, initial investment costs are signifi-

cantly higher than those for gas-based converters, and the facilities need to be

operated at maximum rates for a long time in order to achieve a positive return on

investment (IHS China Coal Chemical Industry Analysis 2013).

The industry in the Middle East is strong due to the availability of low-price gas

feedstocks. Saudi Aramco and SABIC, for instance, have been able to extend their

value chains and convert their feedstocks into chemical products (Saudi Aramco

2015; SABIC 2015).

Europe’s chemical industry cannot build on low-price feedstock. The continent

relies mainly on naphtha and also faces strict regulatory requirements. The

European chemical industry has thus become a world champion in efficiently

using feedstock by integrating production and infrastructure. For example, between

1990 and 2014, the chemical industry more than halved its emissions of greenhouse

gases while increasing production by 78%. Despite these efforts, the European

chemical industry lost considerable market share over a 20-year period (1995,

32.3%; 2015, 14.7%) due to rapidly growing chemical production in Asia. At the

same time, the European chemical industry has focused more and more on solutions

and specialties requiring a strong focus on innovation (Cefic, online 2016).

3.3 Importance of Innovation

Innovation is a key driver in the chemical industry, and examples are numerous—to

name a few: industrial synthesis of ammonia enabling the large-scale production of

fertilizers, invention of plastics making products lighter and more durable, or the

industrial production of vitamins. The steadily increasing importance of innovation


is reflected in rising global research and development (R&D) spending in recent

years. A closer look reveals, however, that this increase in R&D spending is mainly

driven by China, which is not satisfied with producing basic chemicals alone, but is

eager to also develop specialty products and its own robust technologies.

This development is mirrored in patent statistics. Between 2001 and 2013, the

number of chemical patents doubled with China becoming an important player in

the field of innovation. The country not only recorded the largest absolute increase

in R&D spending, it also filed for significantly more patents: In 2000, China

accounted for 7% of all patent applications only, but in 2013 it already accounted

for 52%. The number of patents filed by other players from the emerging markets

has also been picking up speed (Fig. 3).

3.4 Sustainability: An Integral Part of Today’s Business Models

Business models in the chemical industry need to reflect the importance of sustain-

ability. Sustainability means to combine economic success, environmental protec-

tion, and social responsibility, and its perception has strongly evolved in the last

years—starting with a license-to-operate view, it is today also a strong business

driver.2 Thus, the spectrum of topics in the field of sustainability is broad ranging

from compliance with ever-stricter regulatory requirements, continuous efforts to

increase efficiency efforts of one’s own processes, and customer demand for more

sustainable products to requests for high transparency from the public and

Fig. 3 Increasing R&D spending in chemicals is mainly driven by China (Source: Feri Chemdata,

BASF SE)

2See also guidelines of VCI for sustainability/chemiehoch3 (online, 2015).

46 K. Bock

investors. It is obvious that sustainability means more than just reducing the number

of accidents or emissions; it “has become part of the corporate DNA on a global

scale . . .” (Roland Berger 2011).

Sustainability goes hand in hand with innovation and will also offer chemical

companies opportunities to grow, especially for those who have implemented inte-

grated sustainable thinking into how they run their businesses. To illustrate this,

according to the latest estimates from the UN, more than 9.5 billion people will live

on the planet by 2050. According to the UN, until 2050, the population living in

cities worldwide is expected to grow by 2.5 billion; this equals approximately

100 times the size of Shanghai’s resident population today. The share of the global

population living in urban areas will grow from 50% today to two-thirds by 2050;

by comparison, the figure in 1950 was just 29% (UN 2014 and 2015; chinadaily.

com February 2014).

As a consequence, it is predicted that the demand for primary energy will rise by

50% (World Energy Council 2013; Exxon Mobil 2015)3 and the demand for food

by 30% by 2050 (The Food and Agriculture Organization of the United Nations

2012). It is obvious that this growth will put an increasing strain on the world’s

resources. Chemistry, with its wide-ranging portfolio of products and technologies

for nearly every industry, is an enabler for solutions to these challenges, including

energy scarcity, climate change, food waste, and clean water. Examples are new

materials for batteries enabling electromobility, filter membranes for water purifi-

cation and desalination, and highly effective plant protection products, which

increase crop yields.

4 Business Models in the Chemical Industry

4.1 Competitive Environment

The trends highlighted in the previous chapter describe a highly competitive and

complex market environment which may be summed up as follows:

• New companies from emerging markets have entered the marketplace strongly

challengingWestern chemical companies in an increasing number of value chains.

• These new competitors are also stepping up their R&D efforts and develop

robust technology positions.

• The gap in feedstock costs between the regions is growing, particularly affecting

European chemical producers in an adverse manner.

• Sustainability is increasingly gaining in importance, especially to fulfill cus-

tomer needs, and is strongly linked to innovation.

Such an environment places heightened demands on sharpened business models

as a basis for competitiveness and future success. Based on their strengths and

3And own computations based on ExxonMobil “The Outlook for Energy: A View to 2040.


capabilities, companies need to have a clear idea, which business model to choose.

They also need to be prepared for the next disruption—following the fast growth of

the new emerging country competitors, digitalization will change industry’s land-

scape significantly, challenging formerly successful business models.

4.2 Business Models in Comparison

In principle, three business models can be distinguished in the chemical industry:

• Basic chemicals, produced in big volumes: For this category of products,

so-called commodities, scale effects as well as technological and cost leadership

are decisive factors. Cost-competitive access to resources as raw materials and

energy is key but can be compensated for by smart logistics and highly inte-

grated production and infrastructure.

• Application-oriented solutions are products offering specific features for

defined customer industries, complemented by services: Key success factors

here are proximity to customers, understanding of their markets as well as regu-

latory requirements, and innovation power.

• Product innovation-driven specialties: The ability to develop new active

ingredients or new chemical entities, formulation know-how, as well as life

cycle management including regulatory expertise are critical success factors.

The following example illustrates some differences between the business

models. Today’s world-scale plants for producing the basic chemical methanol

have a capacity of more than two million tons based on 8000 h of operation per year

that translates into 6000 ton of methanol every day, which is transported by

pipeline, truck, and railroad. The volume produced in such a plant on one day

typically represents the annual production volume of a life cycle product.

Figure 4 highlights the differences between the three business models in terms of

resource requirements. These models have to be understood as archetypes—in

practice, there might be overlaps between the models.

Fig. 4 Business models by intensities (percentage of expenses in relation to sales) (Source: BASF

SE)

48 K. Bock

4.2.1 Basic ChemicalsBasic products typically demand high capital expenditures—speaking of an “asset-

heavy” business. In contrast, labor intensity is low due to large economies of scale,

automation, and a lean sales and marketing setup—that means a higher turnover per

employee can typically be achieved in comparison to the other business models.

Technical service is usually not required as the product performance is well known

to the customer industries with a defined specification. Raw materials make up the

major share of the costs. The product is sold into a large variety of industries, which

has a stabilizing effect on demand to a certain degree.

Basic products like methanol are usually easily exchangeable with competitors’

products. For example, one characteristic of a commoditized basic chemical busi-

ness is swap arrangements between competitors to lower the distribution costs for

the benefit of the customers.

Within this business model, differentiation between the producers of base

chemicals mainly takes place on the basis of their access to cost-competitive raw

materials, their production technology, and the derived position in the cost curve.

The marginal producer—the one with the highest costs at a given level of

demand—sets the price. Typically, price steering within this business is done

centrally, based on a clear customer segmentation and on the actual supply and

demand situation. The sales process is often supported by e-commerce platforms.

As the planning and construction of new plants require lead times of several

years, market intelligence must indicate where and when to invest.

While R&D intensity is relatively low, continuous investment into further

process improvements—incremental and disruptive ones—is key. Partnering with

engineering companies is one further option to strengthen a company’s competitive

position.

Example: Building on Economy of Scale and Integration into the “Verbund”The increasing pressure on Europe as a location for the production of basic

chemicals has been described in Chap. 3. One possibility of mitigating the

disadvantages of a lack of access to low-price feedstock is the “Verbund or

integrated site concept”—a key success factor for BASF’s operational excellence.

In this regard the production of acrylic acid is a good example of strong

integration of value chains in the production. Acrylic acid is based on propylene

and a chemical building block for a diverse downstream portfolio of products by

BASF. Acrylates for example are used in dispersions for paints and coatings, via

polymerization of acrylic acid superabsorbers are produced as a basis for hygiene

products like diapers. The majority of acrylic acid is therefore used in the internal

production network, allowing for optimization and close integration with regard to

energy and material flows.

In combination with a continuous technology improvement the economy of

scale and cost advantages offered by the Verbund production are key success

factors for BASF’s leading position in acrylic acid (Fig. 5).


http://dx.doi.org/10.1007/978-3-319-48938-4_3

4.2.2 Application-Oriented SolutionsThe second business model is represented by the application-oriented solutions.

Capex intensity is low to medium, but labor intensity is high. Products are designed

to, for example, improve a customer’s product or even enable a specific application.

Thus, a sound understanding of how the customer is using the chemical product is

crucial, and the value of the product is determined by the performance in the appli-

cation. Moreover, it is not about selling just a raw material but enhancing the offer

with, e.g., specific application know-how or services. Business is typically done in

projects with the customers and leads to joint innovations, making customer

intimacy quite high.

As the customer industries vary strongly in their needs, the nature of this busi-

ness model can be best illustrated through examples. The following highlights three

possible focus points—enabling a customer to use a specific product in an appli-

cation, taking over a production step within the customer process, and supporting

customers in selecting the more sustainable product.

Example 1: Enhancing a Product Offering with Specific Processingand Application Know-HowBASF’s engineering plastics are used in the automotive industry to replace metal

parts, helping to reduce weight. To achieve this, these materials are formed into

their final shape (see photo) via injection molding. BASF supports customers with

its highly sophisticated simulation tool Ultrasim® in order to evaluate the final

Fig. 5 Acrylic acid plant, Ludwigshafen, Germany (Photo: BASF SE, 2014)

50 K. Bock

properties of the molded component, such as its structural performance, and to

optimize the customers’ process. Overall, this technology reduces components’

mass, minimizes design and development costs, and improves customer confidence

in using high-performance plastic materials to replace metal parts (Fig. 6).

Example 2: Integration into the Customer’s Value ChainThe second example shows how specific application know-how can even entail

integration into the customer’s value chain. BASF supplies coatings to the auto-

motive industry and has acquired broad expertise not only in the production but also

the application of various paint layers. Together with the carmakers, BASF is

developing innovative application processes and helps to optimize production.

The cost-per-unit (CPU) concept is a particular form of this close partnership.

With CPU invoicing, the car manufacturer no longer pays for the amount of paint

delivered but instead for each perfectly coated body.

Fig. 6 The world’s first plastic transmission crossbeam in the rear axle subframe has been

developed by ContiTech Vibration Control and BASF for the Mercedes-Benz S-Class. Thanks

to Ultrasim®, it was possible to define the component geometry at an early stage and reduce the

number of prototypes (Photo: BASF SE, 2015)


Example 3: Comparing Product Alternatives Using the Eco-efficiency MethodIn a growing number of cases, customers today often expect not only a reliable

supply of high-quality material but additional support when it comes to choosing

the most sustainable solution for a specific task.

Based on an “eco-efficiency analysis,” introduced by BASF in 1996, the envi-

ronmental impact of using new amino carboxylate chelating agents compared with

phosphate in household automatic dishwashing (ADW) tabs under European

conditions has been investigated.

The environmental categories analyzed across the product life cycle are energy

consumption, resource consumption, emissions, human and eco-toxicity, risk, and

land use. The results demonstrate that the new amino carboxylates have less impact

on the environment than phosphate. The differences are derived from resource

consumption associated with the production of phosphate, as well as from the

impact of water emissions and solid waste. Using this analysis, customers can

make better choices. In addition, BASF has offered the formulation expertise how

to include the new ingredient in the ADW product.

In conclusion, the business model “application-oriented solutions” builds on a

solid understanding of customer processes. Differentiation takes place via appli-

cation know-how and additional services beyond the pure product offering.

4.2.3 Product Innovation-Driven SpecialtiesThe third business model comprises the development, production, and marketing of

what are known as “specialties,” characterized by a high level of R&D and labor

intensity. Typical examples are new active ingredients for plant protection

products. Successfully implementing such a business model requires sound knowl-

edge of chemical synthesis, combined with an understanding of the mode of action,

facilities to test the new ingredients under real-life conditions, and regulatory

expertise to obtain the required regulatory approvals. It is also critical to manage

the innovation pipeline by continuously seeking new active ingredients and safe-

guarding one’s competitive position through patent protection. Furthermore,

customers expect support in learning the most efficient and safe application of the

product.

As competitors usually enter the marketplace with generic products after the

patent protection has expired, measures must be in place to defend a company’s

position. Examples are enhancing product performance through new formulations,

expanding the geographical scope, or strengthening customer loyalty via brand

management.

Example: Active Ingredient Innovation ProcessManaging the innovation pipeline is key when it comes to specialties. BASF’s Crop

Protection division broadly screens molecules in lab and field trials to identify

candidates to be analyzed in more detail; these are the “development candidates.”

The R&D intensity is high (R&D expenses typically amount to about 10% of net

sales) compared to that of a basic chemical model (BASF, 1–2%). The average cost

until the market launch of a new active ingredient can total more than€200 million

(Fig. 7).

52 K. Bock

4.2.4 New Business Model on the Horizon: Circular EconomyAside from the three rather classic business models presented above, a new way of

doing business with chemicals is gaining importance. It is about closing product

loops—giving rise to the term “circular economy.”

Drivers for this new model are limited resources and the rise of the sharing

economy. This can mean in practice to supply a chemical product with a specific

performance feature to the customer, recover it after the customer has applied it,

purify or reprocess it, and finally resupply it to the customer. Such a model also

paves the way for different pricing models, as the chemical product is a transit item

and what counts is its performance in the application.

Closing the loop is a viable option when the product does not change its

chemical identity during the application phase and when it has a high value. This

type of business model is already established in the catalyst business. Catalysts

typically do not change their chemical identity during the use phase and contain

high-value precious metals like platinum or palladium, offering an incentive for

recovery, as the following example shows.

Example: Recovery of Precious Metals Used in CatalystsOne major application for platinum, palladium, and rhodium (otherwise known as

platinum group metals, or PGMs) is in vehicle catalytic converters, sold by BASF to

the automotive industry. When an automobile has reached the end of its useful life,

BASF retrieves the spent automobile catalysts and recovers the PGMs. Building on

Fig. 7 For specialties managing the innovation process is key (Source: BASF SE)


large-scale PGM recycling units keeps costs competitive compared to alternatives

like mining or open-market purchases.

With resources becoming scarcer, such closing of product loops might become

attractive for other chemicals in the future, such as high-value solvents.

5 Business Model Success Factors and the Next Challenge

5.1 Portfolio Management as a Precondition

Before deciding on which business model fits best, one key question needs to be

answered: In which kind of businesses does a company want to be active? That is

the basis of portfolio management.

The selection of businesses a company wants to focus on is often driven by

overall strategic considerations. As an example, a company with highly cost-

competitive access to raw materials like natural gas or naphtha would probably

build its strategy on this key differentiating feature and would strive for a strong

position in the arena of basic chemicals. Recalling its own strengths, such a com-

pany might refrain from establishing small-size specialty businesses.

This can be totally different to a company that has continuously developed new

products or has spotted new applications opportunities based on a broad expertise in

specific customer industries. This company might build its strategy on the trends

that are most relevant for its customers and where innovative chemistry and appli-

cation know-how can add value.

A third approach could be to have several businesses along specific chemical

value chains, starting from basic chemicals up to specialties, built on common

infrastructure and R&D platforms to utilize synergies.

Overall, the portfolio of businesses must fit to the strengths and the strategic

orientation of a company, and it is also clear that the portfolio is typically not static.

Businesses that have been an important part of the portfolio, might be divested as

new owners, could better shape their future. Moves like divestments, acquisitions,

or bundling of businesses in joint ventures might be complemented by redistri-

bution of resources within the existing portfolio.

Portfolio management is a continuous task, and new strategic orientations could

lead to significant change of course, e.g., acquisitions of businesses that are new to a

company, but complement its technological or geographical base. It is therefore no

surprise that the chemical industry is one of the most active industries in terms of

portfolio optimization.

5.2 Success Factors for a Multi-business Model Company

With the portfolio of businesses given, a clear decision on the business models must

be taken, especially amid increasing competitive pressure in the chemical industry.

In practice, there might be certain hybrid forms between the archetypes, such as a

54 K. Bock

basic chemical model that includes some selected services. However, the major

theme of the business model implemented must be understood and embraced by the

organization: Is it about cost leadership, or deep understanding of the customers’

applications, or about managing the life cycle of a new active ingredient?

And this is essential: A perfectly designed business model will not lead to

success unless it is strictly implemented, building on the proper mindset of the

entire organization. In a business model dealing with basic chemicals, the focus

must be on cost and efficiency, the search for ways to optimize production and

logistics; the team for the application-oriented solutions, on the other hand, has to

understand the customers’ processes as well as their market needs and develop new

value-enhancing services.

Against this backdrop, the question arises as to whether it is possible to run

several business models in one company. Looking at the development of the

chemical industry within the last decades, it becomes clear that many Western

chemical companies have chosen to focus on selected businesses and sharpen their

business models. Often, the business with base chemicals has been spun off, thus

breaking away from a value chain orientation which has been the hallmark of the

chemical industry since its beginnings.

It is true that having more than one business model in the portfolio can lead to

unsatisfying trade-offs. There is often an organizational bias toward “fancier”

business models or models built on high innovation intensity and close customer

contacts. They are often perceived by an organization to be more value adding.

Nonetheless, it is possible to run different business models under one roof. And

for large companies, it is indispensable to master different business models simul-

taneously. Four success factors can be named here, factors that should also apply for

those companies opting for a more pure play approach:

• Understand the market needs: The market teaches whether the customer is

willing to pay a premium for specific services or not. Market characteristics

should therefore be reviewed regularly, and changes in customer buying behav-

ior must be recognized early on.

• Implement the model consistently: It is essential to decide on one of the models

and then stick to its implementation. The organizational setup must reflect this

decision, e.g., businesses dealing with basic chemicals should be managed

separately from those taking care of solutions and specialties, and personnel

with the required competencies has to be allocated to the different businesses. In

addition, a clear set of KPIs must be defined—these KPIs are different for each

of the different business models. Whereas a basic chemical producer will regu-

larly measure its cost position, a business based on application-oriented solu-

tions will monitor the number of customer projects.

• Review it regularly: Business models are not static and need to be adapted to

changes in the market environment. A review system must therefore be in place

to track whether the business model is still valid. For example, a business model

once based on providing application know-how might face pressure if the

industry supplied begins insourcing this expertise—unless new application fields


can be identified, adapting the business model toward basic products might

become necessary. Or it might be necessary to continue with a specific additional

service in emerging markets while mature markets are no longer willing to pay.

The implementation of the business model therefore also needs to account for

regional differences. And in case adaptations to or changes in the business model

do not succeed, portfolio measures might be necessary, e.g., divestment of

businesses or strengthening the competitive position through acquisitions.

• Ensure flexibility in supporting functions: A company running several differ-

ent business models needs flexibility in its support functions. A business unit

managing specialties typically needs different services—for example, regulatory

support for product approvals, customized testing facilities—than a unit respon-

sible for basic chemicals. The supporting functions must adapt their offerings to

these business needs accordingly.

5.3 The Next Challenge: The Impact of Industry 4.0

After the rise of competitors from emerging markets, the next wave is rolling in:

Industry 4.0 has the potential to challenge well-established business models and

push companies to change, enhance, or sharpen their approaches.

Driven by significant advancements in computer performance, nanoelectronics,

and communication infrastructure, many digital technologies have reached levels of

price, performance, and robustness at which applications in industry become

attractive (Budde, McKinsey & Company 2011).4

Around 2010, digital technologies passed a new threshold, enabling the digitali-

zation of the world of physical goods and kicking off Industry 4.0 in consumer

goods, tools, and the automotive sector. Compared to other manufacturing

industries, the chemical industry has been slower to embrace digitalization for its

process technology and is just starting to embark on the transition to Industry 4.0

(BDI and Roland Berger 2015).5 There are several reasons for this, including little

demand thus far for digitalization from the chemical industry’s customers, the high

complexity of introducing digital technologies, and the fact that the life cycle of

chemical plants is significantly longer than those of plants in other manufacturing

industries. The closer an industry is to consumers, the more discrete the

manufacturing is; and the more the core of the business model is data driven, the

more advanced a company is likely to be in its digital transformation.

However, several applications are linked to Industry 4.0 that could hold potential

for the chemical industry. The applications can be divided into two groups:

4In Germany, the federal government has allocated up to €200 million for the program “Future

Project Industry 4.0,” aimed at shaping the next industrial revolution and strengthening Germany’s

attractiveness as a business location (BMBF 2015, online).5BDI and Roland Berger name in the study Die digitale Transformation in der Industrie, 2015, athird wave in industry 4.0 in which the chemical industry is part of.

56 K. Bock

applications aimed at improving efficiency and productivity, such as preventive

maintenance, real-time monitoring of sea containers, demand planning assisted by

big data, and horizontal networking of planning systems with customers and

suppliers, while new and established digital business models can improve offerings

to customers using digital technologies.

One example of how BASF is already using intelligent analysis of big data is an

application called “agIT.” This tool, offered by the Crop Protection division,

develops external data resources, such as satellite information, images, agronomic

data, and weather data and combines these with BASF data. This provides farmers

with information to help them, for example, optimize the use of crop protection

products. When farmers agree to participate and share their data, BASF’s agro-

nomics experts can use those data sets to generate automated recommendations. As

the growing season progresses, farmers receive increasingly reliable simulations

indicating the impact each of their decisions will have on the harvest. The informa-

tion also helps to unlock more of biology’s secrets, which plant breeders can use in

turn for further optimization.

In terms of the main business models, Industry 4.0 opens up new opportunities—for

example:

• Efficiency in manufacturing processes and logistics can be further increased to

enable a better position on the cost curve—basic chemical producers will have to

discover how to make use of the new technologies in order to stay competitive.

• New data-driven value-adding services will be possible, allowing for better

differentiation on the market—those running an “application-oriented solutions”

model will especially have to consider this and enhance their service offering.

6 Conclusion

The market environment for chemical companies has changed significantly during

the last decades. The rise of emerging market players has intensified competition

significantly. With Industry 4.0 knocking at the door, the pace of change will not

slow down. A recent McKinsey study speaks of an era of “hypercompetition”

(Dobbs et al., McKinsey & Company 2015).

To translate the associated challenges into opportunities and business growth,

chemical companies need to have a clear strategy in place. They first have to decide

which businesses should be in their portfolio. Second, organizing businesses

according to their characteristics and pursuing a strict business model will be

decisive in creating and strengthening competitiveness. The different types of

business models that chemical companies can opt for are basic chemicals,

application-oriented solutions, and product innovation-driven specialties.

As outlined the corresponding success factors are keeping a clear view of

market realities, employing strict implementation, having a review system in

place, and ensuring flexible back-end organization. If this can be achieved, several


business models can be run inside one company, resulting in a style of business

model management besides the traditional portfolio management.

The final part of this article assessed how Industry 4.0 will affect the chemical

industry. While a commodity chemical will remain a commodity chemical in the

future, additional services could create new revenue streams. The chemical industry

needs to continue to transform itself. Just as in other sectors, chemical companies

must have the will to reimagine themselves before tech and tech-enabled firms do

so. Digital transformation will open significant opportunities for those who under-

stand how to apply it.

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Business Model Innovation: Some KeySuccess Factors at Bosch

Volkmar Denner

The notion of “business models” or “business model innovation” has recently been

very fashionable. This is to some extent due to the tremendous success of start-up

companies such as Uber and Airbnb who revolutionized traditional businesses. But

we should remember that adapting the way how to do business has always been

crucial for sustainable success. In the 1950s, McDonalds advanced the fast-food

industry by building on franchise systems, and in the 1980s, Dell renovated the

computer industry by providing individualized PC hardware based on stock com-

ponents. At the end, it is not surprising that “business models” are at the center of

discussions since, in a nutshell, they describe how a company makes money.

1 Business Model Innovation at Bosch

Bosch has its roots in the automotive industry focusing from the beginning on the

development and production of innovative, high-quality components. This

Tier 1 role with most of the time B2B relationships still characterizes the majority

of Bosch’s business today. Additionally, technology has been and still is at the

center of Bosch’s innovation strategy. With industrial, consumer goods, energy,

and building-related sectors, the business portfolio of Bosch is nowadays much

more diversified than it has been at the beginning and reaches around EUR 70 bn of

sales in 2015. Nevertheless, Bosch has to continuously screen its competitive

environment and be alert for potential disruptive threats. Especially in the upcom-

ing Internet of Things era, relying on technological improvements is not sufficient.

As mentioned before, the revenue model is the most disruptive element for

businesses, and this is even more true for the Internet of Things. The increasing

ease of technology deployment over the Internet leads to shorter life cycles than in

the past, especially for software. Updating software over the air has been

V. Denner (*)

Robert Bosch GmbH, Stuttgart, Germany



DOI 10.1007/978-3-319-48938-4_5

61

unthinkable a couple of years ago, but is now a common practice for smartphones

and even strikes the automotive industry now. Furthermore, the progressing digiti-

zation allows to streamline existing value chains. Companies such as Uber and

Airbnb have successfully based their business on platforms allowing them to

capitalize on inefficiencies in the value chain. Furthermore, they leverage the

network effect of their customer base as market entry barrier for their competitors

and are capital efficient since they practically operate without assets.

Bosch is striving for a leading position in the Internet of Things; therefore it is of

tremendous importance that the company capitalizes on its own strengths and

products while continuously reinventing its business to prevent the attack of

disruptors. Hence, Bosch decided to pursue different approaches to be aware,

to test, and to implement new business models which will be described in the

following.

1.1 State-of-the-Art Knowledge and Best Practices for BusinessModel Innovation

First of all, to operate at state-of-the-art level, it is important to set the theoretical

base for business model innovation within Bosch. Even though different business

models have always been in practical use, the scientific research about this topic is

relatively recent. The most important academic contributions to this field include

publications from the institute of Prof. Gassmann at the University of St.Gallen

(Gassmann and Frankenberger 2013), from Prof. Fleisch at the University of

St.Gallen (Fleisch 2014), from the business theorist and consultant Alexander

Osterwalder (Osterwalder and Pigneur 2010), from the blogger Eric Ries (2011),

and from Prof. Blank from Stanford University (Blank and Dorf 2012). The

University of St.Gallen pursues the approach of analyzing best practices from

successful enterprises which currently results in 55 business model patterns (in a

recent publication the authors considered extending the concept to 57 patterns).

Those patterns cover a comprehensive collection of possible business model

concepts which can be transferred, altered, and combined to create new business

models. To offer a practicable way to apply this method in organizations, the

patterns were summarized on 55 cards, each containing general information and

practical examples of one specific business model pattern. These sets of cards can

be used in workshops or sent to users worldwide via interactive software. The logic

behind this method thus does not lie in the uniqueness of the cards themselves but in

their creative combination and application. The key element of the Osterwalder

approach is the Business Model Canvas which structures in an illustrative way the

different elements of a business model. The value proposition and its design are at

the center of this methodology. Last but not least, Eric Ries developed in 2008 the

lean start-up philosophy based on his experience as a start-up advisor and

co-founder. The core philosophy is based on the lean manufacturing idea pioneered

by Taiichi Ohno from Toyota (Ohno 1988). It means “learning to tell the difference

between the activities in an enterprise that create value and those activities that are a

62 V. Denner

form of waste” (Ohno 1988). The core of the model is represented by one loop that

consists of iterative “build,” “measure,” and “learn” steps. They represent the

experimentation and validation (learning) through working with customers. The

most known concept from the lean start-up methodology is the so-called Minimum

Viable Product (MVP). The MVP is created during the “build” phase and intends to

check the fundamental business hypothesis with the least effort possible. The MVP

concept is ideally enhanced by the “design thinking” principles of Tim Brown

(2009) which bring together the process of user-centered design with the techno-

logical innovation and the business model. Finding a user-centered solution is not

as easy as it sounds and requires insights, observation, and empathy during the

design process. But as we know from the success stories of the iPhone or the

Thermomix “converting need into demand” pays off in terms of economic value.

All mentioned methodologies are part of the business model innovation process at

Bosch, supporting the different phases of it. The phases are not a predefined

sequence (process) but will in reality be handled in a highly iterative way, adapting

and looping back whenever needed. In the ideation phase, the search for new ideas

is best supported and complemented by the 55 business model patterns from the

University of St.Gallen which provide guidance and inspiration. Once an idea has

been selected, the Osterwalder Canvas helps structure and complement the thoughts

around it. A good business model idea is usually characterized by a clear and

distinct value proposition. So, the clearer the business model can be described by

working through the Osterwalder Canvas, the easier the actual start of business will

be. The start itself is best supported by the lean methodology which tests the ideas

which have been generated and elaborated before. Customer focus, so finding a

user-centered solution, is then the key element. The “Minimum Viable Product” is

used to get in contact with first customers, discover and validate their needs, and

evolve the marketing and sales strategy. Ideally, this phase also allows to build first

customer demand, so creating market pull. But, it should be noted that anytime

during this journey, facts or insights can come up that make it mandatory to change

the idea or the actual approach, so to pivot. This pivoting is one fundamental

distinction to the classical development process which focuses on proper specifi-

cation and execution. Targets of the classical development are set at the beginning and

then pursued through until the start of production. This structured and focused

project management approach secures the quality and excellence needed in today’s

automotive products. Interestingly, the core of the classical development process

and the business model innovation approach have one thing in common. Both are

valid independently of the business sector or industry in which they are used.

Of course, the classical development process considers necessary standards of the

industry, but is in its fundamentals applicable to different products and business

sectors. The business model innovation process, as described above, is derived from

start-up and best practices and as such independent of the industry sector.

Business Model Innovation: Some Key Success Factors at Bosch 63

1.2 Change Perspective to Open Up for New Business Models

Building on cross-industry innovation and opening up for external ideas is another

approach how Bosch fosters business model innovation within the company. As

Prof. Chesbrough from Berkeley University described in his book “Open

Innovation” (Chesbrough 2006), it is not always the one with the best technological

solution who outperforms the market, but the one with the best business model. He

claims that it is important to build the company’s innovative strength not only on

internal ideas but also on external inspirations. Building on Chesbrough’s concept,

business model innovation can be fostered by bringing in external and diverse

perspectives. For this reason, Bosch established in 2008 a corporate venture capital

organization. One main purpose of this initiative is to observe and screen the

start-up scene for innovative and disruptive ideas. Beyond scouting, the venture

capital setup allows to invest in a few selected start-ups. The start-ups benefit from

the investment not only financially but also by the collaboration with Bosch. On the

other hand, this allows Bosch to complement its own activities by testing different

technological approaches or business models through the start-up investment.

Therefore, investing in external start-ups allows not only to observe the start-up

scene but provides the opportunity to diversify the corporate’s risk profile. Addi-

tionally, the venture capital group challenges continuously the internal Bosch

organization by confronting it with external ideas. In some cases, this might be

provoking for the internal development, leading to a “not-invented-here” reaction

and the actual investment in the start-up might not take place, but this outside view

always inspires and might alter the perspective on the topic.

Not only external start-ups give the opportunity for a corporation such as Bosch

to diversify its own risk profile. Also setting up start-ups within the corporation

paves the way for creating and testing new business models. For this reason, Bosch

created the so-called “Bosch Start-up Platform” which provides infrastructure and

guidance for start-up ideas that arise within the corporate research department. This

setup allows first of all to commercialize and therefore to test ideas that are outside

of the core business of the corporation. But even more importantly, it provides the

opportunity to test new business models and market approaches in a start-up like

environment. Again, this increases the freedom in thinking and creating new and

potentially disruptive solution sets. As a side effect, the start-up like environment

attracts young outside talents which additionally bring in further insights and

diverse perspectives.

All these initiatives from the Bosch side to bring in external views intend to

capitalize on cross-domain know-how and thinking. Consequently, the business

model innovations that arise from those activities are mostly independent from the

current industrial setup of Bosch. It should be noted that the start-up activities and

the research oriented business model innovation approach from Bosch described

above mutually inspire and support each other. For example, the Bosch internal

start-ups use methodologies such as the Osterwalder Canvas and the “Minimum

Viable Product” approach. On the other hand, the business model support organi-

zation benefits from the practical hands-on experience from the start-ups to further

64 V. Denner

evolve their own methodologies. Consequently, the internal start-ups provide

learnings to the Bosch organization that are beyond their actual business.

1.3 Core Competencies as Source for Business Model Innovation

Besides all the external, theoretical, and cross-industry approaches, one should not

forget that business model innovation is also possible within the core organization

and business. First of all, the core business at Bosch relies on one important strength

which is the knowledge of the customer. As Osterwalder already described in its

business model canvas, knowing the gains and the pains of the customers is crucial

for elaborating the value proposition. Strong domain expertise and customer access

are a clear advantage when identifying the customer needs. This is especially true

for industries, such as the automotive industry, characterized by a limited number of

customers worldwide. Bosch can build on its 130 year long history in this industry

to fulfill customer needs. Building the business on distinct customer needs and

insights from user experience increases the opportunity for differentiation and

therefore for economic success. Beyond customer know-how, it is essential to

know the value chain and competitive landscape to identify changes and disruptive

opportunities that arise from it. Again, deep industry insights are advantageous for

the understanding of the value chain.

2 Case Studies for Business Model Innovation at Bosch

As described above, Bosch uses different approaches to identify and develop new

business models. Some of those activities are based on cross-industry approaches

such as the methodologies and the intentional perspective changes. Other activities

rely on the fundamental strengths of Bosch, such as customer focus based on deep

industry insights. To get a better understanding of those approaches, each of them

will be illustrated by one example in the following.

2.1 Case Study 1: Parking Reinvented

The first example describes how new methodologies and tools are vital for great

innovations. Since a couple of years, Bosch uses an internal communication tool

called “Bosch Connect” which offers the opportunity for associates around the

world to exchange ideas, know-how, and best practices. Up to now around 17,000

communities have been created and associates from more than 73 countries are

using this way of interaction. In 2012, two associates shared their innovative idea

about the new way of finding a parking spot in one of those communities. Intensive

discussions among community members arose since the topic of parking bothers

many people, and finally those discussions helped push the idea forward.

Complemented by a thorough analysis of the business field, this idea became the


nucleus of a newly created project about “connected parking” at Bosch which

officially started in 2015. The “connected parking” project has three central topics.

The idea of “community-based parking” intends to use the existing sensors in the

car to identify parking spaces in neighborhoods and to share them via cloud

services. The second topic is the “active park lot management” which uses sensor

information installed in the parking area to identify and guide car drivers to the

nearest parking spot available. This technology additionally helps garage operators

to improve the utilization of their capacities. The third topic is the one with the

highest user benefit but also the one with the most demanding technology

requirements, the so-called “automated valet parking”. This solution relieves

drivers of having to search for a parking place by enabling the vehicle to park

itself. Drivers simply drop off their vehicle at the entrance to a parking garage.

Using a smartphone app, they instruct the car to find itself a place to park. Fully

automated parking will require several things, including an intelligent parking

garage infrastructure, on-board vehicle sensors, and connectivity for both. The

advantages of this solution are clear. Car drivers save time and money—first

because the time for finding a parking space is eliminated and second because the

automated vehicle avoids damages on the car while driving securely based on its

accurate sensor information.

While the user advantage is clear, the best business model had to be developed.

For this reason, the project team made use of the methodologies and the know-how

about business model innovation that were gathered at Bosch. First, the project

team used the Osterwalder canvas to establish an initial business model idea. In a

second step, they elaborated this initial idea to develop seven business models with

different values for different customer segments and for distinct business

ecosystems. One example is the use case of airport parking. Today, car drivers

arriving at the airport have to first search a parking spot in one of the parking areas

nearby. Then, they have to carry their luggage to the check-in gate, rushing through

security to catch the flight. Automated valet parking would allow the drivers to drop

off their car right in front of the check-in gate area and the car would park itself in

one of the parking areas. The project team established for this particular use case a

detailed Osterwalder canvas identifying different customer segments from business

travelers to traditional holiday customers. For each of those customer segments, the

gains and pains were identified building the basis for the corresponding value

proposition. Mapping then the customer value add to the willigness-to-pay helped

prioritize among the customer segments. Furthermore, the work with the

Osterwalder Canvas leads to a clear picture of required key partners to bring the

business to success. Mapping the potential revenue streams to the ecosystem makes

additionally the financial incentives within the system transparent. For example, the

garage operator benefits from the automatic parking by increasing the utilization of

its parking area. This is not only due to the fact that parking spots can be identified

more efficiently. Automatically parked cars can be packed more densely since there

are no passengers who have to get out of the parked car. By this, 20%more cars can

be parked on the same area. This incentivizes the garage operator to invest in the

required infrastructure.

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This example shows that generic, cross-industry methodologies such as the

Osterwalder Canvas guide successfully the teams to elaborate their business

models. Additionally, this approach broadens the thinking which can then result

in new customers for Bosch, as, for example, the garage operators. Nevertheless,

strong industry ties are then the enabler to bring the solutions to the market. In June

2015, Bosch announced (Bosch 2015a) that it will develop the automated valet

parking in collaboration with one of his main customers: Daimler. Both

companies—Daimler and Bosch—unites the user centricity. “Our customers are

always the center of attention and all of our actions are oriented towards them. In

future the car will even go to them,” explains Prof. Dr. Thomas Weber, Member of

the Board at Daimler AG, responsible for Group Research & Mercedes-Benz Cars

Development. “In collaboration with our partner Bosch and our mobility service

car2go we are developing and testing an infrastructure-based solution for a fully

automated valet parking service. For us another step on our way to autonomous

driving—or as in this case: towards autonomous parking!”

2.2 Case Study 2: Corporate and Start-Up as Perfect Complement

The parking example showed that innovative ideas can arise within companies and

that cross-industry approaches support the internal teams in elaborating the busi-

ness models. The second example will rather focus on how external ideas can

contribute to internal innovations. As described before, Bosch uses a dedicated

venture capital group to scout and collaborate with the external start-up scene. One

way of interacting with the start-up scene is to invest directly into chosen start-ups.

Besides the financial support, the start-ups can leverage the collaboration with

Bosch to foster their own business. In 2014, Bosch invested in the software

company Flybits. Flybits was founded in 2013 to commercialize the pioneering

work on context-aware computing and ubiquitous computing done by Dr. Hossein

Rahnama and his team at Ryerson University (Canada). Companies around the

world develop mobile apps for their products and services. Apps are the most

common way to deliver a mobile experience today and they are an important way

to reach customers. However the majority of those apps are one-fits-all solutions

instead of being personalized and mostly they are static instead of interactive. As a

consequence, the apps lose their appeal resulting in less business value add for the

authoring companies. Flybits offers a software-as-a-service solution that allows

companies to personalize their apps. Beyond location information, Flybits allows to

take as contextual data anything that can be sensed, measured, or imported and

provides a simple and unified way to manage and use all of it. As such, this enables

companies to leverage a highly customer-centric mobile app strategy which

provides them differentiation potential. This combination of location-based and

user-centered personalization of mobile experiences is especially interesting for

providing a superior connected city experience. Since 2013, Bosch cooperates with

municipalities around the world to elaborate and realize concepts for connected

cities. Bosch’s sensor experience and its software platform are essential enablers to


provide connectivity throughout a city and to build services around it. For example,

city infrastructure and public services—such as bus networks, parking lot manage-

ment, paper and waste collection, and information on roadwork—can be connected

virtually, providing local residents with real-time information. This makes it possi-

ble for citizens and visitors to interact with the local authorities directly. If, for

example, part of the infrastructure is not working properly, residents and visitors are

able to immediately find out where there is a functioning alternative and inform

services that there is a need for repair. The Flybits solution offers additionally a

possibility to make those connected city services context sensitive and therefore

providing superior customer experience.

Bosch’s investment in Flybits is the basis for a close cooperation between the

two companies. For example, Bosch can include the Flybits solution into its

offerings to municipalities and enhancing by this the value and uniqueness of the

Bosch solution. On the other hand, Bosch’s first-hand access to municipalities

provides Flybits with additional market access, distribution power, and as a conse-

quence with additional projects. Furthermore, the start-up Flybits benefits from the

brand reputation of Bosch gaining credibility. Looking at this example from the

business model perspective reveals that both companies enhance and complement

their offerings by cooperating and additionally create the opportunity to elaborate

and implement new business models by combining their services. This shows that

not all innovative solutions have to come from within the company and that

including external perspectives and services opens up the solution landscape.

2.3 Case Study 3: Bosch Internal Start-Up Success Story

The first two examples of business model innovation at Bosch rely on cross-

industry methodologies or external complements. But as mentioned before, busi-

ness model innovation can also be derived solely from inside the company. The

success story of the Bosch Engineering Group will serve as an example for this

case. In the automotive sector, Bosch fulfills in most cases the Tier 1 role supplying

at large quantities parts and software to the car manufacturers. Specific customer

requests, that only resulted in small quantities, usually could not be fulfilled due to

time and economic constraints. Therefore in many cases, those customer requests

had to be declined. Therefore, in 1999 Bosch founded the subsidiary called ASSET

(Automotive Systems and Engineering Technology GmbH)—nowadays called

BEG (Bosch Engineering Services Group)—to fill this specific gap in the Bosch

portfolio. This Bosch internal start-up started with 13 associates as a complete

greenfield approach. Independent from Bosch processes, everything had to be

organized by the small start-up team—from buying pencils to organizing the

concierge service. Even the accounting software was different from Bosch and

there was no reporting structure towards the parent company. This complete

freedom, as one of the founding managing directors remembers, was challenge

and opportunity at the same time.

68 V. Denner

One fundamental asset and contribution to the success of the BEG was the team.

First of all, the team comprised former Bosch associates as well as externally

recruited talents. For some of those externally recruited associates, this was even

their first job after their studies. This combination of experience with fresh open

mindset created a special team spirit—one could even say a “BEG company

culture.” For all associates it was essential to listen and learn from each other, to

be tolerant and flexible. This culture was important for the team itself, but paid off

even better for business. The core business of BEG is, as mentioned before, to

develop customer specific solutions and the team, trained to listen carefully, proved

to be highly customer-oriented and acting with entrepreneurial spirit. Furthermore,

the associates had different academic backgrounds from mechanical to software

engineering. This provided the team with a good understanding of inter-

dependencies and system optimization. The customers, mainly from the premium

and luxury segment, valued this strongly and consequently the business developed

favorably.

Additionally, the business model of the BEG proved to meet the trends of the

industry. Big automotive manufacturers are expanding their range of vehicle

models seeking increasingly for support for the software development and the

application adaption. Small, exclusive automakers are looking for unique

functionalities to differentiate with. On top, new target customer groups arose, for

example, from the off-highway segment needing products and engineering services

for excavators and alike. Even more, other industry sectors discovered the advan-

tage to use automotive technologies for their products and requesting the services of

BEG for boats, rail, and industrial applications. In all use cases, the recipe for

success is to provide tailored solutions and to combine the economies of scale of the

Bosch group with the value add of engineering services. The managing director of

BEG, Bernhard Bihr, explains “Our development services are the digital equivalent

of a tailored suit. We select components and systems from the Bosch Group’s

extensive product range, adapt the software to our customer’s individual needs, and

develop new functionalities. Only when the system fits perfectly and the customer

is happy we can declare our job done.” BEG started in 1999 with 13 associates,

already one year later the 100th associate joined, and in 2015 more than 2000

employees contribute to the success of being the leading provider of engineering

and development services across 14 locations in nine different countries, including

Japan, North America, France, Austria, China, Brazil, Italy, and the UK.

3 Leadership: Key Success Factor for Business ModelInnovation

3.1 Make Room for Creativity

It is commonly understood that time pressure kills creativity. Nevertheless, in most

companies development cycles are shortened and go-to-market strategies are striv-

ing for fast achievements. Bosch intentionally tries to counterbalance this trend of


acceleration in selected areas. The majority of technologies and products are

developed within the specific business units, but the forefront of the research activ-

ities at Bosch is the main task of the Corporate Research Group at Bosch. The focus

is therefore on the idea stage, usually until the first prototype, and the opportunity to

transfer the results into the business units. Out of 100 ideas, only four are trans-

ferred to the business units. At first sight, this might seem as a poor result, but a high

selectivity ensures, similar to the venture capital industry, that only the best ideas

can come through. Therefore, to enhance the chances for great technologies and

products, it is essential to ensure the flow of ideas to select from. Since a couple of

years, the Corporate Research Group reserves 10% of its budget for idea genera-

tion. This is reflected in the work routines of each associate since this budget is

entirely spent for the so-called “concept time”. Each associate can use 10% of

his/her time to work on own ideas, concept studies, or projects. To set a clear sign,

every Tuesday morning has been freed from regular or management meetings such

that all associates have the opportunity to work together on their own ideas. During

this time, management is available for coaching and feedback. The idea behind the

concept time is to give associates the freedom to experiment and to work with col-

leagues across projects, functionalities, and regions. Finally, the concept time is one

measure of the management to initiate a certain “outside-of-the-box” thinking, thus

to foster also business model innovation.

As described above, Bosch created at a similar time the so-called “Bosch Start-

up Platform”. Therefore, not only new technologies and products can be transferred

to the business units, also start-up ideas have their room for development. The idea

of the concept time has additionally a strong motivational aspect. As known from

Daniel Pink’s book Drive (Pink 2009), motivation for conceptual, creative tasks is

not driven by monetary rewards, but by three fundamental motivators—autonomy,

mastery, and purpose. By implementing the concept time, the associates can use

their time in a self-directed way (“autonomy”) by choosing with whom to work and

what to work on. Additionally, they have the opportunity to use their time to

enhance their skill set by working on specific topics. For example, a biologist

could explore working with an IT specialist about big data in health care and

enlarge the own IT skills. As such, the concept time also supports the motivational

factor “mastery” and fosters cross-domain innovations. Finally, it should be noted

that the concept time is not only a method to foster creativity and motivation, it also

symbolizes a change in leadership style and working culture. Instead of imposing

subjects and projects, the management gives its associates credit to explore the most

valuable ideas, it empowers its associates to act self-directed, and it pleads for

transparency by transferring hidden projects to the official concept time. On the

other hand, implementing concept time means also a change in attitude and working

culture for the associates. Used to get directives, some associates needed time to get

adapted to the new freedom.

Beyond concepts and time, a room for creativity also needs actually a physical

space. In 2015, Bosch opened officially the new research campus in Renningen. In

the main building, one floor has been declared as creativity space for the associates

of Corporate Research—the so-called “Platform 12”. In a worldwide unique way,

70 V. Denner

Bosch cooperated with a group of artists (Akademie Schloss Solitude und

Künstlerduo Wimmelforschung) to mix artistic with industrial research and to

shape this room for creativity. There is one central room called “base” consisting

of desks, chairs, and sofas as well as 3D printers, tools, and all kinds of digital

interfaces. The “think tank” and the “talk terminal” are completing the “base” and

allow time for thinking as well as for workshop atmosphere. A so-called “strange

agent” from the group of artists accompanies the evolvement of the “Platform 12”

and with his own inspirations initiates change. The idea of the “Platform 12” is to

have a room full of inspirations and continuous experiments.

3.2 Dare to Explore New Territories

Being an entrepreneur, the challenge is not only to have the idea, it is also to dare to

implement it. This requires leaders with entrepreneurial mindset, courage, and

convictions. Bosch has proven that it is possible to make internal start-ups success-

ful, not only in the case of BEG but also in the case of Bosch Sensortec. Bosch

Sensortec is a spin-off of the division “Automotive Electronics” from Bosch. As the

name of the division indicates, the main intention is to develop components for the

automotive industry. The spin-off was created in 2005 to also serve the consumer

electronics market with sensors based on the initial developments in the automotive

division. Micromechanical accelerometers and gyroscopes that used to be

implemented, for example, in ABS/ESP applications, should then be used for

game consoles, laptops, and in smartphones. To attack the volatile, fast, and cost-

driven consumer electronics market, it required full start-up mindset from the first

day. The nucleus of this start-up was a management team with courage and

entrepreneurial thinking. To explore this new business field, the team had the

freedom not only to choose its location outside of Bosch premises but also to

reduce corporate directives to a bare minimum. The task was not only to explore

new markets but also to alter the core competences to outperform these new

markets. One fundamental strength of the “Automotive Electronics” division was

the quality of all their products. This required intensive testing and qualification

procedures. The challenge for the newly founded Bosch Sensortec was to leave

known grounds to explore how to adapt procedures to the market requirements. To

do so, the management team installed intentionally newly hired talents on the

interfaces to the market, while recruiting Bosch experts for the technology part.

This might have created some friction among team members at first sight, but was

the only possibility to implement fast enough the “consumer DNA” into this newly

created entity. Also on the business side, the leadership team had the chance to dive

into the full risk and explore new territories. This required flexibility as well as

resilience. But to legitimize the risk and to reward the team, it was clear from the

beginning that quick wins such as the first purchase orders were required. To keep

the risk calculable, the management team had the task to define and report potential

exit scenarios at all times. But in hindsight, the risk fully paid off.


Ten years after its foundation, Bosch Sensortec has achieved the position of the

leading global provider of innovative micromechanical sensors and solutions in the

consumer electronics market. Since 1995, Bosch has delivered nearly 7 billion

micromechanical sensors (MEMS), and today, three out of four smartphones

worldwide use Bosch Sensortec sensors. Jean-Christophe Eloy, President and

CEO, Yole Developpement, comments as follows for the tenth anniversary

(Bosch 2015b): “Among the ten biggest MEMS companies, Bosch has become a

real titan. It is today the only MEMS company that is taking full manufacturing,

engineering and commercial advantage of its positioning in dual markets, automo-

tive and consumer. The creation of Bosch Sensortec in 2005 has provided the Bosch

group with an incredible competitive advantage and has propelled the company to

first place, with its total MEMS market size worth USD $1.2 billion, 50% higher

than its closest competitor, and an incredible growth momentum.”

3.3 Find a Strong Mentor in the Organization

The examples of “Platform 12” and of Bosch Sensortec show that it requires

creativity, entrepreneurial mindset, and resilience to identify and implement dis-

ruptive ideas. One key success factor is the starting management team that makes it

happen and installs the right start-up mentality within the team. But one should not

forget that all entrepreneurial ventures have to overcome setbacks. Therefore it is

crucial even for a corporate start-up, not only to have a steering committee that

gives directions (and money) but to win at least one senior management executive

as mentor. The role of this mentor can be, for example, to protect the idea from

being “killed” initially.

In 2011, Bosch sold the first components for electrified bikes. The idea of

serving the e-bike market was not equally received at the beginning: some

supported the concept to use core competences of Bosch such as for electric motors

to foster electromobility beyond cars, and others assumed that the market for

electrified bikes would only be a very limited niche market—bikes for elderly

people that require support. Market reality proves the skeptics wrong. Only in

Germany, around 400,000 e-bikes were sold in 2014 summing up to 1 million

e-bikes in Germany in total. The reason for this is clear: driving an electric bike is

fun and superior technology attracts a wider range of customers including passion-

ate bikers. It was essential for the e-bike start-up at Bosch that a few senior manage-

ment executives strongly supported the idea and protected the venture from the

skeptics. Similarly, Bosch Sensortec benefitted from senior management executive

support during tough times, for example, as one lead customer refrained from

cooperation. Again, protecting the venture from being stopped because of a setback

is one of the roles of the mentor. Another is to help find a way together with the

management team to overcome the occurring challenge. Last but not least, the

mentor has to provide the start-up team at all times with the visionary framework.

Starting a business can mean to be caught in daily operational tasks from buying

pencils to fulfill first customer orders. But, what holds the start-up team together is

72 V. Denner

the purpose: making this venture happen. Therefore, it is fundamental that the

mentor believes and reminds this overall goal.

4 Conclusion

Innovating business—this is necessity, fun, and challenging at the same time. In the

case of Bosch, using a combination of cross-industry approaches while building on

fundamental company strengths has proven successful, and this article provides

some insights in those success stories. Nowadays, to persist as a company, it is a

prerequisite to continuously scout for potential disruptive threats and to reinvent the

own business by developing and implementing new business models. Using best

practices and insights from the start-up scene or from academic research has shown

to be appropriate means to support this process at Bosch. Success stories such as the

evolvement of the Bosch Engineering Group or the Bosch Sensortec prove that it is

possible to bring internal start-ups to life and that leveraging the own company

strengths has great potential for business model innovation. Finally, seeing internal

ventures grow and flourish is economically reassuring, but at the same time, this is

the payoff of risking resources, time, and money. Reaching the 2000th associate,

breaching the level of EUR 500m of revenue, and becoming global market leader

are milestones that help forget the setbacks during the start-up phase and all the

challenges that the initial team had to overcome. Finally, one should not forget that

leadership is a key success factor for creating new business models by giving room

for exploration and experimentation, by having the courage to touch on unknown

territories, and by providing the reassuring backbone to overcome challenges.

Furthermore, it can be noticed that the traditional requirement for industry

expertise to successfully innovate businesses has diminished. With globalization,

knowledge sharing and full transparency via the Internet, cross-industry inno-

vations gain importance and shape businesses more and more. Therefore companies

and executives need to foster collaboration and the ability to “think outside of the

box.” Additionally, different phases of ventures demand for dedicated approaches.

While the ideation process is strongly pushed by creativity impulses and lives from

the mutual inspiration of different domains and people, the implementation phase

requires leaders which have the entrepreneurial mindset and the industry expertise

to bring the idea to life.

Business models—that is what gives business that extra something, the extra fun

and the extra challenge. And business innovation is always about leadership.

Recruiting the right management team, overcoming setbacks, and providing the

visionary framework all this requires leaders that are willing to shape their industry

by innovating business. But it is always worth it.


References

Blank, S., & Dorf, R. (2012). The startup owner’s manual. Pescadero: K&S Ranch.

Brown, T. (2009). Change by design: How design thinking transforms organizations and inspiresinnovation. New York: HarperCollins.

Chesbrough, H. (2006). Open innovation: The new imperative for creating and profiting from tech-nology. Boston: Harvard Business School.

Fleisch, E. (2014).Businessmodels and the Internet of things. St.Gallen:Whitepaper Bosch IoTLab.

Gassmann, O., & Frankenberger, K. (2013).Gesch€aftsmodelle entwickeln: 55 innovative Konzeptemit dem St. Galler Business Model Navigator. München: Hanser.

Bosch (2015a). Bosch and Daimler automate parking: Mercedes with built in valet (Press Release8955). Stuttgart: Robert Bosch GmbH.

Bosch (2015b). Bosch Sensortec: 10 years of MEMS sensors innovation (Press Release 8933).

Stuttgart: Robert Bosch GmbH.

Ohno, T. (1988). Toyota production system. Portland: Productivity.Osterwalder, A., & Pigneur, Y. (2010). Business model generation: A handbook for visionaries,

game changers, and challengers. Hoboken: Wiley.

Pink, D. (2009). Drive: The surprising truth about what motivates us. New York: Penguin Group.

Ries, E. (2011). The lean startup: How today’s entrepreneurs use continuous innovation to createradically successful businesses. New York: Crown Publishing Group.

74 V. Denner

Environmental Management

Jens-Uwe Fischer

1 Environmental Management

The United Nations World Commission on Environment and Development

(WCED), which was convened as a result of a 1983 United Nations General

Assembly Resolution, formulated a set of basic principles for the management of

natural resources and the conservation of the environment. These principles are

based on the following definition:

Sustainable development is development that meets the needs of the present without

compromising the ability of future generations to meet their own needs.” (Our CommonFuture, also known as the Brundtland Report 1987)

The conservation of ecological balance, the preservation of an intact environ-

ment, and the protection of the natural systems that support life on Earth are aims

that place significant demands on every individual, as well as every manufacturing

company. Environmental protection has become an essential issue and a determin-

ing factor in today’s market. Companies will increasingly be confronted, both

internally and externally, with the environmental demands of their customers,

suppliers, and other cooperation partners.

Particularly since the early 1990s, the negative consequences of industrial

production—e.g., environmental pollution, the growing scarcity of resources, and

the impending collapse of transport systems—are no longer accepted without

contradiction by the population. The quality of the environment has become an

increasingly important criterion for the quality of human life. As a result, it became

necessary for companies to focus more on the issue of environmental protection in

their business policies. Environmental management was developed as a distinct

J.-U. Fischer (*)

University of Leipzig, Leipzig, Germany



DOI 10.1007/978-3-319-48938-4_6

75

area of business management to enable companies to comply with company poli-

cies and regulatory requirements concerning environmental protection.

In the beginning, this development focused on business decisions aiming to strike

a balance between the conflicting priorities of economy and environment. In other

words, environmental protection had to be both feasible and affordable. Initially, all

action plans and environmental protection measures that went beyond compliance

with the legal requirements were almost exclusively company-oriented, rarely sector-

oriented, and never cross-sectoral. In the medium term, the aim was to create a

management system for the implementation of environmental activities in order to

increase transparency around the company’s environmental performance, which in

the past had been widely perceived as a black box (Fischer 1995, see Fig. 1).

The fundamental aim of manufacturing is to cost-effectively convert raw mate-

rials into products of a desired quality and quantity. Environmental impacts occur at

all stages of this process. The raw and auxiliary materials needed for production,

along with the required air and water, are taken from the environment, transported,

processed, temporarily stored, and ultimately disposed of. Both during the produc-

tion process and after use, the product or parts of it are returned to the environment,

sometimes in altered form.

The environmental impacts of these processes can be very complex. Production

analysis, product life-cycle assessment, and environmental business management

practices can serve as the basis for appropriate mitigation strategies (see Table 1).

Fig. 1 The inputs and outputs of industrial processes are widely known today. However, much

less is known about internal processes. (source: author’s diagram, in Zeitschrift fürwirtschaftlichen Fabrikbetrieb ZWF, 1995, pp. 278–281)

76 J.-U. Fischer

Table 1 Environmentally orientated company structure based on a comprehensive platform for

business management

Environmentally oriented business management

Technology

Business

administration Management Culture

Product development

Ecological market

economy

Organization/

environmental committee

Business

principles

• Designing for

complete recycling

• Reduced use of

materials

• Substitution

• Use of secondary

raw materials

• . . .

• Environmental

value analysis

• List of materials

• Environmental consultants

• Guidelines for the

handling of materials

• Safety data sheets

• Environmental suggestion

scheme

• Environmental

organization of

working time

• Environmental

identity

• Credibility

• Setting a

good example

Processes

Environmental

financial accounting Personnel training Open information policy

• Energy

conservation

• Water, soil,

and noise

protection

• Closed-loop

circulation

• . . .

• Financing of

environmental

investments

• . . .

• Handling of

hazardous substances

• Environmental

protection in the

workplace

• . . .

• Company newspaper

• “Green” notice board

• Openness in the case of

accidents or malfunction

• Environmental report

Disposal technology Eco-marketing

Management-

related measures

Sharing ideas that make

people think

• Recycling of

production waste

• Segregation of

waste

• Environmentally

conscious pricing

• Environmental

product information

• Environmental PR

• Collection of

special waste by

staff

• Conversion of

vehicle fleet

• Budget

consultation

• Project group of

trainees

• . . .

• New coalitions in the

environmental sector

• Future

Other conditions Environmentalmanagementcontrol

• Green building

• Greening/biotopes

• Environmental

information systems

• Environmental

auditing

• Environmental

data registration

• Life-cycle

assessment

Source: based on author’s diagram in Zeitschrift für wirtschaftlichen Fabrikbetrieb ZWF, 1995,

pp. 278–281

Environmental Management 77

Environmental protection measures have an effect on every stage of the manu-

facturing process (procurement, production, market launch), as well as on the stra-

tegic postproduction stages (impacts on the surrounding area, disposal, research and

development). For example, one objective related to impacts on the surrounding

area would be to reduce or avoid environmental liability risks.

In the context of these developments, the German Federal Government

formulated ten management rules aimed at promoting sustainable development

in Germany as recommendations for stakeholders and their areas of action

(http://www.bundesregierung.de/). These rules are based on the following

principle:

Each generation must solve its own problems and not burden the next generations with

them. It must also make provisions for foreseeable future problems. This applies to the

conservation of the natural foundations of life, to economic development, to social cohe-

sion and to demographic change.

1.1 Management Rules and Stakeholders

1. Citizens, manufacturers, consumers, industry, trade unions, science, churches,

and associations, together with the state, are all important stakeholders in sus-

tainable development. They should take part in public discussion on the model of

sustainable development and be responsible in orienting their decisions and

actions toward these aims.

2. Companies are responsible for their production and products. This includes pro-

viding consumer information on product properties that are relevant to human

health and the environment, as well as information on sustainable methods of

production. The consumer is responsible for choosing products and using them

in a socially and ecologically sustainable manner.

3. Long term, the rate of use of renewable resources (e.g., wood and fish stocks)

should not exceed the rate of regeneration. Long term, the rate of use of non-

renewable resources (e.g., minerals and fossil fuels) should not exceed the rate of

development of alternatives, such as other fuels or materials able to perform the

same functions. For the continuation, the rate of release of substances or energy

into the environment should not exceed the capacity of ecosystems (e.g., cli-

mate, forests, and oceans) to absorb them.

4. Dangers and unjustifiable risks to human health should be avoided.

78 J.-U. Fischer

http://www.bundesregierung.de/

1.2 Management Rules and Areas of Action

5. Structural change triggered by technical developments and international compe-

tition should be shaped in a way that is economically successful, as well as

ecologically and socially sustainable. For this purpose, policy fields should be

integrated in such a way as to ensure that economic growth, high employment,

social cohesion, and environmental protection go hand in hand.

6. Energy and natural resource consumption and the provision of transport services

should be decoupled from economic growth. At the same time, efforts must be

made to ensure that growth-related increases in demand for energy, resources,

and transport are more than offset by efficiency gains.

7. Public budgets should take account of intergenerational equity. The federal

government, the federal states, and the municipalities should present balanced

budgets as soon as possible and then take the further step of continually reducing

their debt level.

8. Sustainable agriculture must be compatible with nature and the environment;

furthermore, it must take into account the requirements of animal welfare in

livestock farming and of preventive consumer protection, particularly concern-

ing human health.

9. In order to strengthen social cohesion, efforts must be made:

• To reduce poverty and social exclusion to the greatest possible extent

• To ensure that all segments of the population have the opportunity to benefit

from economic development and take part in social and political life

10. The international framework should be designed in such a way that people in all

countries are able to live a life in dignity and self-determination and to benefit

from economic development. Environment and development are intrinsically

linked. In an integrated approach, efforts to combat poverty should be

connected with:

• Respect for human rights

• Economic development and environmental protection

• Good governance

Many companies have used these rules as a basis for their environmental man-

agement policy. Environmental management is part of the overall management

system of an organization, regardless of the legal form. It deals with regulatory

requirements and company policies concerning the environment, particularly envi-

ronmental protection. Companies use environmental management to ensure not

only that their products and processes are environmentally friendly in the long term

but also that employees and stakeholders undertake their duties in an environ-

mentally responsible manner.


Environmental management pursues the following aims:

• Environmental protection, e.g., the use of technical measures for reducing envi-

ronmental impacts, avoidance of unreasonable environmental exploitation/

degradation, and contributions to prevention and remediation efforts

• The use and reporting of environmental performance indicators (measurable

results related to environmental impacts, e.g., emissions, wastewater, soil pollu-

tion, consumption of resources)

• Compliance with regulatory requirements and limits

• Social norming (promotion of eco-friendly behaviors among stakeholders)

• The development and maintenance of the organization’s environmental policy

(e.g., identification and implementation of measures that are both environ-

mentally and economically beneficial)

The implementation of these measures requires the use of an environmental

management system (EMS) that includes guidelines in the form of a legally com-

pliant organization, which can also involve the delegation of company responsi-

bilities (see Fig. 2). All applicable requirements, targets, instructions, and/or

Fig. 2 Diagram showing the relationship between environmental management and the environ-

mental management system (source: https://de.wikipedia.org/wiki/Umweltmanagement)

80 J.-U. Fischer

https://de.wikipedia.org/wiki/Umweltmanagement

process descriptions are documented in a management handbook and then imple-

mented and monitored through the environmental management system.

In principle, companies can choose any type of environmental management sys-

tem; in practice, most companies follow the guidelines of the environmental manage-

ment standard ISO 14001 and/or the EMAS Regulation (EU Eco-Management and

Audit Scheme, aka “Eco-Audit”).

The corresponding Council Regulation (EEC) No. 1836/93 “allowing

voluntary participation by companies in the industrial sector in a Community

eco-management and audit scheme” was introduced in Germany in 1995, along

with the applicable guidelines in the annexes.

The main objective of the EMAS Regulation is to promote the establishment of

environmental management systems among European companies, particularly in

the industrial sector, e.g., food, chemical, machinery, and vehicle construction

companies.

The relevant company-specific environmental management reports were

initially sector-oriented. No transparent, cross-sectoral review of this data was

possible until the environmental statements had been compiled and analyzed in

comprehensive reports by organizations like the chambers of commerce and

industry.

Recommendations for environmental management systems can also be found in

the guidelines of the ISO 14004 (Environmental management systems: General

guidelines on principles, systems and support techniques). The environmental

protection standards outlined in ISO 14001 are based on the ISO 9001 standard

for quality management systems.

If the company already has a quality management system in place, an envi-

ronmental management module can also be added to the existing system so that

an integrated management system remains in use. This integration is comparable

to the specifications on occupational health and safety management, e.g., the

standard OHSAS 18001 (Occupational Health and Safety Management

Systems—Requirements). The so-called standard documents (management

handbook, instructions, descriptions, etc.) that are commonly used in environ-

mental management systems define not only the requirements for achieving the

objectives and targets of the company’s environmental policy but also the

respective areas of responsibility. It is necessary that management

documentations have a modular structure.

In general, the ISO 14001 and EMAS systems are subject to a continuous

improvement process in the company, i.e., the organization is expected to conti-

nually optimize its processes. Only if all results and improvements are documented

in the context of an annual validation, only then the company is authorized to

continue using the EMAS logo for its strategic, organizational, and marketing-

related aims. The registration process that must be followed for this purpose in

accordance with the EMAS Regulation is illustrated by the phase model shown in

Fig. 3. The use of an environmental management system offers a range of benefits

to companies, not only with respect to their strategic potential—e.g., ability to meet

customer and market needs—but also with respect to requirements for research and

development projects and investment planning. Furthermore, the ongoing audit


process leads to a reduction in potential hazards and incidents, an improvement of

employee motivation, reduced energy and material costs (e.g., for raw, auxiliary,

and operating materials), and the prevention of fines related to noncompliance with

environmental legislation. It is important to note that the staff requirements associ-

ated with the implementation of an EMS can be covered by the personnel required

for compliance with environmental laws, such as the role of the company represen-

tative for water protection in accordance with Germany’s Federal Water Act

(WHG). The Eco-Audit process is carried out by an independent auditor with an

understanding of the specific environmental practices of the industry.

The structure of the EMAS Regulation (“EU Eco-Audit”) was created for use by

companies in various industries (cross-sectoral). However, the companies’ targets

and objectives are sector-oriented, e.g., specific to the electrical industry, the

construction industry, etc.

The following example for the company ABB Deutschland illustrates the imple-

mentation of the EMAS Regulation and the integration of the environmental man-

agement system (EMS) into an existing management system using a representative

selection of programs and aims (Fischer 1995). The EMS in this example was

implemented on the basis of the AUGE registration system for hazardous

substances (see Fig. 4).

Fig. 3 Phase model for EU Eco-Audit registration (source: author’s diagram, in Zeitschrift fürwirtschaftlichen Fabrikbetrieb ZWF, 1995, pp. 278–281)

82 J.-U. Fischer

On the basis of a safety-data-sheet system for “time-optimized accident pro-

cessing and hazard analysis” (ZUG), the company ABB developed a waste moni-

toring system. The “work- and environment-related data-acquisition system for

hazardous substances” (AUGE) is used for the collection of environmentally

relevant data and thereby serves as the basis for an environmental information

system with the addition of the two modules “Environmental Protection” and “Fire

Protection.”

One operational example is the optimization of environmental compliance,

e.g., by reducing the number of products that contain plastics while striking a bal-

ance between customer specifications, production specifications, and recycling

targets (see Fig. 5).

These were the first steps taken by ABB toward the implementation of a compre-

hensive environmental management system. However, this process went far beyond

the development and introduction of an environmental management system: it also

involved a reevaluation of the strategic direction of several business units due in

part to the Eco-Audit scheme. For example, one cross-sectoral question that had tobe resolved was whether it is strategic, environmentally sound, and forward-

looking for a company with a consistent focus to maintain an independent business

unit for environmental protection.

As a result of these considerations, ABB Deutschland phased out its business

unit for environmental technology, ABB Flakt GmbH, in the years 1992 and 1993.

Fig. 4 Structure of a data-acquisition system for hazardous substances (source: author’s diagram,

in Zeitschrift für wirtschaftlichen Fabrikbetrieb ZWF, 1995, pp. 278–281)


The respective products and services were integrated, as far as possible, into the

remaining divisions for transport, energy, and building management. The strategic

approach of making environmental protection an integral part of every company

division has been systematically adopted and implemented. The integrated man-

agement systems consolidate the requirements from the various divisions of the

company into a uniform, overarching structure. Management efficiency is increased

by exploiting synergies and pooling resources.

2 Sustainability Management

However, this field continued to develop—from environmental management and

corporate social responsibility (CSR) to sustainability management, which is

characterized by responsible business practices. CSR covers measures and activ-

ities aimed at strengthening the social responsibility of companies beyond their

compliance with legal requirements, such as human rights and the Core Labour

Standards of the International Labour Organization (ILO). CSR management plays

Fig. 5 Environmental compliance of products that contain plastics, achieving a balance between

customer specifications, production specifications and recycling targets (source: author’s diagram,

in Zeitschrift für wirtschaftlichen Fabrikbetrieb ZWF, 1995, pp. 278–281)

84 J.-U. Fischer

a key role, particularly in companies that operate globally (e.g., in the implementa-

tion of intercultural processes). This is why today’s sustainable companies are

characterized by the fact that they view not only the environmental aspects

described above but also economic and social aspects, as integral to their business

model. Companies, particularly multinationals, are facing more sustainability-

related requirements from their stakeholder groups than ever before; today’s society

demands that companies take responsibility. For example, wage justice, the crea-

tion of humane working conditions, and the environmental impacts of the manu-

facturing processes in the textile industry have been the subject of critical discussion

for some time now. At the same time, the business models of entire markets are

changing in response to new, green technologies. The following examples illustrate

both national and global changes that have had a lasting impact on the strategic

direction of companies in Germany.

2.1 The “Energy Revolution”

With the subsidized transition of Germany’s energy supply system to renewable

energies, such as solar, wind, and biomass, the reliance on fossil energy sources for

constant, high, and centralized energy production (base load production) has been

called into question. As a result, the concept of low-carbon economy was intro-

duced in the context of climate change mitigation. Within a single generation,

people began challenging the business models that had been used for decades by

Germany’s well-established energy producers (e.g., RWE, EON, Vattenfall,

EnBW). During roughly the same period as its transition to renewable energies,

the country began withdrawing from nuclear power. However, for the closure of its

coal-fired and nuclear power plants, Germany has yet to come up with coherent

decommissioning concepts that would be consistent with the sustainability

principles of the Brundtland Commission.

2.2 The “Mobility Revolution”

In the medium to long term, social and climate changes will also lead to changes in

people’s mobility requirements. New propulsion technologies (e-mobility, fuel

cells, etc.) combined with new passive-adaptive systems are changing not only

the final product but also the entire value chain, from suppliers, vehicle manu-

facturers, drive unit manufacturers, and service providers to petrol station chains,

along with secondary value chains, e.g., recycling companies. In the coming years,

the secondary value chains will be making a particularly important contribution to

the economic performance of a society, independent of the pricing of raw materials.

In response to these changing conditions, the so-called three-pillar model was

introduced as a sustainability management model to take the place of the environ-

mental management system. With this model, sustainability is described as having

three dimensions: environmental, economic, and social. The model has cross-


sectoral relevance, although industry-specific conditions can trigger various mea-

sures. The business measures of the three-pillar model should be given equal weight

in their implementation. However, implementation can vary depending on the com-

pany and sector.

The following are several of the questions that companies and institutions are

expected to answer on the basis of the three-pillar model (see Fig. 6):

• Which normative aspects play a role in solving environmental and social issues?

• Which social and technical innovations can help solving environmental and

social problems?

• How can resource efficiency be ensured throughout the value chain?

• What specific impacts will the company’s activities have on future generations?

• What path dependencies are created by investing in ultra-long-life assets?

• Where are sustainability-related growth markets, and how can they be

developed?

• Do we need new definitions of growth in terms of sustainable management?

• How can product stewardship and compliance with socially acceptable working

and business practices be ensured in global value chains?

Fig. 6 Sustainability for economy, environment, society (source: author’s diagram)

86 J.-U. Fischer

3 Sustainability Management, Risk Management,and Opportunity Management

In the context of the ongoing development of sustainability management and in

response to the requirements of international financial reporting standards (e.g., US

GAAP, IAS/IFRS), companies began gradually adding sustainability management

data to their risk and opportunity reports. As a result, the sustainability report was

introduced across all sectors.For example, in the context of its integrated risk management report, the German

railway company (Deutsche Bahn AG Annual Report 2013) describes a risk and

opportunity report that includes not only external factors, such as regulation, sales

market, procurement market, energy market risks, etc., but also internal factors,

such as production, technology, personnel, and other risks, e.g., impending losses,

transport contracts, decommissioning and disposal of power stations, demographic

collective agreements, remediation of contaminated sites, real estate valuation,

receivables portfolio, and inventories. This report also covers risks associated

with project and infrastructure finance, political risks, financial risks, and compli-

ance as well as legal and contractual risks. Environmental issues play an integral

role in risk assessment in these areas. Along the same lines, the report includes an

assessment of opportunity management, in which environmental, economic, and

social aspects are taken into consideration. In this context, changes in social atti-

tudes and/or behaviors, such as mobility patterns and consumer behavior, can open

up new sector-specific opportunities.

As a result of the further development of sustainability management, the new

instrument of “greening” was introduced in 2011 through the Idea Workshop of the

International Controller Association (ICV) to create an even stronger link between

the environment and economics (Isensee and Michel 2011). Environmental man-

agement control systems, also known as sustainability management control systems

(or as “green controlling” in German), are aimed at the incorporation of key envi-

ronmental and social performance indicators (KPIs) into the practice of manage-

ment control. Some typical KPIs are energy and water consumption, CO2

emissions, percentage of employees with a migration background, and equal pay

for men and women. The ICV study on the status of environmental management

control systems takes a closer look at the integration of environmental aspects into

management control processes and the incorporation of environmental information

in management control tools.

The authors distinguish between four different types of green strategies:

1. Environmental goals have the highest and most far-reaching strategic signifi-

cance in companies with a “comprehensive green strategy.”

2. The strategy “green products and solutions” has a stronger-than-average focus

on the development and delivery of green services and is therefore more market

oriented.


3. Companies who use a “wait-and-see strategy” have an awareness, internally, of

green opportunities and risks, but the strategic significance of these aims is

below average due to a low level of external influence.

4. The “green compliance” strategy focuses exclusively on compliance with

legal requirements.

In general, it can be noted that companies with a strong green strategy deal more

with environmental issues in their management control systems. However, it is

important not only to transparently present company-specific topics but also to

consider overarching social and environmental issues, such as land use. For exam-

ple, since 1960, Germany has seen a continuous “decoupling” of its rates of

population and employment growth from the rate of land use for “settlement and

transport areas,” defined as built-up areas and open spaces related to buildings,

transport infrastructure, recreational areas, and cemeteries (see Fig. 7). Between

1960 and 2010, the specific rate of land use relative to population and employment

almost doubled. In spite of the fact that the past German Federal Governments set

themselves the objective of reducing the rate of land use to 30 ha/day by the year

2020, the current rate of land use is still approx. 86 ha/day, indicating that the target

may be impossible to reach.

This increase in land use for built-up areas—of which 30% is used for transport

infrastructure—not only has socioeconomic impacts but is also associated with

company-specific impacts, e.g., through the ever-increasing distance between home

and workplace in recent years. Hence, one strategic goal of sustainability manage-

ment is the decoupling of land use from economic growth. From these issues,

certain questions can be derived for a company in the context of an integrated sus-

tainability model, for example, what requirements can be imposed on these com-

panies in the future with respect to urbanity and mobility in the digital age and how

can these requirements be met.

Questions dealing with the future of public services and the future shaping of

the business environment, e.g., urban development, are also of major importance

for companies and their respective sectors in the context of integrated

sustainability management systems. The required transformation of future urban

Fig. 7 Changes in settlement area (land use), population, and employment in Germany (source:

BBR 2008)

88 J.-U. Fischer

development—from a monocentric to a polycentric structure—plays a fundamen-

tal role in this area (see Fig. 8). Once we have returned to an urban model in which

home is closer to the workplace, mobility patterns will change, as will individual

mobility requirements, meaning that companies will have to modify their mobility

solutions for employees, for example, a company car scheme can then be replaced

by integrated mobility solutions.

The “compact city” (or “city of short distances”) is a future urban planning and

design concept that was developed in 2000 by leading cities and city planners for

the year 2015. It includes a strategic approach aimed at ensuring that most of the

facilities essential for daily life, e.g., homes, workplaces, and schools, are within

comfortable walking distances (500 m), meaning that human mobility would

become climate-neutral.

Polycentric urban models are also associated with the restructuring of commer-

cial and industrial areas; in the future, these areas will be increasingly relocated to

inner-city districts. This trend is being accelerated by the phenomenon of digitali-

zation and the implementation of several measures from the platform “Industry

4.0,” particularly in this context, urban production. The use of new production

methods and technologies, such as vertical production, “transparent” factories, and

3D printing, with its wide range of services, will contribute to the development of

city models offering shorter distances between work, home, and daily life.

Accordingly, companies will have to increasingly develop sustainable business

strategies; in the process, they will be able to achieve direct economic effects and

secure a greater availability of workers through more flexible working arrange-

ments and through their proximity to markets, customers, suppliers, and centers for

research and technology. Employees will be able to enjoy new freedoms in the

Fig. 8 Land use, urbanity, urban development from a monocentric to a polycentric structure

(Source: author’s diagram, in “Flachenverbrauch und nachhaltiges Flachenmanagement in

Deutschland,” lecture at the VSVI Seminar 2014 in Halle/Saale, 3 April 2014)


organization of their lives as a result of more flexible working arrangements, the

integration of work and private life, and the implementation of part-time and flexi-

ble employment models. The companies that offer these types of solutions in con-

nection with new work models will indirectly contribute to the reduction of carbon

emissions because shorter commuting distances (currently, the average travel time

to work in Germany is approx. 70 min.) will reduce the commute-related CO2

emissions per employee.

In this respect, companies should follow further analysis at concepts for

decentralized utilities and urban farming as new topics in the context of sustainable

business models. In sustainability management, it is fundamentally essential that

such concepts are not only considered from a sector-oriented perspective but alsoanalyzed with respect to their social and thereby cross-sectoral implications. The

measures associated with a company-specific CSR management concept also play

an integral role.

These new aspects and new quality are already being taken into consideration by

companies that search for suitable business locations. Hard factors, such as trans-

port links, regional sales markets, the availability of land and office space, the

availability of qualified staff, and proximity to vocational training facilities and

research institutes, are basic requirements for a business location. However, soft

factors, such as quality of life, recreational value, the region’s image as a business

location, social climate, schools, cultural offerings, and the attractiveness of the

entire city and city center, are also absolutely critical factors in the choice of a new

business location. Regions that fail to meet companies’ expectations in terms of

both hard and soft location factors are destined to shrink.

Only the regions that are able to satisfy the requirements associated with not only

hard location factors but also a majority of the soft location factors will continue to

be attractive for companies and people in the future. These regions support the

reconciliation of work and private life, foster the establishment of functional

mixed-use zones, and are able to increase the number of employment and edu-

cational opportunities, achieve higher tax revenues, and reduce traffic volume and

emissions from energy supply sources.

In summary, it can be argued that today’s sustainability management must cover

both cross-sectoral and sector-specific content. A cross-sectoral view serves as a

platform for the attractiveness of a company and can satisfy the requirements asso-

ciated with future MEGATRENDS, such as globalization, demographic change,

urbanization, digitalization, and climate change.

References

BBSR: Report 2008. URL: www.bbsr.bund.de.Deutsche Bahn AG: Annual Report 2013 (in German). URL: www.db.de/gb.

Fischer, J.-U. (2014). Fl€achenverbrauch und nachhaltiges Fl€achenmanagement in Deutschland.Lecture at the VSVI Seminar 2014 in Halle/Saale, 3 April 2014.

Fischer, J.-U. (1995) Umweltmanagement in dezentralen Unternehmensstrukturen. In: Zeitschriftf€ur wirtschaftlichen Fabrikbetrieb ZWF (pp. 278–281).

90 J.-U. Fischer

http://www.bbsr.bund.de/

http://www.db.de/gb

German Federal Government: Concept for Sustainability Management (in German). URL: http://

www.bundesregierung.de/Content/DE/_Anlagen/Nachhaltigkeit-wiederhergestellt/2012-04-17-

managementregeln-der-nachhaltigkeit.pdf?__blob¼publicationFile&v¼2, [version: 23 Novem-

ber 2015].

Isensee, J., Michel, U. (2011). Green Controlling als (neue) Aufgabe für den Controller?

Controller Magazin, (41), 18–20.Wikipedia. Umweltmanagement. URL: https://de.wikipedia.org/wiki/Umweltmanagement,

[accessed: 23 November 2015].

World Commission on Environment and Development. (1987). Brundtland-Bericht (1st ed.).Greven: Eggenkamp Verlag.

Further Reading

Beckmann, K. J., Gies, J. (2011). Leitkonzept—Stadt und Region der kurzen Wege. Texte Umwelt-

bundesamt 48/2011. URL: www.umweltbundesamt.de.

BMU (pub.). Nachhaltigkeitsmanagement in Unternehmen, 2007. URL: http://www.bmub.bund.

de/fileadmin/bmu-import/files/pdfs/allgemein/application/pdf/nachhaltigkeitsmanagement_

unternehmen.pdf, [accessed: 23 November 2015].

Brauer, H. (1996).Handbuch des Umweltschutzes und der Umwelttechnik. Berlin: Springer Verlag.Daly, H. Big Idea: A Steady-State Economy. Adbusters 81, 17 December 2008.

F€ortsch, G., & Meinholz, H. (2014). Handbuch Betriebliches Umweltmanagement. Wiesbaden:

Springer Verlag.

Hardtke, A., & Prehn, M. (2001). Perspektiven der Nachhaltigkeit—vom Leitbild zur Erfolgs-strategie. Wiesbaden: Gabler Verlag.

Hartmann, L. (1992). €Okologie und Technik. Berlin: Springer Verlag.Hotzan, J. (2004). dtv-Altlas Stadt: Von den ersten Gr€undungen bis zur modernen Stadtplanung

(3rd ed.). Munich: dtv Verlag.

L€obel, J., & Sch€orghuber,W. (2013).EU-Umweltaudits: Zukunftsf€ahigeGesch€aftsprozesse gestalten.Berlin: Springer Verlag.

Müller, W. (1999). St€adtebau (4th ed.). Leipzig: Verlag Teubner Stuttgart.

Simonis, U. E. (2003). €Oko Lexikon. Becksche Reihe: Verlag C.H. Beck.


http://www.bundesregierung.de/Content/DE/_Anlagen/Nachhaltigkeit-wiederhergestellt/2012-04-17-managementregeln-der-nachhaltigkeit.pdf?__blob=publicationFile&v=2





https://de.wikipedia.org/wiki/Umweltmanagement

http://www.umweltbundesamt.de/

http://www.bmub.bund.de/fileadmin/bmu-import/files/pdfs/allgemein/application/pdf/nachhaltigkeitsmanagement_unternehmen.pdf



Innovation for Health: Success Factorsfor the Research-Based PharmaceuticalIndustry

Christoph Franz

1 The Drivers of the Industry

1.1 The Market and Environment

The global pharma market1 exceeded sales of 1.1 trillion USD by the end of 2015

(IMS Health 2015). Every player in this market is strictly regulated by national

governments due to the direct impact of pharma products on health and well-being.

However, in the EU, regulatory approval of new medicines is obtained by decision

of the European Medicines Agency (EMA) for all member countries.

After two decades of double-digit sales growth, global pharmaceutical market

growth has slowed significantly over the recent past. This slowdown has been

triggered by two main factors:

• The tremendous pressure on public budgets (mainly caused by the financial

crisis) also hit the healthcare industry in terms of efforts from health insurers

and public regulators to curtail drug spending, including price cuts.

• Patent expiries for major blockbuster drugs (the “patent cliff”) have reduced

drug spending in the developed markets, while healthcare spending in many

emerging markets has grown significantly, yet currently not enough to compen-

sate for the reduction in the developed world (Fig. 1).

C. Franz (*)

Roche Group, Roche Holding Ltd, Basel, Switzerland

1The pharmaceutical market includes biopharmaceuticals, over-the-counter (prescription-free)

drugs, and traditional medicines (including generics) distributed and administered through

regulated delivery systems, such as pharmacies, hospitals, clinics, physician offices, and mail

order.



DOI 10.1007/978-3-319-48938-4_7

93

The global market is expected to increase in the mid-single-digit range by 2020

(IMS Health/EvaluatePharma, World Preview Report 2014b). A major part of this

growth is likely to come from emerging markets, particularly China. Nevertheless,

the USA will remain by far the most important pharmaceutical market with

approximately 40% of global sales. For any larger pharma company, this means

that the US market was and will remain crucial for its overall success.

Going forward, there are unprecedented dynamics at play driving rapid shifts in

the mix of spending between branded products and generics across both developed

and emerging markets. Industry analysts believe that the following trends will

shape the marketplace over the next decade (PricewaterhouseCoopers, Pharma

2020):

• Demographic changes will increase average lifespan and foster age-related

diseases, placing even greater pressure on already stretched healthcare budgets.

• Healthcare policy-makers and payers (health insurers or governments) are

increasingly mandating what doctors can prescribe.

• A growing number of healthcare payers are measuring the (pharmaco-)economic

performance of different medicines. Widespread use of electronic medical

records will provide the data needed to insist on outcome-based pricing.

• Governments are beginning to focus on prevention rather than treatment alone.

These trends will compound the challenges the industry faces, but they will also

provide some major opportunities.

Fig. 1 Global pharma market growth. Source: EvaluatePharma sales, October 2015

94 C. Franz

1.2 The Companies

The group of today’s global top ten pharmaceutical companies is dominated by US,

European, and, to a lesser degree, Japanese companies which are represented in the

top 25 (Fig. 2).

The market share of the top ten companies increased from 48% in 1995 to 51%

in 2005, essentially driven by megamergers and acquisitions. Since then, it has

declined to roughly 44%, the main reasons being divestments of noncore

businesses by major companies, their inability to compensate the patent expiry of

major drugs, and the entry of new innovative players.

While the industry is still fragmented from a total market share perspective,

industry concentration is often much greater, and competitive dynamics only really

play out when looking at specific therapeutic areas or classes of medicines. Some

companies have established strong franchises, for example, Biogen, the global

market leader in multiple sclerosis, or Roche, the global oncology leader, with

market shares of around 38% and 28%, respectively. Other major therapy classes

with strong players are pain drugs, antihypertensives, and antidiabetics. A novel

drug which changes the standard of care can change even a strong market position

virtually overnight, regardless of the status quo. This is a major difference com-

pared to, e.g., the consumer goods industry, where a strong market share creates the

distribution and pricing power for a defensible market position.

1.3 The Portfolio of Business Segments

There is not only one “right” way for companies in the pharma industry to remain

viable and prosperous. Some companies have diversified their portfolio into

Fig. 2 Top ten pharma companies—ranking by market share. Source: EvaluatePharma Rx

(prescription drugs) sales, 2015

Innovation for Health: Success Factors for the Research-Based Pharmaceutical. . . 95

generics and biosimilars, vaccines, OTC pharmaceuticals,2 or MedTech,3

reallocating their resources into areas where they expect a better or more manage-

able return for their risk than they can achieve with their existing core research-

based pharmaceutical business. Other players prefer focusing their management

attention on innovation-driven, patented prescription medicines.4 The current trend

is toward concentrating the business on two to four segments, as is apparent from

the way some of the top ten players are divesting parts of their portfolio (e.g.,

Novartis divested Vaccines to GSK and Animal Health to Eli Lilly) (Fig. 3).

1.3.1 Patented Prescription MedicinesBranded, patented prescription medicines make up by far the largest part of the

portfolio of leading companies (EvaluatePharma 2015). They accounted for 612 bil-

lion USD in 2015, or nearly 56% of global pharmaceutical spending (IMS Health

2015). Consequently, this article is focused on those medicines where innovation

(developing novel medicines on a continuing basis) is key to a company’s success,

either for growth or to overcome a substantial drop in revenue when its patents on

Fig. 3 Leading pharma companies—portfolio structure. Source: EvaluatePharma, 2014a FY

segment sales as % of total WW Revenues

2OTC pharmaceuticals are medicines available to patients and consumers without the need for a

prescription; they have to be used primarily to treat a condition that does not require the direct

supervision of a doctor and must be proven to be reasonably safe and well tolerated.3Medical devices.4The pharmaceutical business of selling drugs that legally require a medical prescription to be

dispensed.

96 C. Franz

blockbuster5 medicines are set to expire (see Sect. 2 on the research-driven business

model).

1.3.2 Generics and BiosimilarsAs patents of leading branded drugs have expired in developed markets, the share of

generics6 and the new class of biosimilars7 has increased (to 356 billion USD in

2015), constituting slightly more than 36% of the global pharma market (IMS

Health 2015).

The business model of generics and biosimilars is essentially based on “cost-

plus” pricing. The most successful company will be the one with the best cost

position, not with the best innovative capacity. Historically, margins have been

substantially lower for generic pharma companies. After loss of exclusivity (LoE),8

many research-based pharma companies decide to manage “mature products”

separately from patent-protected medicines, or set up a separate business segment

for generics with its own specific success factors, or even leave the market

completely by licensing out or by selling the brand name of the original drug.

In the case of the emerging biosimilar market, there might be an opportunity for

the originator companies to stay (longer) in the market. Because the safety of

patients is paramount, copies of biopharmaceuticals must meet the regulatory

criteria for biosimilarity in terms of quality, safety, and efficacy compared to the

originator product. As a result, biosimilar companies have to bear substantial

development costs for clinical trials of their own. The originator may continue to

compete in the market with an attractive margin because his research and develop-

ment (R&D) costs were already recovered during patent life. However, the specific

price erosion scenario will depend on the type of disease, number of biosimilar

competitors on the market, and on the pricing systems (Fig. 4).

As shown in the graph (Fig. 4), price erosion for biosimilars is expected to be

substantially smaller than for generics.

1.3.3 OTC DrugsThe global OTC pharmaceutical market reached 132 billion USD in 2015, driven

by demographic and economic trends, the switching of medicines from

5A blockbuster drug generates annual sales of at least 1 billion USD for the company that has

developed it.6The term “generics” or “biosimilars” applies to copies of brand-name drugs. After the patent on a

brand-name drug has expired (see Sect. 2), other pharmaceutical companies can start to copy it

using the extensive documentation filed by the original discoverer and manufacturer with the

approval authorities (USA, FDA; EU, EMA; Japan, PMDA; etc.).7While it is relatively easy to identically copy small molecule products produced by chemical

synthesis (“generics”), it is very challenging to copy biotechnological products (“biologics”) as

they have big and complex molecular structures and are obtained in living systems through highly

complex manufacturing processes which are impossible to reproduce identically (therefore, copies

of biologics are called “biosimilars”).8Loss of exclusivity (patent expiry or data exclusivity).


prescription-only to highly marketing-driven OTC sales, changes in cultural

attitudes to self-medication, and regulatory processes in national markets (IMS

Health 2015). The market continues to attract pharma companies seeking to build a

diverse portfolio of healthcare businesses, as well as consumer goods companies

aiming to extend their range of consumer brands. As it is the consumer/patient who

makes the decision to purchase a particular OTC product, conventional marketing

techniques for building major brands, including promotion through the mass media,

are utilized in an effort to influence consumers’ purchasing behaviors. Success

factors are similar to those in the classic fast-moving consumer goods industry.

2 The Fundamental Business Model of Pharma Innovation

For the past 100 years, the private sector has produced nearly all medicines

available on the market. Of all industrial sectors, the research-based pharmaceutical

industry has consistently invested the most in R&D: approximately 19% of

revenues (Evaluate 2012) (Fig. 5).

The industry’s success will continue to rest on innovation based on this very high

R&D spend. Two factors drive medical progress: a patent system that creates

favorable conditions for investing in the discovery and development of drugs and

the existence of a generics industry that compels research-based companies to

innovate on a continuous basis.

Fig. 4 Generic and biosimilar competition—typical sales erosion curves. Biosimilar erosion: CitiInvestor Report by Andrew S Baum, February 2015; Generic erosion: Roche internal analysis,

based on IMS Midas Data

98 C. Franz

2.1 Patent Protection as Backbone

Since patents are the only means of securing temporary market exclusivity, they are

the backbone for the research-based industry, providing the incentive and risk

mitigation to invest in R&D.

Patents are generally granted for a 20-year term from the filing date. Drug

development is a complex process requiring tremendous know-how of top

researchers and engineers and a substantial investment of time and money. Starting

with the identification of a biomolecular target, translating an idea into a new

medicine takes an average of about ten years and is estimated to cost roughly 2.5

billion USD (Tufts 2014). This total includes the costs of the many projects that

have to be terminated, often because a compound proves less effective than hoped

for, or has undesired side effects. More than 90% of all clinical studies evaluating

new medicines will eventually fail. This attrition is far greater than in any other

industry and is a reflection of how complex the human body is and how little we still

understand about it.

Because of the need to file a patent at a very early stage in development (as soon

as a drug clears the first laboratory hurdles) and because of the long development

time for clinical trials, the inventor has roughly only ten years left out of the 20 years

of patent protection to recoup the substantial R&D expenditures (Fig. 6).

To stay in business and to grow, a player in this research-driven industry must

renew its entire product portfolio with patented new drugs and therapies on average

at least once every ten years. This clearly describes the core challenge for

management.

Fig. 5 Pharma R&D spend of leading companies. Source: EvaluatePharma, October 12, 2015


From a healthcare system perspective, cheaper generics (i.e., copies of off-patent

drugs) provide cost savings which can be “reinvested” into newly launched, patent-

protected, innovative medicines. This roll-over mechanism is essential to mitigate

the growth of drug budgets in a world of ever-increasing total numbers of medicines.

2.2 Change in Cost Structure Post Patent Expiry

The following chart illustrates the cost structure in sales, general, and administra-

tive expenses (SG&A);9 the manufacturing cost of pharmaceuticals, commonly

known as cost of goods sold (COGS);10 and R&D costs.

Research-based companies with brand-name products spend much more money

on R&D and SG&A than do generics companies. The latter are not involved in the

discovery of new therapies, so their small R&D expenditure is likely to be more

geared toward developing formulations of already approved drugs whose patents

are about to expire.

For generics, the manufacturing expense is nearly 50% of the total sales

revenues as compared to about 27% of that for brand names (Basu et al. 2008)

(Fig. 7).

Fig. 6 Pharma business model for innovation. Source: Illustrative, Roche 2013

9SG&A covers sales, marketing, as well as general expenses incurred by the product pipeline.10An aggregate figure that includes all costs incurred in producing the goods including write-offs

from plant, property and equipment, raw materials, and inventory.

100 C. Franz

2.3 The Challenges for Research-Driven Companies

Despite significant medical progress, it is estimated that two thirds of all known

diseases currently lack an available and effective treatment (Coda Corp USA 2010).

Furthermore, there are still relatively few treatments that target the causes of the

disease, and often patients fail to respond adequately to the treatments that are

available (efficacy, safety). New forms of old foes have also reemerged as threats to

public health, notably multidrug-resistant tuberculosis and multidrug-resistant hos-

pital-acquired infections. Hence there is still a high unmet medical need and

demand for more specific diagnostic tests and more effective, better tolerated

medicines.

2.3.1 R&D ProductivityIndustry-wide R&D spendings more than doubled in the first decade of the new

millennium to roughly 147 billion USD (EvaluatePharma 2014b). At the same time,

the number of approved new medicines (NMEs)11 remained relatively stable at

around 28 a year globally. This is reflected in the significantly increased average

R&D cost per new approval (Fig. 8).

Fig. 7 Generic and biosimilar competition—typical sales erosion curves II (illustrative). Source:

Roche 2015

11New molecular entities.


Productivity in the research laboratories has declined for two main reasons:

• First, as a result of higher regulatory hurdles, companies are required to tightly

manage risks at each stage of development and provide ever more data.

• Secondly, the research-driven industry has been shifting its attention from

diseases that are relatively common and easy to treat to those that are more

complex and difficult to treat—such as cancer, Alzheimer’s, or rare diseases

(orphan drugs) (Field and Boat 2010).

On a yearly basis, there have been significant changes in the number of NMEs

(including small molecules and biologics) approved by the US Food and Drug

Administration (FDA).

On average, 27 NMEs have been approved annually and the fact remains that

even a “Big Pharma” company is likely to only have one to two NMEs approved per

year.

Breakthroughs remain difficult to achieve, as innovation usually happens in

incremental steps and only rarely in giant leaps. Scientific excellence and a

thorough understanding of disease biology are key and will increase the likelihood of

success (see Success Factor 1, page 105). Although innovation can also be the result

of serendipity and luck, having the right people and decision capabilities, combined

with knowledge and expertise, can significantly increase the odds of success (see

Success Factor 6, page 110). Yet this is still no guarantee, due to the complexity and

interdependencies of biological pathways in the human body.

Furthermore, productivity varies greatly between research-based companies:

The best-performing company recoups four times as much for each single USD it

invests in R&D compared to the worst-performing company (Meta Analysis,

Roche). Historic trends in R&D productivity are an important factor in explaining

Fig. 8 Approvals of new medicines in the USA and related costs per new approval. Sources:

EvaluatePharma, World Preview Report; Tufts Center for the Study of Drug Development, NME

Analysis 2014; Roche analysis

102 C. Franz

how companies respond to impending challenges, i.e., why different players take or

are forced to pursue different strategies. To maintain and improve R&D productiv-

ity is the single most important challenge for any research-based pharma company.

Any shortfall in internal innovation creates the necessity to acquire external

innovation, or worse—to shrink/downsize when major patents run out and sales

and profit contributions cannot be replaced.

2.3.2 Making Innovation AccessibleAccess to healthcare products remains a global challenge as healthcare and

healthcare regulation vary dramatically from country to country. Total health

expenditures range from roughly 4% of gross domestic product (GDP) in India to

more than 17% of GDP in the USA. In developed markets, roughly 10% of GDP is

spent on healthcare, whereof 10% (i.e., 1% of GDP) on medicines. Ultimately, it is

a governmental/societal choice as to how much to spend on healthcare. In some

countries, sophisticated innovative medicines and tests are widely available (cov-

ered by health insurance or public money), while in others there is little or no basic

infrastructure. However, even in established markets, it can take years until novel

medicines are approved and/or reimbursed and thus become available to patients.

The industry responds with partnerships all over the world to help break down the

barriers to healthcare availability. Most companies run programs tailored to specific

local needs, whether to support disease education or make products affordable,

some examples being:

• The industry is working closely with payers to develop differentiated pricing

models in emerging markets and more sophisticated reimbursement models in

industrialized countries that reflect the medical value novel treatments bring to

patients (see Success Factor 5, page 109).

• Patient access programs in the USA providing free or affordable medicine to

underinsured or noninsured patients.

• Seminars, client forums, and disease awareness campaigns that help educate the

population and improve prevention and early detection.

3 The Evolving Business Model and Its Success Factors

3.1 Pharma Business Model in Transformation

The monolithic blockbuster business model12 that underpinned Big Pharma’s

success in the 1990s is irreparably broken (Windhover 2003). However, the funda-

mental business model of the research-driven pharma industry (as described in

Sect. 2.1) still works, but is evolving. Market changes have forced companies to

12Companies used to have less diversified drug portfolios with one or more blockbuster drugs

(sales of more than 1bn USD).


become more innovative, collaborative, diversified, and value-driven. Today, most

pharma players are in the midst of a transformation to the next level, namely,

toward understanding and using IT technology with respect to healthcare and

moving to an evidence-based, outcome-focused environment (Ernst & Young

2012) (Fig. 9).

Unlike the prevailing current model, which is in essence product-centric, the

emerging model will need to be more patient-centric (PricewaterhouseCoopers

2007). This development is leading to more targeted therapies (personalized

healthcare) and expanding the industry’s focus beyond treatment to include pre-

vention and diagnosis.13 And by doing more for patients, this model will also have

implications on the entire health system, delivering real value to healthcare’s other

stakeholders—regulators, providers, and payers. While prescriptions used to be the

sole prerogative of the doctor, they are now increasingly influenced by payers.

This model and the move to a world toward individualized treatments will

accrue financial returns to those who can best demonstrate that they significantly

improve health outcomes. This development is also creating tremendous

opportunities for companies new to the healthcare business. As a consequence,

nontraditional entrants—information technology companies (see Success Factor 4,

page 108), retailers, nutrition companies, telecommunication companies, etc.—are

moving into the healthcare arena.

Fig. 9 Pharma business model in transition based on Ernst & Young, Progressions, 2012

13Accurate diagnostic tests reduce costs by identifying patients with a very high likelihood of

responding to a drug, diminishing subsequent health problems, reducing hospitalization, or

avoiding unnecessary treatment.

104 C. Franz

3.2 Success Factors for the Future

The emerging business models are shaped by six key success factors:

Success Factor 1: Excellence in Science

The progress in science and technology driven by the genomic revolution14 will

enable the industry to discover new medicines to treat many of today’s incurable

diseases (Fig. 10).

Over the past few decades, biotechnology (among other technologies) has

enabled medical progress which used to be barely imaginable.

The medicines available today all involve the same 120 or so target molecules.

In relation to the more than two million proteins in the human body, that is a very

small number. The decoding of the human genome, the growing understanding of

genes and their function, the proteins they encode, and the biological pathways

these proteins are involved in—all this, among many other discoveries, provides the

pharmaceutical industry with a dramatic increase in plausible biological targets for

novel therapeutics (Lowe and Reddy 2015). Scientists are only now learning to

understand disease mechanisms and what it is exactly that is malfunctioning inside

the body, with a view to developing highly specific molecules to counter the root

cause of disease.

Yet science is not only changing the way medicines are discovered but also how

they are developed. Today, clinical trials account for 36% of R&D expenditure in

the industry and thus constitute the biggest single cost in drug R&D (Strategic

Insights 2013). With increasingly well-defined, preselected patient populations, the

future will hold an increasing number of smaller and more cost-efficient trials.

Fig. 10 Turning scientific knowledge into novel therapies. Source: Roche internal analysis

14The fast and dramatic increase in understanding the human genome and its influence on the

biological pathways in the human body.


Success Factor 2: Tapping into External Scientific Innovation

Ninety-nine percent of innovation in the pharma industry happens outside one

single company. Truly innovative research is most likely to flourish in companies

with strong in-house capabilities and a diverse and extensive network of

partnerships and alliances with small biotech companies, universities, and research

organizations around the world. M&A strategies alone have not entirely mitigated

the R&D productivity risks (see Sect. 2.3.1) (Mittra 2007). The increasing range

and scope of strategic alliances and licensing deals have contributed to a significant

broadening of the innovation network for therapeutic products (ibid.). In-licensing

and targeted acquisitions of products, research compounds, and technologies have

become a must to strengthen existing franchises. It is particularly important to

identify and invest in emerging new technologies as early as possible to stay ahead

of the competition.

Sometimes the research that is needed and the associated investments are so vast

that single organizations are no longer able to bear the risk alone. Risk-sharing

collaboration is taking place in many different ways, including with precompetitive

nonprofit organizations, to accelerate the development of new drugs in more

difficult, costly, and risky disease areas such as Alzheimer’s disease (see

Sect. 2.3). Companies are thus increasingly licensing in and out technologies and

knowledge instead of keeping everything in-house. This facilitates the dissemina-

tion of technologies and know-how to a much wider scientific community while

allowing industry to incorporate promising external research into its own know-

ledge pool (IFPMA 2012). Entrepreneurial success in this world highly depends on:

• The scientific reputation of the in-house R&D organization. Top research

institutions are keen to partner with top research pharma companies, and top

scientists want to collaborate with other top scientists. Thus, reputation and

being the preferred partner is a crucial factor in a company’s ability to attract

the best potential partners.

• The ability to identify the best ideas outside the own R&D organization. The

strategy of complementing own innovation efforts by acquiring the best ideas

among the top research institutions or among the spectrum of the global 5000—in

most cases—small biotech companies is being pursued by big pharma companies.

However, no company can completely outsource R&D. Without in-house

scientific expertise, the ability to appropriately value the quality of external

ideas is limited. The ability to identify an innovative idea and (co-)develop the

molecule up to market approval needs a high-performing internal R&D

organization.

• Having in place the process and structure to screen thousands of opportunities

and ultimately manage a multitude (sometimes more than 100) of collaborations

in parallel. Successful partnering needs dedicated resources to streamline differ-

ent interfaces inside a large organization, set up legal contracts, set milestones in

projects, and create a positive collaborative spirit among all individuals

involved.

106 C. Franz

In the future, effective pharmaceutical companies are likely to find themselves as

decision-making hubs at the center of a network of collaborators and suppliers.

Success Factor 3: Expertise in Personalized Healthcare

Patients typically vary in their response to medicines. Differences in genes and their

expression can help explain these different responses. The goal of personalized

healthcare (PHC) is to improve clinical decision-making by distinguishing in

advance those patients most likely to benefit from a given treatment. Sophisticated

diagnostic tests for genetic mutations and other biomarkers are used to identify the

most effective medicine for patients.

In oncology, these personalized medications account for nearly 30% of the

global oncology market today, and this trend is expected to continue. The majority

of emerging molecules (70%) will require a companion diagnostic (CDx) to steer

patient selection. Both the number of personalized medicines and the number of

their manufacturers (currently 12) are expected to double in the near future (Strate-

gic Insights 2013) (Fig. 11).

PHC has advanced fastest in oncology. Researchers estimate that nearly all

cancers are fuelled by between 200 and 400 gene mutations in the DNA, many of

which are in genes that regulate molecular pathways responsible for cell growth.

There is a growing understanding that tumors can be defined by their genetic

makeup in addition to their location in the body. The increased understanding of

interactions between cancer and the body’s immune system offers new

opportunities for novel treatments (immune therapies) and combination treatments

(immune therapies with targeted treatments and/or chemotherapies).

In more and more disease areas, diagnostic tests will help to stratify the patients

who will most likely benefit from a treatment. This increases the chance of

achieving high levels of efficacy in clinical trials and of getting approval of the

specific drug (and its CDx). Furthermore, payers are more willing to pay/reimburse

treatments demonstrating a high patient benefit.

Fig. 11 Personalized healthcare on the market; global sales of FDA-approved oncology drugs

which require a companion diagnostic or pretreatment assay on the label. Sources: www.fda.gov;

EvaluatePharma (full brand revenues) as of May 2016; Roche


http://www.fda.gov/

Success Factor 4: Making “Big Data” Relevant (Digitalization)

The ongoing big-data revolution in healthcare is being driven by an explosion of

information about the human genome, digitalization of medical records, and access

to healthcare outcome databases:

• It took 13 years up until 2003 and cost roughly 3 billion USD to sequence the

first human genome and its 3 billion base pairs.

• In 2015, anyone can have their genome sequenced within a few hours for a little

more than 1000 USD. This cost will further decrease in the coming years.

• Thousands of hospitals worldwide collect data on patients, as patient monitoring

equipment generates tens of thousands of readings per day15 (Healthdirections

Blog 2015; Office of Health Information Technology 2015).

• Eighty percent of medical data is unstructured but clinically relevant (IBM

Analytics 2015).

Today, there are two different sides: the controlled one with clinical trials, where

the pharmaceutical industry owns the data. On the other side, there is the clinical

practice, and the data here is owned by physicians, the patients themselves, or the

payers. For the healthcare industry, indeed the healthcare system overall, the

challenge is to standardize and manage this data in order to gain new insights to

fight diseases.

The ability of companies to integrate data across organizations and the value

chain, from discovery to regulatory approval and clinical decision-making, is key.

This requires standards for consolidating, characterizing, validating, and

processing or aggregating data.

Integrating (real-world) clinical routine data and combining it with clinical trials

data will open up promising opportunities, e.g., providing clues for new targets in

R&D or optimizing treatment plans in the clinic (Fig. 12).

Reliable and standardized outcome data is also important for new, more sophis-

ticated reimbursement models for payers (see Success Factor 5, page 109).

Due to progress in information technology, data storage and information sharing

have become easier, and new health IT tools and applications are emerging. There

are still quite a number of challenges to overcome relating to health information

technology interoperability. Another key issue to be resolved is ensuring data

privacy and regulatory oversight.

Pharma companies have taken steps to get access to and use the growing number

of digital databases for their research, the goal being to translate better information

into better drugs and better care. The role of digitalization will be a critical long-

term success factor, but, for the time being at least, all players are still evaluating

and learning in this evolving field.

15Worldwide 16,000 hospitals and 86,400 readings/day, according to Referral MD. USA alone:

75% of nonfederal acute hospitals.

108 C. Franz

Success Factor 5: Innovative Pricing

The pharma industry is working with numerous partners to reduce the barriers

preventing people from having access to their medicines—be it measures to

improve infrastructure, training, diagnosis, or affordability. The latter includes

innovative pricing.

Pricing can basically be differentiated in two ways: by ability-to-pay circum-

stance and/or by medical benefit:

(A) Pricing differentiation based on economic affordability

Up to now, uniform national pricing still predominates for innovative medicines.

As a consequence, price differentiation means providing more expensive patent-

protected medicines to wealthy countries and cheaper off-patent medicines to less

developed countries. Recently, the pharma industry has adapted the strategy to offer

the same drug at different prices in different countries due to the following:

• A larger middle class in emerging markets has led to more price elasticity;

whereas in the past the situation consisted mainly of two sides, as the poor

could only afford generics and the rich could pay any price.

• The willingness of governments to increase co-payments or reimbursement as

populations become more demanding (e.g., in Russia, Brazil, and China).

• The willingness of different stakeholders to work together (e.g., providers,

NGOs, pharma companies, authorities) to improve access rather than evade

responsibility.

Fig. 12 Integrating and combining data for more efficient R&D and better patient care (illustra-

tive); Source: Roche, 2014


In the Philippines, for example, the public healthcare system does not cover the

cost of all medicines. Patients often have to pay out of their own pocket for

treatment, especially for the most sophisticated medicines. The majority of patients

cannot afford to do so. Socialized pricing programs addressing and considering the

individual affordability levels of patients can bridge the affordability gap.

However, making this kind of system work demands solidarity. The rich need to

be willing to pay higher prices than the poor. There also needs to be solidarity

between countries for international differential pricing to work. Otherwise—as is

the case inside the EU—gray reimports (parallel trade) from low-price countries

undermine the differentiation strategy.

(B) Pricing differentiation based on medical value

The industry is exploring pilot cases for a new, more value-based approach

(primarily in industrial countries) by testing pricing models that differentiate the

price of medicines across various indications and patient segments based on the

benefits they deliver to patients. Such personalized reimbursement models will

apply to single products as well as treatment combinations. This framework

provides payers with more flexibility when making reimbursement decisions. The

“pay-for-performance” approach is underpinned by reliable, standardized outcome

data (see Success Factor 4, page 108).

Given the broad spectrum of regulatory systems from country to country, there

can be no “one-size-fits-all” solution to pricing. Success in this area will be defined

by the ability of individual companies to develop targeted pricing concepts for each

country, sometimes for each therapeutic area. Collaboration with the local regu-

latory authorities and payers and a reputation as a “trusted partner” in these talks

will make a huge difference.

Success Factor 6: Shaping Innovation with People, Structure, and Culture

Innovation-driven pharma companies highly depend on finding and retaining talent,

because people, particularly top scientists, are ultimately the key to success for

innovation.

Effective talent management and retention strategies, as well as performance

and incentive measures supporting and fostering the behaviors a company wants to

encourage, are as crucial as ever (PricewaterhouseCoopers 2007). Addressing skill

shortages will become critical in the years ahead. Skill shortages appear likely to

increase as globalization and competitive pressure take hold across sectors and

industries. Also, improving economic conditions spur employees to seek new jobs

(KPMG 2014). The recruitment market for the pharmaceutical industry is highly

active and short on candidates; hence companies need to develop an excellent

employer reputation to attract the best of the available talent (Hays 2015), while

remaining aware that they are not alone in competing with their industry peers

(Posthumus 2014).

Globally successful companies will need to build a very strong culture that

defines who they are and what makes them distinct in order to attract the right

110 C. Franz

talent. Innovation demands a diversity of approaches and perspectives: a culture

where people can excel, take risks, and try out new things and are allowed to make

mistakes. This is particularly important in R&D, where only one in ten clinical drug

candidates makes it to the market. No matter how streamlined and well structured

the organization is and no matter what technologies are owned, innovation depends

on the ability to attract the best scientists globally and encourage them with the right

company culture. A decentralized approach to management—simple and lean

structures and minimal central functions—creates the necessary freedom for crea-

tive people.

4 Conclusion

The last few years have brought a period of rapid and fundamental change to the

pharma industry, with a number of key trends converging. What is more, the speed

of these changes is unprecedented. The mission, however—to find better ways to

alleviate suffering and prolong human life—has not changed. There is still an

enormous medical need for better diagnosis and therapies. Science’s rapidly

expanding knowledge of disease biology and the causes of disease hold particular

promise for patients and the innovation-driven industry.

Readers of the financial press may be forgiven for thinking that it is mergers,

acquisitions, and consolidation that are the decisive success factors. Yet in all too

many cases, financial transactions and (mega)mergers merely reflect the

deficiencies in a pharmaceutical company’s own R&D productivity and its lack

of output of own new drugs. In other words, they are a means of buying a certain

amount of time and generating cost reductions, but ultimately they do not offer an

alternative to managing the six success factors for innovation.

Indeed, it is not the size of R&D organizations that is the crucial factor; size per

se does not create synergies and scientific success—on the contrary, beyond a

certain critical mass, it can easily lead to complexity and bureaucracy, which stifles

innovation. Furthermore, as healthcare is regulated differently from country to

country, commercial success can only be shaped at the individual country (local)

level, not from global headquarters. It is, after all, the six success factors which are

shaping the evolving business models of the research-driven pharma industry, and it

is a company’s ability to exploit them which will ultimately secure its long-term

success.

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112 C. Franz

Industry Expertise and DynamicChallenges: Perspectives of an AdoptedRailwayman

Rudiger Grube

1 Introduction

An investment in knowledge pays the best interest—Benjamin Franklin

This quotation of Benjamin Franklin shows the importance of knowledge for every

individual and enterprise as well as for society. Since Franklin’s days society has

changed considerably and with it also our challenges. The management of a

company must continually ask themselves what kind of knowledge will be required

for the future success of the enterprise and in what form. This determines individual

priorities in development and the appointment of senior executives.

One standard and fundamental question concerns the importance of industry-

specific expertise in relation to transversal management skills. It is a question which

is regularly faced by corporate managements and comes under intensive discussion,

particularly in large companies and in traditional industries, even among the

general workforce.

The answer is both clear and simple: A company always needs a mixture of both

competences and both types of expertise. However, there are also deepening

questions where the answers are more difficult: What is the right mix between

industry expertise and transversal management skills? How is the optimum mix

impacted by a company’s challenges? What is the role of specific industry expertise

in the context of digitization, i.e., the biggest change in our business models and

customers? These are the issues which this paper seeks to explore.

Rail transport in Germany provides good material for a case study. It is an

industry with a major tradition. What makes it so suitable as a research object for

the abovementioned questions is that, on the one hand, it has always been

characterized by generations of “real railwaymen” and that, on the other—since

Germany’s railway reforms in 1994, if not earlier—it has also had managers with a

R. Grube (*)

Deutsche Bahn AG, Berlin, Germany



DOI 10.1007/978-3-319-48938-4_8

113

broad range of external experience. The two types of people are often wrongly

regarded as opposites. Another reason why German rail transport is worth studying

is that, in the past, this industry has been confronted with a much larger number of

radical structural changes and challenges than most other sectors in Germany. We

will focus, in particular, on Deutsche Bahn (DB) as the biggest railway company in

Germany and a globally leading mobility and logistics provider.

The paper is structured as follows: In the next section, we will start by defining

the relevant terms. This is followed by three core hypotheses, derived from the

abovementioned questions. Next, we will use the example of Germany’s rail

transport as an illustration and support for the hypotheses. Finally, we will conclude

with a summary of the core hypotheses and recommendations for action.

2 Definitions of Terms

To assess the value of industry expertise, we first need to define the industry as such

and also what we mean by industry expertise and what kind of a reference parame-

ter should be used in the analysis.

There are several approaches to defining the industry:

(a) Rail transport in Germany. This definition focuses on DB’s historical origins

and continues to specify the core business of DB. Where the transport side is

concerned, it covers rail-bound long-distance passenger transport, regional

passenger transport, and freight transport. But it also includes Germany’s

national railway infrastructure.

(b) The national and international mobility and transport sector. This definition is

much wider than the one in (a) and includes not only German rail transport but

also public transport, in general, long-distance coaches and logistics. DB is an

international group with numerous operations in those areas.

(c) The entire transport industry. This extends the definition of (b) even further,

covering also the relevant manufacturing industry and relevant institutions. It

includes other market players, such as representatives of the supply side,

government agencies, and authorities at all levels of the value chain.

(d) Network industries. These are all the industries that provide services based on

an infrastructure. They display certain similarities, such as natural

monopolies1 at specific stages within a central value chain. It includes sectors

such as telecommunications, electricity, gas, and also rail transport.2

In this paper we will use definition (a), i.e., rail transport in Germany. This

definition describes the core business of DB and therefore gives us the most reliable

1For the definition of a natural monopoly, see Knieps (2001), Chapter 2.2We can find the following statement as early as Sax (1879): “Having a monopoly is in the nature

of rail transport (. . .).”

114 R. Grube

reference framework for the past, present, and future. Moreover, it matches the

standard interpretation that is used in in-house discussions. Quite independently,

however, any assessment of a person’s industry expertise would need to look at the

extent to which it might also cover expertise from the wider definitions.

In addition, we need a clear definition of what exactly we mean by industry

expertise (or industry knowledge). To gain a suitable understanding, it is useful to

subdivide expertise into relevant categories within an industry, as industry-specific

knowledge can be found in several dimensions. Industry expertise is therefore

defined here as special in-depth knowledge in at least one of the following areas:

• History of the industry

• Technical systems expertise3 (e.g., rolling stock or infrastructure specifications)

• Financial and performance indicators

• Regulatory framework and legal basis

• Industry players and stakeholder networks

Industry expertise typically also manifests itself in the use and knowledge of the

relevant terminology, abbreviations, and highly specific language of the railway

industry.

We will distinguish between the concepts of industry expertise, on the one hand,

and general management skills which are independent of the industry, on the other.

Such skills include expertise which is identical or similar in the way it is applied in

different industries—e.g., in finance, legal affairs, and HRmanagement—but it also

includes some typical transversal skills, such as:

• Project and process management

• Rationalization skills

• Presentation and communication skills

• Leadership skills

In large corporations the abovementioned skills can be found to varying degrees

in different divisions and at different corporate levels. Our further analysis will

concentrate on the significance of industry expertise within senior management. We

define this level as the Board of Managing Directors or Management Board as well

as the next level lower down.

3This can potentially be subdivided into many further areas, which is also reflected in the

numerous professional magazines about railway transport and engineering.

Industry Expertise and Dynamic Challenges: Perspectives of an Adopted Railwayman 115

3 Derivation of Core Hypotheses

Traditionally, SMEs have industrial expertise and transversal management skills at

the management level, often within a single individual. However, as an organiza-

tion grows in size and complexity, we can observe an increasing division of labor,

with different areas of specialization being shared among several individuals. In

such cases the managerial function is not so much a matter of dealing with the finer

details of issues, but of leading the organization and making wider strategic

decisions. A growing enterprise expands its portfolio more and more from within

its core business, both internationally and with regard to its products and services.

It might therefore seem plausible to conclude that any increasing division of

labor in industry and any growing globalization should reduce the centrality of

industry expertise at the management level. In a highly diversified enterprise,

industry expertise might be found at entirely different levels. This may appear to

indicate that the entire senior management should be totally exchangeable between

different industries and that they can concentrate fully on their transversal skills

without any negative impact on the success of their relevant company.

Such a view, however, is not shared in this paper. The first core hypothesis is

therefore:

(I) Lack of industry expertise at the management level leads to poorer decisions

and to cultural conflicts within the enterprise. Lastingly successful companies

are marked by a healthy mix of industry expertise and transversal skills at the

senior management level.

Both areas of competence must be seen as complementary and not as substitutes

for one another. Such a mix can be sought both in the individual profile of an

executive and in the composition of the management team.

A low level of industry expertise among the management may lead to wrong

decisions, as industry-specific circumstances are not sufficiently taken into account.

This is particularly true for highly complex production processes that depend on

specific procedures and which have grown historically. Professional literature also

supports this hypothesis for decisions which, superficially, appear to require trans-

versal skills. Custodio and Metzger (2013), for instance, conclude that industry

expertise is equally vital in mergers and acquisitions. Having looked at the connec-

tion between a CEO’s industry expertise and his or her success in M&As in the

relevant industry, the authors show that CEOs with industry expertise are more

successful, as they are in a better position to identify profitable acquisition targets

and because, in takeover negotiations, they can make specific use of their knowl-

edge of economic conditions in that industry.

Cultural conflicts can occur within an enterprise after another company has been

acquired from a different industry, and the workforce within the enterprise see the

skills of the newcomers as inadequate and therefore distance themselves from them.

The worst-case scenario is that the workforce might not identify with their company

116 R. Grube

sufficiently well—something which, from the company’s respective, can lead to

severe problems if people lack motivation and take no pleasure in being innovative.

The next hypothesis goes further and focuses on the current dynamic

developments in the economy, i.e., globalization, digitization, and thus also

differentiation:

(II) The optimum mix of industry expertise and transversal management skills

changes in time, depending on the prevailing challenges.

Different challenges may include, for instance, growth vs shrinkage, strong

economic influences, changes in the regulatory framework, and a balancing act

between tradition and innovation.

We are currently at the threshold of a new era—the transformation from an

industrial society to a digital and global society.

Digitization creates enormous new opportunities, yet the enterprise must also be

prepared to part with outmoded patterns if it wants to achieve lasting entrepreneur-

ial success in the digital age. Not only does this apply to technologies and the way

we use them in the various sectors and spheres of our lives, but digitization4 is also

set to revolutionize our working lives and, as a result, present the management and

its various levels with new opportunities and challenges.5 How we understand

management at a time of digitization is a question which is of major social and

academic value.6

The last core hypothesis is:

(III) Digitization increases the role of industry expertise at the senior management

level.

This hypothesis may seem counterintuitive at first because, thanks to digital

media, specific knowledge has never been as readily accessible as it is today. It no

longer appears to be linked to the expert but can be called up anywhere and by

anyone. Surely, one might conclude, this development should give more promi-

nence to transversal management skills. In such an environment, we might think

4Bill Gates (1999) presents various ideas on this question, showing how the flow of information

can be managed, so that it reaches the right place within an organization at the right time. He also

shows how interaction will change between an organization and its environment, its potential

competitors, and its customers.5Michael Porter and James Heppelmann (2015) explain the enormous impact of the development

of new, smart, and mutually networked products (the Internet of Things) on industry and point out

the vast opportunities for the national economy arising from the expected increase in productivity

and product developments. The authors also outline the areas of uncertainties, challenges, and

management strategies.6See, for instance, Wilson III (2004) with a summary of the most important research issues arising

in connection with digital leadership.


standardized management methods should be adequate for the successful manage-

ment of an enterprise.

However, digitization also produces three effects which suggest the exact

opposite of this conclusion:

– Digitization has increased the flood of information that needs to be handled by

the management.7 This means that an industry-specific knowledge base is now

even more important for managers, as it enables them to distinguish between

relevant and irrelevant information and helps them process such information

more quickly in their minds.

– One central success factor in connection with digitization is the speed of the

decision-making process. Here, too, a management needs to rely on its own

judgment on technical issues. Lengthy consultation with the technical staff is, in

many cases, not possible.

– Although digitization enhances the level of simplicity for the end user, it also

increases the complexity of production processes and technology in the back-

ground. The more complex the production process and the stronger a company’s

capital tie-up, the greater the importance of industry expertise in general.

At the same time, the context of digitization means that industry expertise needs

to be supplemented by further skills. As well as industry-specific experience, it is

essential, for instance, that a person should have gathered their own experience with

digital media. To make the most of the potential offered by digitization in one’s

own industry, it is important not only to have industry expertise but also an ability to

set aside traditional patterns and to question existing routines and insights. This

means that managers are now subject to totally new requirements which should be

the object of further research.

Below we will take a closer look at the three abovementioned hypotheses as

illustrated by rail transport in Germany. In particular, we will focus on the second

hypothesis, the changing significance of industry expertise as a result of changing

challenges.

4 A Case Study: Rail Transport in Germany

To start with, we need to look at the specifics of German rail transport and also

some of its historical background, as this will give us a better understanding of the

features of this industry.

Rail transport is a relatively old industry which is dominated by technology, has

continually adapted to new requirements, and has had a substantial impact on

7See, for instance, Herget and Mader (2008) on the problem of information overload and on

possible solutions. The authors report that 43% of all managers in a survey feel that important

decisions are delayed by irrelevant details.

118 R. Grube

mobility in Germany for 180 years now. The long history of the railways, strong

interaction between infrastructure and transport, and long-term capital tie-up have

made rail transport a particularly complex industry. Moreover, it is highly impor-

tant to the national economy, and its business activities are often connected with

political procurement contracts.

The history of German rail transport8 started with the first steam train traveling

from Nuremberg to Fürth9 on 7 December 1835. Ever since this historic journey,

the railways have undergone many major changes. It started with an optimistic,

pioneering mood—the heyday of the railways—in the nineteenth century, when a

large number of lines were opened. During this time the initiative was left to private

entrepreneurs. When Germany became a unified empire in 1871, the state made its

first attempts to create a nationwide state-run railway system.

The railways were the engine of industrialization. As the population increased,

rail transport became increasingly relevant, conveying more and more passengers.

This heyday continued until the First World War.

After the war Germany’s Weimar Constitution included an article creating a

national railway company, Deutsche Reichsbahn (German Imperial Railways).

During this time the railways went through massive economic problems due to

political circumstances, reparations to the allied forces, and a global economic

crisis.

After the Second World War, Germany had two state railway systems, Deutsche

Bundesbahn (German Federal Railways) in West Germany and Deutsche

Reichsbahn (German Imperial Railways) in East Germany, which, together,

represented the entire industry. At the time there was no strong intramodal compe-

tition of the kind we now have in rail passenger transport and rail freight. It was a

time when the managements of both Deutsche Bundesbahn in West Germany and

Deutsche Reichsbahn in East Germany focused primarily on industry expertise and

were determined by political criteria. Neither company was managed under strict

business objectives. Lack of cost efficiency and the increasing rise of intramodal

competition presented by road transport led to a historic slump in the market shares

of rail transport—a situation which continued until the 1990s.

Reunification of the two Germanies and the country’s 1994 railway reform

caused an opening of the market to competition in rail transport and a clear

separation between entrepreneurial and governmental responsibilities. This separa-

tion also meant that the country’s state-owned railways came to be managed as a

private enterprise, with the foundation of Deutsche Bahn AG,10 a mobility and

8An interesting introduction to the history of the railways can be found, for instance, in

Rossberg (1999).9The history of rail transport started with the Stockton and Darlington Railway in England, where

it opened on 27 September 1825. The Stockton and Darlington Company was the first public

railway service to convey passengers. See Kirby (2002).10Following Germany’s railway reform in 1994, Deutsche Bahn AG was created through a merger

between Deutsche Bundesbahn and Deutsche Reichsbahn. An overview and the results of the

railway reform can be found in Schwilling and Bunge (2014).


logistics company that has since then been increasingly operating globally. This

amounted to a fundamental realignment of the railway system. To push ahead with

this transformation, it became necessary to include more and more skills from other

industries and to establish a modern form of business management.

Since the German railway reform, four phases, each with its own very different

challenges, can be distinguished.

Phase 1 (1994–2000): Restructuring and Improvement in Efficiency One major

challenge during the first phase, after the railway reform, was to achieve the

required paradigmatic change, i.e., organizing and restructuring DB along entrepre-

neurial lines. The main focus was on improving efficiency. This meant, above all,

ensuring the availability of transversal management skills.11 Although industry

expertise continued to be important at this stage, the strengthening business empha-

sis meant that such expertise played a relatively secondary role in the skill profile.

The measures that were taken at the time can be seen as successful, as the

fundamental reorientation of DB as a private enterprise had achieved its purpose

and had laid the foundation for a rebirth of the railways. The goals of the railway

reform have been reached, not just in business terms but also with regard to

transport, boosting both the performance and market share of rail transport. Another

central goal of the railway reform that has been reached extremely well was a

reduction of the system’s need for public funding.12

Phase 2 (2000–2009): International Growth and Ability to Operateon the Capital Market After DB had been transformed into a private enterprise

(i.e., formal privatization) by its owner, the German state, the second phase was

marked by the endeavor to realize the partial material privatization of

DB. However, this had to be preceded by achieving certain key financial figures

for a due diligence, permitting a launch on the financial market. It became impor-

tant to build up a suitable recent track record and to show that good equity could be

realized in the future. Analysts and market experts correctly understood the impor-

tance of an international and intermodal lineup of the enterprise. Acquisitions and

expansion into international activities had to have the full practical support of the

management. One central milestone was the acquisition and integration of Stinnes

AG in 2002, which also led to the Schenker brand joining the Group.

The purpose during this phase was to strengthen the company’s ability to launch

on the capital market and thus to ensure its planned IPO. However, in view of

substantial uncertainties on the financial markets resulting from the financial crisis

and in order to safeguard an appropriate offer price, the German state, as the owner,

11The first chairman of the Management Board of Deutsche Bahn AG, Dr. Heinz Dürr, had a veryclear business background and had worked for AEG and Daimler-Benz AG before joining DB

AG. See also Sassmannshausen (2003).12See Schwilling and Bunge (2014).

120 R. Grube

eventually decided not to go ahead with the planned listing of DB Mobility

Logistics AG on the stock exchange.

Throughout this entire second phase after the railway reform, the management

was marked by a need for transversal management skills and expertise in areas

which are more typical of other industries, such as financial marketing, strategic

project management, and in-depth professional expertise in mergers and

acquisitions. Obviously, however, industry expertise continued to be relevant

during this time, as Germany’s railways were facing major challenges in the form

of increasing intramodal competition and a growing regulatory framework.

Phase 3 (2009–2014): Sustainability and a Return to Core Business During the

third phase after the railway reform and after the German Government had aban-

doned its IPO plans, DB began to focus on sustainable corporate success and social

acceptance. The two core issues were its internal cultural transformation and a clear

attention to the core business of DB, i.e., railway service in Germany. During this

phase a number of measures were initiated to resolve the challenges to its core

business. They included, for example, the strengthening of Berlin’s S-Bahn (local

train) maintenance facilities. Also, after a broken axle on an ICE train in Cologne

2008, even greater importance was attached to interaction between manufacturers,

operators, and licensing authorities in matters of railway engineering. And when the

ICE4 was ordered, it was the biggest train contract in the company’s history. At the

end of 2014, a second multi-annual Service and Financing Agreement13 with the

German Government was concluded to safeguard the long-term quality of the

railway infrastructure until 2019. It constitutes the largest modernization program

in the history of German railway infrastructure.

The third phase also involved the development of a sustainable corporate

strategy, called DB2020+, defining ambitious targets in three dimensions: econom-

ics, the environment, and social responsibility. The major component of the strategy

is a focus on sustainability as a fundamental management principle, based on a good

balance between all three dimensions.

The developments described here illustrate a noticeable rise in the demand for

industry expertise, while globally standard management practices became some-

what more secondary again.

Phase 4 (Since 2014): Digitization and Further Intensificationof Competition The fourth and current phase is largely influenced by digitization.

The DB2020 strategy is valid as a corporate compass, and the management is

paying special attention to the challenges that are facing railway transport in

Germany. At the same time, we can see nearly all industries, including transport

markets, responding to the mobile Internet in a major way. This will create vast

13The Service and Financing Agreement is a multi-annual contract between the German state and

DB’s infrastructure companies and was concluded to ensure the long-term financing of the

infrastructure.


opportunities and new business models in the entire sphere of mobility and

logistics—including DB. Twenty years after the railway reform, DB is now

investing heavily in improving its offers to customers. This includes, for instance,

a long-distance travel and transport campaign as well as DB’s 4.0 initiatives which

are directly linked to digitization.14 The initiatives are improving DB’s operational

processes, increasing its product quality and making rail transport more contempo-

rary and competitive for the future. At this point innovation is linked to a high level

of professional expertise.

Digitization fosters a totally new relationship between a company and its

customers. By involving customers directly and entering into dialogue with them,

the company and its management can acquire an unprecedented amount of detailed

knowledge of their customers’ needs and the demands of the market. The business

opportunities are obvious, as such interaction enables a company to make its offer

even more attractive and to meet customers’ preferences. This strengthens demand

and reinforces customer loyalty. It also makes it possible to include all stakeholders

in an open quality process.

To develop the best products in our age of digitization, it is necessary to combine

industry expertise with new knowledge and new methods. These are basic

requirements to innovate and stay competitive in the future. It is becoming more

and more important to interact with other market players and to be prepared to

cooperate with potential competitors, including new companies which are increas-

ingly penetrating the market and which come from different industries. Another

important element is to ensure data transparency and purposefully gain the support

of external innovators and providers of ideas.

DB is therefore working increasingly both with start-ups and with established

corporations which are now opening up under the impact of digitization. Another

central element is the development of new and unconventional channels of distri-

bution. Intermodal traveling platforms and car-sharing apps are important

examples.

The future of the railways in Germany is a joint challenge, requiring complex

and diverse skills. This principle applies both on a large scale and on a small scale,

and it impacts the specific managerial work of the Management Board as well as the

next level lower down. At a time of digitization, it is all the more important to

ensure that industry expertise and new know-how are not regarded as mutual

substitutes, but as complementary. To be truly successful, there needs to be the

right mix.

We can now draw the following conclusions with regard to the three hypotheses

derived in Sect. 3 of this paper: Hypotheses (I) and (II) can be confirmed for the

case in point. The complex demands on the core business of the railway service

invariably mean that senior management must have in-depth industry expertise.

Without such expertise it would be impossible to lead a complex enterprise such as

14In all, the DB Group has hundreds of digitization projects covering a wide range of purposes, and

the volume of such projects is growing.

122 R. Grube

DB. The different challenges of rail transport in the course of time serve to illustrate

the importance of ensuring an optimum mix of industry knowledge and transversal

management skills.

Hypothesis (III) can also be confirmed. Industry expertise will never diminish in

importance, even under digitization, and the only way to be successful is through a

balanced mix. One crucial challenge, however, is to find the best way to anchor the

knowledge that is required for digitization, both within the management and

throughout the wider organizational structure, and then to ensure the best way to

combine this knowledge with industry expertise.

5 Conclusion and Recommendations

There are numerous factors that determine what kind of knowledge a company

needs, when, and to what extent. First of all, major roles are played by the market

environment, technological change, increasingly faster changes in customers’

needs, and of course the political environment. One of the most important manage-

ment tasks is to find the best possible mix.

In this paper we have looked at the importance of expertise, using the example of

Germany’s railways and DB as a mobility and logistics enterprise. Following the

German railway reform, DB has gone through four phases, each with its own very

different challenges and tasks. Throughout this period DB has changed fundamen-

tally and has adapted to the prevailing new conditions. Now Germany’s railways

are again facing major challenges. To continue as the backbone of public mobility

and of German industry, it is vital that DB’s business model should remain

economically sustainable. This requires a critical look at existing corporate

structures and traditional rules of conduct and also at the general conditions and

competitive situation in the transport sector—particularly when we consider that

the environmental benefit of the railway system will continue to gain importance in

response to climate change. In the future digitization will cause changes in mobility

and also changes in customers’ mobility needs. DB wishes to have a successful

hand in such change and wants to be actively involved in impacting the future. To

do so, industry expertise will be just as essential as transversal management skills

and new knowledge contributed by other industries.

The following general recommendations can now be derived:

– Industry expertise must be cultivated and anchored at the senior management

level. Industry expertise and transversal skills complement each other.

– It is the responsibility of every manager who enters a new industry to develop a

high level of industry expertise within a short period of time. This is essential for

their ability to make decisions and for their acceptance within the company.

– Any companies which operate in fast-changing environments need to create such

a mix of industry expertise and transversal skills more quickly and must control

the necessary transformation within the corporate management.


– Digitization does not reduce the importance of industry expertise among the

management. However, it does change the complementary skills that are needed.

This latter aspect, in particular, should be studied more closely in further-

reaching academic analyses. After all, it is already obvious now that—with the

exponential multiplication of information—we will see an even greater need for

skills to translate such information into entrepreneurial success.

This is why Benjamin’s insight will continue to be valid in our digital age: An

investment in knowledge pays the best interest.

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Informationsflut. Konferenzbeitrag KnowTech 2008. Frankfurt am Main.

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124 R. Grube

The Airline Industry: Flying on Its Own Isnot Enough

Harry Hohmeister

1 Introduction

The airline business is a special industry. The managerial challenges have always

been vast: Ever since the Wright brothers’ first flight in 1903, managers were

challenged to ensure passenger safety against the background of a rapidly develop-

ing technology and high growth rates. Unlike other industries, aviation has from the

onset on been an international industry. States have always been heavily involved,

as owners of airlines and as regulators. In economic terms, aviation should not even

exist as a private industry: Over the course of its history, the airline industry rarely

covered its cost of capital. Today, aviation is a highly competitive industry with an

increasingly commoditized product, characterized by the unique combination of six

elements: (i) safety as the overacting principle, (ii) oligopolistic supplier markets,

(iii) high dependence on external cost, (iv) high capital intensity but cash-richness,

(v) high state influence, and (vi) only two viable business models (hub and low-cost

carrier).

What managerial practices are needed to strive in such an environment? Does

the ideal top management team of an airline possess in-depth industry expertise, or

is it of advantage when it has experience in various industries? In the article at hand,

I argue that the airline industry is characterized by unique dynamics, with the result

that the necessary managerial skillset has always been quite industry specific.

However, I believe that different business models require a different degree of

specialization. Especially today, hub carriers require a top management team with

in-depth industry knowledge; a low-cost carrier (in the following “LCC”) in

contrast may benefit from cross-industry experience, especially from the retailing

sector.

I make my argument in four steps. First, I present my understanding of the term

“managerial skillset.” The second section shows how the industry dynamics and the

H. Hohmeister (*)

Swiss International Air Lines Ltd, Basel, Switzerland



DOI 10.1007/978-3-319-48938-4_9

125

necessary managerial skillsets have evolved throughout the history of aviation.

Third, I elaborate on the six forces that make aviation special. The final part

discusses the difference in the required managerial skillsets for today’s main

business models in aviation: hub airlines and LCC. I focus on passenger airlines,

ignoring subsectors such as airline freight or private jets. Moreover, I discuss the

European and North American airline industry, given the fact that in most other

parts of the world, airlines still are to a large extent state-owned, which requires a

different managerial skillset.

2 The Task of a Manager

My personal philosophy is that management must in essence be based on three

basic elements. First, managers must always act as part of a team. Second, all

decisions must be based on facts and figures. Third, constant talent development

must be assured by putting employees continuously in new and challenging

situations.

I take only one book as reference point for this article: Peter Drucker’s (1973)

seminal Management: Tasks, Responsibilities, Practices. To begin with, not all

organizations need management. But with a certain size, managers are a necessity

because any large organization is characterized by interdependent elements.

Drucker thus writes “When a variety of tasks all have to be performed in coopera-

tion, synchronization, and communication, an organization needs managers and

management” (p. 3). This fits perfectly for the description of a hub airline. I relate

the term “management skill” to the skills of the leaders of the organization. This

means the top management team and their direct reports. The goal of the top

management team is to maximize the performance of the system as a whole. It isone of my core belief that in today’s ever more global and ever-changing environ-

ment, a complex organization can only be led by a team of leaders with different

skills, not by a single individual.

Peter Drucker defines key managerial skills, thereby laying the fundament for

the discussion about cross-industry management practices versus industry-specificmanagement skills. Slightly adopted, I am of the opinion that any (top) manager in

any industry has five different categories of tasks:

1. Decision-making: The leadership must decide how to tackle the various

problems that a firm faces—this can be in the area of operations, but focus is

of course also on tactical and strategical aspects. In my opinion, this requires a

continuous reflection of the decisions made, especially in the sense of mitigating

failures and a sustainable safety culture.

2. People decisions: The top management team must decide who is best skilled to

steer the various parts of the organization. But that is not all; I believe we need to

develop management talents by constantly putting them into new challenging

environments. After all, these are the next generation of leaders—the company’s

future.

126 H. Hohmeister

3. Communication: The leaders must be capable of talking and listening to

various internal and external stakeholders, enabled by an optimized organiza-

tional design. The goal is to facilitate collaboration between teams—on vertical

but also horizontal level.

4. Planning and steering: The leadership team must decide where to best allocate

a company’s scarce resources over time. They must “place their bets”—always

based on facts and figures.

5. Measurement and controls: The managers must be able to understand the

performance of the organization as a whole and decide on which of the various

metrics to emphasize on. But simultaneously, a lean organizational approach is

of the essence.

3 History of Aviation Industry and Management Skills

The airline business always was and to some extent still is a special industry, with

its very own patterns and subsequent management practices. I will in the following

shed light on the history of aviation, which gave rise to the dynamics of the industry

that we observe today.

Phase I: Pioneering and Safety First

The end of World War I, where planes were used on the battlefield for the first time,

suddenly put a high number of pilots out of work. It was these pilots who offered the

first small-scale commercial flights: ad hoc transports of mail and passengers from

one city to another. Gradually, the first airlines emerged from this trend in Europe:

KLM in 1919, Finnair in 1923, Lufthansa in 1926, Aeroflot in 1923, or Air France

in 1933.

What set the airline industry apart at that point in time was the enormous risk that

these pioneers had to deal with. Aircraft technologies were in their infancies; they

needed unknown logistical support over long distances. Aviation lacked interna-

tional standards, navigation techniques, and consistent infrastructure. Accidents

were a daily event. Hundreds of airlines went bankrupt. It was, to say it moderately,

more gambling than managing.

These were the days of the true pioneers. Airline managers had to handle vast

technical challenges and had to take on huge risks. They had to find and train risk-

loving pilots and innovative mechanics. They had to push states to build the

regulatory framework. Most often, the managers were (self-taught) pilots them-

selves. Most of them were in the game because of their “love” for flying, not

primarily to make money. For these pioneers, establishing operational reliability

became their highest priority: For the industry to take off, the passenger needed to

know that flying was safe. And ever since, safety first remained the top priority of

airline managers.

The Airline Industry: Flying on Its Own Is not Enough 127

Phase II: From Safety First to Industry Standardization

The second phase started toward the end of World War II and was shaped by three

main movements.

First, the period was characterized by increasing standardization. In 1944, the

Chicago Convention created the basis for international air law and the International

Civil Aviation Organization (ICAO), thereby enabling global regulatory standards.

In 1945, the formation of the International Air Transport Association (IATA), an

industry organization, enabled industry standardization. As a consequence, naviga-

tion and infrastructure became increasingly standardized through the ICAO. Pilots

could gradually find the same airport signalization in Manila as they did in Miami,

and radio transmissions were increasingly the same in Sao Paulo as they were in

San Francisco. In addition, pricing and reservation logic became standardized

within IATA; the organization acted as a body for official and at that time legal

price fixing. This enabled cooperation between airlines and paved the way for

global distribution. Both movements lead to industry-wide standardization, thereby

increasing operation reliability and cooperation. ICAO and IATA led the funda-

ment for the enormous growth of aviation over the following decade.

Secondly, the state increased its influence in the still-young industry. States

decided which airline was allowed to fly, which route, and at what price. In Europe,

almost all airlines were at least partly state-owned (e.g., Lufthansa, British Airways,

Air France). In the USA airlines were mostly privately owned (e.g., Pan Am,

TWA), but the state nevertheless created monopolies by designating airlines to

certain routes. Market access was (and to a large extent still is) dependent on bi- and

multilateral treaties between states. The heavy involvement of the state limited on

one hand competition and on the other hand the potential of creative destruction.

Third, aircraft technology developed rapidly. The jet age begun in the late 1950s;

the introduction of the B747 “Jumbo Jet” in the 1970s paved the way for the modern

long-haul aircraft. Thus, operational reliability increased tremendously. Flying not

only became much safer; it also became much more efficient: During the 1960s,

fuel burn per passenger kilometer dropped by almost 40% (ATAG 2010). Thus,

new technologies paved the way for the enormous growth in passenger numbers,

enabling safe and commercial viable flying.

In this environment, shielded from the pressures of competitive markets and

enjoying fast growth, the main and new task of the top management team was toadminister the rules and regulations, to implement the standards, and to managethe growth. All of that in order to use the gains of efficiency for increased

connectivity. This led to an increasingly specialized skillset (within the airlinesafety standards, rules, and regulations). High-level decisions became increasingly

concerned with operative aspects and encompassed a range of interdependent

subjects, such as aircraft maintenance, network design, or onboard product. The

key task for an airline’s leadership team was to put these different (operative) pieces

together. The main commercial challenge during this period was also to fill the

planes with passengers, especially in the 1970s, due to the effect that the increase in

efficiency automatically led to more offered seats in the market.

128 H. Hohmeister

The focus on operations required an in-depth knowledge of the industry. Man-

agement focused their people decisions on training their own specialized work-

force, equipping employees with the skills for a lifelong career in the airline

industry. As a result, the airlines management team often consisted of people

with high operational and technical knowledge but often relatively low commercial

and financial background: pilots and engineers. Thus, even high-level decision-

making was primary driven by operative, not necessarily commercial, criteria. For

instance, investing in new aircraft was easy due to state backing. As a result, airline

fleets often consisted of many different types of aircraft—fun for the pilots but a

nightmare for cost efficiency.

Phase III: Liberalization and Hub Optimization

The third phase saw increasing deregulation and as a result the emergence of large

hubs. This trend started in the late 1970s in the USA and came to Europe almost

10 years later (and another 10 years later, it begun to emerge in Asia).

In the USA, airline liberalization began in 1978 with the Airline DeregulationAct of the President Carter administration. Suddenly, prices were no longer fixed,

and airlines could serve all routes. Competition increased tremendously—with the

usual effect: Ticket prices decreased tremendously. Nine major carriers (e.g., Pan

Am, TWA, Eastern) and more than 100 smaller airlines went bankrupt

(cf. Wensveen 2007). To ensure the commercial viability of their operations,

large airlines abandoned secondary airports and instead optimized their hubs.

This created the playground for a new business model: LCC began to offer point-

to-point flights between abandoned secondary airports. In the beginning LCC were

focusing on the leisure segment and therefore were just price and cost driven. These

carriers were no more than flying coaches: frugal and cost-effective means for

domestic transportation. For instance, Southwest, the largest LCC today, was

founded in 1967, but growth only took off after 1978.

In the EU, this trend started almost 10 years later in the early 1990s. The EU

gradually created a common aviation area, with a harmonized regulatory frame-

work. In contrast to the USA, the EU deregulated aviation, but not fully liberalized

it. On national state level, European Airlines were gradually privatized, for

instance, British Airways in 1987 and Lufthansa in 1997. Similar to the USA, this

intensified competition tremendously. By some accounts, price fell by more than

30% from 1990 to 2000. Legacy carriers were forced to substantially increase

productivity in order to survive as privately owned entities. Thus, similar to their

North American peers, European carriers consolidated their operations, which led

to the development of the large hubs as we know them today: London Heathrow,

Paris Charles de Gaulle, and Frankfurt Airport. The legacy carriers abandoned

smaller and nonprofitable airports and focused on optimizing their network struc-

ture, hence connectivity via their hubs. As in North America, this paved the way for

the rise of the LCC, which began to open point-to-point services between secondary

airports also in Europe. As an illustration, Ryanair, founded in 1985, increased its

passengers from 745,000 in 1990 to astonishing 7 million passengers in 2000

(according to Ryanair’s figures).


During this time of intensifying competition, the name of the game for airline

managers of established airlines was optimization. They had to design a network

system, which generates optimal connectivity through efficient combination of

short-haul and long-haul flights. This meant that airline managers had to increas-

ingly excel at operative optimization. This again increased the need for in-depthindustry experience, specifically of network economics. High-level managerial

decisions shifted to establishing operational efficiency across all divisions. And so

did the other skills; budgeting, measuring, and control were increasingly focused on

maximizing the connectivity of the hub systems.

Phase IV: Consolidation and State Capitalism in the Middle East

The last phase started in the late 1990s. The tremendous growth of the LCCs

rendered the short-haul networks of hub carriers unprofitable. LCC offered cheap

short-haul routes—but these were the flights that hub carriers needed to ensure

the profitability of their long-haul flights (as the so-called “feeder”). Furthermore,

since early 2000, the external effects became even more important for aviation: oil

prices skyrocketed and economical volatility increased (dotcom bubble, great

recession). Thus, establishing hubs with a high connectivity rate was simply not

enough—efficiency and productivity appeared to be just as important. Airline

managers had to establish the necessary economies of scale to survive. The market

forces pointed to the creation of even larger hubs, thus increasing the pressure for

consolidation. However, the degree of consolidation and the pathway differed

between the USA, Europe, and the emerging Middle East.

In the USA, the consolidation began earlier than in the EU but remained

uncompleted until the 2010s. Historical liabilities and high unionization inhibited

the creation of large and efficient organizations. However, US carriers had one

tremendously successful tool at their disposal to overcome these obstacles:

restructuring under Chap. 11 bankruptcy protection. All large airlines underwent

Chap. 11 proceedings. During this process, the main hub carriers in the USA

consolidated their business. Today, the US aviation market is dominated by three

major hub carriers: United, Delta, and American. On the low-cost side, Southwest is

the main player. Currently, all these carriers are highly profitable. In USA, consoli-

dation worked. However, it remains a domestic industry. Ownership restrictions,

primarily based on security concerns, limit the foreign ownership of US airlines to

25% of equity.

Similarly, intense competition pushed the market toward consolidation in

Europe: Lufthansa acquired SWISS (2007), Austrian (2008), and a share of SN

Brussels (2008). British Airways merged with Iberia (2011) and KLM with Air

France (2004). However, Europe is still a very fragmented market based on three

main reasons. First, national states very seldom let their carriers go bankrupt. Take,

for instance, Alitalia. Technically bankrupt for a long time, it has been rescued

many times by the Italian government—for instance, Mr. Berlusconi forced the

state-owned Italian postal service to invest in Alitalia in 2013. Second, Europe has

similar ownership restrictions with the USA allowing a maximum 49% foreign

ownership. Third, airlines often suffer from their legacy (e.g., pension obligations,

130 H. Hohmeister

diverse fleets, aging aircraft). Europe misses an equivalent to the Chap. 11 in the

EU; moreover, most EU members have a far more rigid labor law than the USA. All

of these inhibit true consolidation and restructuring. As a result, Europe remains

aviation’s most unprofitable region. As with many other topics, politicians in

Europe seem unwilling to make controversial but, in the long term, smart decisions.

Meanwhile, the emerging states of the Middle East and Turkey are actively

building their mega hubs in Dubai or Istanbul as part of their governmental and

industrial strategy. These states heavily support their airlines: they build the neces-

sary infrastructure, unrestricted by noise concerns or environmental charges. Labor

laws are nonexistent. Funds are unlimited. However, most of these carriers (exclud-

ing Turkey) have no home market: In order to survive, they must divert traffic from

the major traffic streams (e.g., Europe to Asia) via their own hubs.

For airline managers, the task was to consolidate in a heavily regulated environ-

ment, riddled by state influence and ownership restrictions, while simultaneously

ensuring profitability in a highly competitive and highly volatile market. Thus, the

airline manager had to possess a far-fetching merger and acquisition skillset withspecialized knowledge of the airline industry. These were the years of the

consultants: The required skillset thus expanded to M&A decisions. People

decisions involved handling different cultures and organizations and budgeting

expanded identifying synergies. Overall, airline organizations grew more complex

(organizationally as well as regionally), and so did the required skillset. A top

management team solely consisting of airline experts did not suffice in such a

rapidly developing environment. Increasingly, a combination of airline-specific

skills and more general as well as industry-overarching skills was necessary.

4 Today’s Dynamics

This short history of aviation illustrates the special dynamics that shape the airline

industry today. Of course, the mega trends of globalization, digitalization, and

liberalization did not spare the airline industry and led to some extent to the

introduction of generic management practices. However, I believe that six particu-

lar elements are unique to the airline industry. These elements are of course also at

play in other industries, but their combination is unique to aviation.

Safety First Legacy carriers have a long history. Their founding principle, as I

elaborated above, was establishing operational reliability and thereby passenger

safety. Until today, safety is the overarching priority at the core of airlines, for both

hub airlines and LCC. Today, flying is the safest of all travel modes. For an

organization, this means high process orientation and excellent capacities for

feedback and learning. However, this at the same time makes innovation

challenging.

Oligopolistic and Monopolistic Supplier Markets In many fields, airlines are

dependent on very concentrated supplier markets. For instance, airlines are


dependent on airports and air traffic controls—natural monopolies, often state- or

semi-state-owned. Historically unions monopolize the market for pilots instead of

continuously developing it to a competitive level (bound by union agreements,

airlines often can’t hire a captain from another airline). There are only a handful of

global distribution systems (GDS), oligopolizing distribution and dictating distri-

bution rules to the airlines. Carriers can only buy long-haul aircraft from the

duopoly of Airbus and Boeing. As a result, everybody along the aviation value

chain makes more money than airlines. Based on our own observations, airlines on

average make 2%, airports and distribution systems 20%, and manufacturers 10%.

High Dependence on Exogenous Cost Airline managers must cope with a high

share of cost that is not under their control. Fuel and exchange rates cannot be

influenced but can make up 40% of cost. Of course, they can be risk-managed

through financial tools (hedging), but that is a mere risk mitigation measure.

Moreover, the largest share of influenceable cost is labor cost (ca. 40%), but

even these are often long-term commitments (e.g., pension obligation, union

agreements). Thus, in a highly volatile market, the airline manager must deal

with little short-term cost control.

Capital Intensive but Cash Rich A long-haul plane easily costs over $300m, and

short-haul planes sell for $100m. Even a medium-sized airline has a fleet of over

80 aircraft. That’s pretty hard to finance with an average return of 2%, in an

industry that does not cover its cost of capital. But aviation is still cash rich if the

working capital management works, due to the fact that passengers pay their flights

before departure, and hence airlines cash in before the product is delivered.

High State Influence Until today, almost half of the world’s airlines are in at least

partial state ownership. In addition, aviation never became part of the World Trade

Organization framework. It thus misses the legal framework for a level playing field

(e.g., flight duty regulation standards, taxation, and operational standards); further-

more there are no coherent subsidy regulations, dispute settlements, or minimal

requirements. Market access still is negotiated between states and fixed in bi- or

multilateral air service agreements. As consequence, airline managers have often to

compete with states, thus not on equal footing.

Only Two Feasible Business Models Only two business models work in aviation:

the hub and the LCC approach. The hub approach comes with its very own

dynamics, as shown above: high economics of scale and a difficult optimization

problem, meaning simultaneously optimizing short- and long-haul profitability

while maximizing the economics of the systems as a whole through connectivity.

Managing these two business models requires fundamentally different managerial

skillsets, as I will show in the next paragraph.

132 H. Hohmeister

5 Business Models and Skillsets

I am convinced that in today’s airline world, the different underlying business

models require different managerial skills. When talking about business models, I

refer to the concept as an activity system (cf. Zott and Amit 2010): a system of

interdependent elements that together led to value creation.

Hub Carrier

The hub carrier is the traditional business model of (large) airline management that

emerged with the dawn of the jet age in the late 1960s and 1970s. Its core value

proposition is to create global connectivity (itinerary) through the optimization of a

network system, with a central hub that efficiently connects short-haul with long-

haul flights. This includes satisfying different travel needs (e.g., leisure, business)

and therefore managing different product offers (economy class, business class, first

class). Such organizations—often labeled “flag carriers” or “legacy carriers”—tend

to be rather old enterprises. As mentioned above, the organization in which I am an

executive board member, the Lufthansa Group, has its origins in the 1920s. As such,

these firms—conglomerates—imply highly complex organizational structures

spanning across a large number of semi-independent subsidiaries. Taking

Lufthansa as an example, it has more than 150 subsidiaries, ranging from areas

such as aircraft maintenance to software development to catering. Such airline

groups often include multiple hub carriers. For instance, the Lufthansa Group

enfolds inter alia SWISS, Austrian Airlines, Lufthansa German Airlines, and

Eurowings; the International Airline Group includes British Airways, Iberia, and

Vueling. Given the enormous numbers of entities, such an organization is usually

tied to a complex hierarchical structure on group level. On this level, the overarch-

ing task of management is the development of this enormous complex entity,

ensuring its adaptability, coherence, and functionality.

At the core of such, airline conglomerates still are the airline business, focusing

on a network of short- and long-haul flights. A rule of thumb is that a hub system

requires a 1:2 relationship in terms of resources invested in short- and long-haul

flights. A hub system includes a far-fetching range of interdependent activities,

such as inter alia:

1. Network management: Optimizing the combination of short- and long-haul

flights with the goal of maximizing connectivity, which is equal to the number of

itineraries. Connectivity in hub system grows exponentially—with two

destinations you offer three city pairs, ten destinations equal 55 city pairs, and

100 destinations equal 5,050 possible travel routes. The goal is to maximize

connectivity while taking into consideration to optimize productivity (equals the

time having an aircraft in the air).

2. Revenue management: Maximizing revenues from seat inventory over the

whole network that is perishable at the point of departure. And of course, this

has to be done over the whole network; as an illustration, take a medium-sized

airline with over 4000 possible city pairs connected through the hub. Assuming


that 25 price points are offered per itinerary, this equals 100,000 prices that

must be balanced. These prices are fully independent of cost, and there are no

bottom-up calculations (e.g., fix cost plus variable cost)—the price is determined

by the level of competition only (for which price will and can the customer travel

from A to B).

3. Operations management: Ensuring the safe and efficient aircraft operations

between the hub and a large number of diverse destinations. This includes

handling different standards, rules and regulations, cultures, and flying

conditions. And punctuality is the major focus as this guarantees the quality of

the hub connectivity.

4. Aircraft maintenance: Keeping an often diverse fleet of long- and short-haul

aircraft in technical reliable condition. This includes everyday and ad hoc

servicing of the aircraft (worldwide) but also major technical checks and thus

a wide range of make-or-buy decisions.

5. Fleet management: Purchasing or leasing the right number of aircraft types and

sub-fleets over time to maintain an efficient short- and long-haul network with an

appealing product. In some cases, airlines lack seasonal capacity and thus use

so-called wet leases (i.e., rent aircraft from other airline including crews).

6. Product design:Optimizing onboard and ground comfort as well as processes for

all passengers, with the goal of maximizing comfort for business and first-class

passengers.

7. Information technology:Managing and developing IT systems that—in certain

cases—date back to the 1950s. The absence of standards in combination with the

high degree of interaction between airlines in various areas makes this especially

challenging.

8. Distribution: Reaching the customers and selling the right tickets through the

right channel across the globe. The combination of decade-old sales channels

(e.g., travel agency), global distribution systems, and own channels makes this

especially complicated.

These key activities have traditionally been managed in a highly specialized

manner. The reason for this is threefold: the network structure, the global reach,and the regulatory density. For instance, the network and the related revenue

management are a very peculiar field of economics—different from selling nonper-

ishable, independent products, which is at the core of most industries. Its optimiza-

tion demands in-depth understanding of the underlying network economics and

competitive dynamics. Of course, the top management team does not have to

engage in these tasks themselves; nevertheless, they must understand the dynamics

and drivers. The global reach adds to this specialization. As aviation is not part of

the World Trade Organization (WTO), country-specific traffic rights must be

secured. Hub carriers must deal with state-owned competition. In addition, the

various markets require different regulatory compliances, distribution channels,

etc. Again, leaders cannot always know all the details of these aspects (yet, it is

not counterproductive if they do know the details). However, they must understand

the effects of the global differences on the performance of the firm. Lastly, aviation

134 H. Hohmeister

is an industry with high regulatory density, based on (historical) concerns about

safety and security. As a result, management positions in operations and techniques

are often required by law to be filled with specialists. For instance in Switzerland,

the Head of Ground Services and the Head of the Technical Division must both take

a mandatory exam with the Federal Office of Aviation. Thus, even at the highest

level of the organization, management positions are filled with specialists. Histori-

cally, a hub airline’s top management team consists of specialized aviation insiders

(e.g., in operations, commerce, or finance).

However, as I showed above, the hub carrier model is getting under increasing

stress. First and foremost, the highly complex organization often does not match

the dynamic environment in which they operate in. Simply put, it is too rigid

and therefore not adaptive enough. Second, the rise of the LCC has rendered the

short-haul network of hub carriers unprofitable. However, hub airlines need

short-haul travelers to uphold the feeders for their long-haul flights (and without

those feeders, long-haul flights won’t be profitable as well). Third, due to the rise of

the new state-owned carriers from the Middle East, the capacity on long-haul flights

has multiplied. What once was the cash cow of aviation is today fighting with

plummeting yields. Fourth, the rise of the Internet has led to full price transparency.

Today’s average passenger consults websites such as Skyscanner in order to find thebest deal. Flying has become a commodity. Fifth, a historically highly unionized

workforce resists necessary changes in order to protect their own (often short-term)

benefices.

The responses to these challenges are, at least on the surface, quite clear. Hub

airlines must simplify their organizational structure, further optimize their network,renegotiate the terms of engagement with their employees, and individualize (anddigitalize!) the sales channels as well as the product. As long as this is not done,

hub airlines will continue to lose market share and consequently will shrink in order

to survive. Hub airlines must first of all decide how to truly differentiate, i.e., define

what their unique selling proposition (USP) is. If flying is a commodity, why should

the passenger pay more to travel on SWISS than on Ryanair? What is the real USP?

I believe that offering global itineraries with a consistent quality standard across the

whole network and value chain as well as additional individualized services

together forms the USP of hub airlines. If we know that Mr. Smith always sits on

24A, travels only with carry-on baggage, drinks a gin tonic, only eats gluten-free,

and wants to read the Financial Times and we manage to offer him this service

across the network, he will chose SWISS as a carrier. The goal is to offer Mr. Smith

a customized service for which he is willing to pay a premium. But as simple as this

sounds, it is difficult to get these changes implemented. The key challenge is to

change large-scale organizations—conglomerates—that are often decades old. The

very nature of the organization breeds employees with rather rigid mindsets: the

hub carrier is per definition a specialized organization.This brings me to the key question: What sort of skillset is required to get these

fundamental changes implemented, i.e., to change the prevailing mindsets? In my

opinion, hub airlines must to a large extent still rely on specialized top managers.

For instance, network optimization, revenue, and union management, the three core


tasks, still require in-depth expertise of the respective fields. In order to decide,

communicate, and control such fields, a manager must understand the details of his

core business. As these fields are quite airline specific, the necessary skills may not

be simply acquired in other industries. Of course, some industries may share similar

network characteristics (e.g., railways, logistics), but the global scope and the

regulatory density are very much airline specific.

However, for other fields—most notably sales, marketing, digitalization, and

product and service design—expertise from other industries is helpful. In terms of

sales and marketing, airlines are lagging far behind the overall market. Within sales,

for example, the Lufthansa Group just recently started to push their own sales

channels instead of using (and paying) old distribution systems. Hence, the

keywords are utilization of Big Data, upselling, and individualization. Offering

supplementary services, e.g., an upgraded meal, extra legroom seats, airfares

without baggage, or even onboard surprises from your beloved ones (like a nice

chocolate cake), is a relatively new concept in aviation, which still triggers a

(surprisingly!) lot of resistance within the organizations and the industry as a

whole. A top manager with experience in other industries may pave the way for

such changes. Think, for instance, of managers with experience in publishing, an

industry that has undergone tremendous change in the last decade. Digitalization

has rendered the newspaper virtually free, so publishers had to come with ways to

sell their services. Some do so now successfully online (e.g., the Financial Times),and some do so with advertising (e.g., 20 min). Hub airlines will have to go through

an analogous development: As revenue from the airfares will continue to fall,

airlines must learn to generate revenues with supplementary and individualized

services. However, even in this case, some specific expertise in the airline business

is of the essence. Airlines rely on sales channels that are decades old,

interconnected software systems that cannot just be replaced. The respective leader

must understand the relevant industry dynamics.

In sum, I believe that the skillset of a management team of large hub airlines

must include both industry-specific and cross-industry knowledge. However, I still

believe more weight must be placed on industry-specific expertise; it should be

complemented with cross-industry experience.

Let me illustrate this point with an example. A key issue is, as in many

industries, ongoing digitalization. In aviation, IT systems have a very long history:

The logic of reservation systems dates back to the 1950s, and revenue management

has been developed early and especially for airlines. As airlines have always been

forced to collaborate in order to establish a global network, these systems have

become closely interlinked over the years. The increasing individualization of

products and sales channels requires us to adopt these systems and standards. If

we want to offer the customer a supplementary service, for instance, an upgraded

meal in economy class, we need to find better ways to analyze the available

customer data and to adopt our distribution systems accordingly. The necessary

modification of IT systems often results in multi-year projects, with cost easily

exceeding $100 million. This requires a solid understanding of Big Data, as it is

currently the case in most industries. However, it also requires experience with the

136 H. Hohmeister

historical complexity of these systems—their origins, their purpose, and their

linkages. In short, it is their complexity. A management team with a profound

cross-industry experience but a lack of experience in the airline business will

probably lack to identify the obstacles to these changes. For offering individualized

services, the interdependence of the IT systems with operation, network, and

revenue management is challenging. Not to forget, changing those systems is

basically conducting surgery on the open heart of an airline.

The Low-Cost Carrier

The LCC is the antithesis of a hub airline: a simple organization with a simple

business model, focusing entirely on efficiency. An LCC’s core value proposition is

to offer short-haul flights in the most efficient way possible—through one brand,

one aircraft type, one product, one price, and one class.

In comparison to hub carriers, this implies three core differences. First and

foremost, such carriers do not operate a network system but merely offer point-

to-point flights. They do not have to design an itinerary. Thus, LCCs operate

multiple bases where aircraft are located and dedicated, but no central hub system

is in place. This of course vastly reduces complexity of operations and cost.

Changes can be implemented swiftly; for instance, a destination can be abandoned

without an effect on the rest of the network (no feeder traffic) or on pricing. In

addition, LCCs normally do not team up with other airlines, thus steering clear of

constructs such as interlining, code-shares, or joint ventures. In a hub carrier,

dependencies are much greater. Second, LCCs usually operate only short-haul

flights. This simplifies fleet management and product design. LCCs usually fly

with one aircraft type (family) only, e.g., EasyJet focusing on the A320 family. This

of course simplifies purchasing, training, and maintenance. The onboard product is

limited to one class only, vastly reducing complexity in seat design, catering, or

training. In addition, such carriers do not offer all-inclusive catering; food and

beverage are sold as supplementary services. Third and connected, the regulatory

density is considerably lower. LCCs usually fly within one market. In case of

EasyJet, this is the EU’s common aviation area (with some exceptions). Thus, no

traffic rights must be secured and the same competition rules apply.

Moreover, it must be noted that these organizations are different from hub

airlines simply based on their age: They carry less historical liabilities. For one,

unionization of employees is basically inexistent. In addition, IT systems and sales

channels have only been established recently. The growth of the LCC was closely

followed by the rise of the Internet. Thus, LCC’s main sales channels are online and

direct to the customer, unlike hub carriers who still rely heavily on indirect channels

(e.g., GDS, travel agents).

These differences imply that the “activity system” of a LCC contrasts from the

one of a large hub carrier. The key difference is the “I am on my own”—principle.

Hub carriers are embedded in a global network with other players, and network and

pricing are linked. LCCs are on their own: They don’t have to compromise and thus

enjoy much more flexibility. Their business model focuses on four key activities:


1. Distribution and marketing: Establish a regionally very present brand with a

simple message (which is only price driven), combined with innovative online

booking possibilities.

2. Revenue management: Offer simple and transparent prices, coupled with a

growing range of supplementary service offers (e.g., food and beverages, extra

baggage).

3. Operations management: Safe short-haul operations with one aircraft type,

maximizing productivity of aircraft (flight time).

4. Destination management: Flexible uptake or give-up of destinations, depen-

dent on (short-term) traffic flows, using primarily cheap secondary airports.

Besides the different underlying activity system, such organizations have to be

significantly smaller, therefore less hierarchical and spanning across fewer

entities. For instance, EasyJet operates under one brand, compared to the many

different brands that are subsumed in the Lufthansa Group. Also, these

organizations buy more services externally, in comparison to the conglomeratic

nature of hub airlines. In short, the underlying business dynamics and the respec-

tive organizations are much closer to “normal” or economic-wide dynamics than

the hub carrier. To put it very simply, running an LCC is comparable with running

a bus company.

The different business models, age, and organizational size require a manage-

ment team with a different managerial skillset. In short, way less specialized

knowledge is necessary in comparison to hub airlines—a majority of the top

management team of LCC often bring a cross-industry skillset to the table. Market-

ing and distribution, a core area, can only benefit from the experience in different

markets. Pricing structures, relying heavily on new and innovative services, may be

further developed based on concepts transferred from other industries. As an LCC’s

model is fundamentally less complex, the top management team must possess less

knowledge about the nitty-gritty details of the business. This may be left to the

experts within the organization. Their focus must be on developing and growing

business. Resistance to change is generally much lower than in traditional airlines;

in fact, change is a factor of everyday life in such organizations. Hence, an LCC can

benefit from a top management team with high diversity when it comes to cross-

industry experience.

One excellent example is Carolyn McCall, CEO of EasyJet. Already her child-

hood and education—growing up in India and Singapore and graduating in history

and politics—set her apart from the traditional executive in the airline business in

Europe. She made a first career in publishing, heading the Guardian Media Group

from 2006 to 2010, overseeing among others the Guardian’s extremely successful

digitalization strategy. Apparently, someone from the media industry is vastly

capable of running an airline: Since she took over, the share price has risen by

more than 400%. It seems that her experience in the media industry—fast change

and ongoing digitalization—is of high value in the airline industry (at least in the

LCC sector!).

138 H. Hohmeister

The Future: The Airline Group

The business models of hub carriers and LCC are increasingly converging. There

are signs that LCCs are moving in a direction that results in more complexity. LCC

increasingly aims to attract business travelers. Such passengers notoriously have

different needs than leisure travelers; their focus lies, for instance, on efficient

ground processes, a decent (and uncomplicated!) onboard product, as well as the

possibility to collect miles. In addition, LCCs are increasingly evaluating the option

of offering long-haul low-cost flights. Norwegian and AirAsia X are two examples

of this endeavor; however, it remains to be seen whether this is successful. Simul-

taneously, traditional hub carriers are establishing their own LCCs, gradually

shifting away from the traditional hub airline system. There are two ways how

these models can be combined—one that works and one that does not.

What does not work is the hybrid model: combining LCC and hub carrier under

one roof. Too different are the cultures, systems, unions, pricing structures, etc. Too

different are the management requirements. The different underlying dynamics

make two separate organizations for hub and LCC entities necessary; their core

business is based on different approaches and cultures. The hub carriers require

in-depth industry experience, while the LCC does not.

What works is the “airline group” model: Hub and LCC can coexist under one

group umbrella but must be organizationally and structurally kept apart. This is

what we will establish within the Lufthansa Group, keeping the LCC (Eurowings)

separate from the hub division. I strongly believe that one must manage both

business models separately, as both follow different dynamics. Managing a hub

carrier and a low-cost carrier are two fundamentally different things. The hub

carrier relies to a certain extent on specialized managers, with in-depth experience

in the industry. These skills may be complemented by cross-industry skills; how-

ever, these are not in focus. In contrast, the LCC relies way less on specialized

dynamics; its managers benefit from far-fetching and cross-industry experience,

which is supported by industry-specific skillsets (but these are not in focus).

6 Conclusions

Is aviation fundamentally different from all other industries? No. The policies

regulating the pharmaceutical or financial industry are almost impossible to under-

stand for an outsider. The meddling of the state in the mining and extractive

industries is far greater than in aviation. Pricing dynamics in the energy industry

are almost impossible to comprehend without experience in the industry. I am of the

opinion that many businesses demand in-depth industry knowledge. The dynamics

driving these industries are much more complex than what generic management

framework suggests. It often takes years for an outsider to understand the dynamics

at play in such industries. Of course, these industries can benefit from managers

with cross-industry experience, but at its core the top management team consists

largely of insiders.


However, some industries with less special dynamics may benefit more from a

top management team with cross-industry experience. What comes to mind is the

retail or luxury goods industry. In such business, generic management practices and

the related cross-industry experience might be much more useful. In general, less

complex products in combination with a lower regulatory density result in less need

for specialization at top management level.

In the end, as so often, the name of the game is diversity. The world is growing

ever more complex; this must be matched with a top management team with a

diverse experience. A single-minded team will not identify the blind spots; a too

different team will fail to put the strings together. What differs across industry is the

extent of the diversity—some firms need more, some less. Every industry must

engage in sustainable talent management in order to continuously ensure the

“supply” of capable next-generation managers. What we must abandon is the belief

that all industries are subject to the same universal dynamics (“laws”). They aren’t.

References

ATAG. (2010). The beginner’s guide to Airline efficiency. Geneva: ATAG.Drucker, P. (1973). Management (Revised Edition) [ebook]. London: HarperCollins

Wensveen, J. G. (2007). Air transportation: A management perspective. Farnham: Ashgate.

Zott, C., & Amit, R. (2010). Business model design: An activity system perspective. Long rangeplanning, 43(2), 216–226.

140 H. Hohmeister

From Data to Business: A Paradigm Shiftin Industry

Joe Kaeser

1 Digitalization Is Radically Driving the Innovation of NewBusiness Models

Late in the 1980s, a young man, together with some colleagues and financiers,

visited the Munich headquarters of Siemens AG. He represented a company that,

among other things, was developing technologies for Internet telephony. And he

asked whether Siemens was interested in investing in his company. At the time,

Siemens was the unchallenged world market leader for digital telephone exchanges.

And people in the company were convinced: “Internet telephony—that can’t work.

Otherwise we would have invented it.” The young man wasn’t even properly

received; nor did anyone want to listen to him. The young man represented a

company named Cisco—at the time a largely unknown startup in Silicon

Valley—today one of the world’s biggest technology providers for enterprise data

networks, with a market capitalization of more than 140 billion euros.

Siemens was big in telecommunications back then but had also become negli-

gent in some areas. And that had consequences: Roughly one decade after the visit,

Siemens’ telecommunications business ran into difficulty and Siemens later gave it

up completely. What had gone wrong? The “incumbent” had wrongly assessed the

force and speed of change: The new technology was disruptive. Why? Because it

not only led to a drastic reduction of costs but also paved the way for new business

models that undermined many existing business models. Today, Internet telephony

is taken for granted. Companies like Skype, founded in 2003, have many hundreds

of millions of users worldwide. You could call Skype’s business model

“freemium.” Internet telephony is offered free of charge, but there is a charge for

premium services such as calls with cell phones, connections to landlines, or for

video conferencing. Newcomers with business models like this in place completely

upended entire industries like telecommunications.

J. Kaeser (*)

Siemens AG, Munich, Germany



DOI 10.1007/978-3-319-48938-4_10

141

Siemens learned a lesson from this experience: Never underestimate a paradigm

shift. And the big “paradigm shifter” today is the same it was back in the early days

of Internet telephony: digitalization. What has changed? For one, disruptions are

occurring much faster. Today it no longer takes a full decade for a fatal error in

judgment to lead to the demise of a business. Another difference: After having

revolutionized B2C industries, digitalization is now pervading B2B markets. It is

transforming industries at unprecedented speed and to a radical degree, leveling

entry barriers in markets previously dominated by incumbents, and giving rise to

completely new business models. It is putting entire value chains to the test. And the

weakest links in the chain are being eliminated: “The internet cuts out the

middlemen.”

In markets that are being transformed by digitalization, the winner generally

takes all. Even if a company’s business model is innovative, even if it offers the best

technology, it is virtually impossible to win customers when a competitor has

already been able to garner the majority of market participants. They’ve already

made up their minds and done so quickly—with a simple click of the mouse. Now

the expense and effort needed to persuade them to switch is much higher.

The market punishes the latecomer—and mercilessly. That’s why the goal of

IT enterprises is often not to generate revenue right away, but to expand the

customer base as quickly as possible. Scalability is everything. Having a billion

customers—unimaginable in the past—is quite realistic today. Just look at

Facebook, or Airbnb: The rental platform was founded in California in 2008 and

now offers, according to its own figures, over two million accommodations for

overnight stays in more than 190 countries (status: November 2015). In compari-

son, Hilton Worldwide, the world’s biggest hotel chain, whose roots reach back to

1919, reported 745,000 rooms in November 2015.

Two factors are determining the speed of the digital transformation. For one,

computing power. For another, the creativity of people who keep coming up with

new business models and try them out. Here, too, it’s advisable to draw on past

experiences and learn the right lessons from them. Failing, quickly recognizing

mistakes, discarding ideas that don’t work out, and a speedy retreat from dead ends

are important aspects of these lessons. They are indispensible for succeeding in

business—because no one today knows with certainty which business model will be

successful tomorrow. One thing, however, is certain: they will change.

Early in the 1980s, the mainframe computer in Siemens’ System 7500 series was

the measure of all things. It filled an entire open-plan office and was capable of

performing 8 million instructions per second (MIPS). Today, a far more powerful

computer easily fits in a purse of pants pocket. Smartphones perform at over 20,000

MIPS and are thus more than 2500 times faster than the System 7500.

Over 50 years ago, Gordon Moore, one of the founders of Intel, had an insight

that became the golden rule for the electronics industry: About every 24 months, the

number of transistors on a chip—and thus the processing speed—doubles. Moore’s

law is still considered valid today.

Along with computing power, data storage capacity has also expanded enor-

mously over the past decades and continues to grow. Moreover, with the spread of

142 J. Kaeser

broadband and mobile networks, data can be transmitted faster than ever and is

available everywhere. At the same time, the prices for sensors have fallen drasti-

cally while the volume of data they deliver has soared dramatically. As a result of

these new technological possibilities driven by growing performance and network-

ing, the surge in the volume of data has been almost unbelievable surge in data

volumes: big data. Up to the year 2000, the world had generated around two

exabytes of new information. Today, this amount of data—two times one billion,

times a billion bytes—is generated in a single day. By 2020, the daily data volume

is expected to grow to 44 zettabytes. A zettabyte is equal to 1000 exabytes. And

there is no end in sight to this flood of data.

The staggering increase in data volume affects companies like Siemens to the

same extent. Today, a gas turbine generates 30 gigabytes of data a day; a Siemens

Energy IP smart grid platform delivers 25 gigabytes a day; a CT scanner delivers

60 gigabytes of data a day; a Siemens controller in the CERN laboratory particle

accelerator in Geneva produces 100 gigabytes a day; and a Siemens traffic manage-

ment system for a city like Potsdam, Germany, delivers a data volume of six

terabytes every day.

2 Digitalization Is Spreading into Industry

Disruptive changes began in “easy-to-digitize” industries like the entertainment and

retail industries, from record stores to Spotify and iTunes, from traditional

bookshops to Amazon and the eBook, and from local travel agencies to Airbnb.

Transportation and traffic came later with Uber, which is radically impacting the

taxi business worldwide, with carsharing rather than car purchases and with navi-

gation systems and virtual aids like Google Maps rather than maps spread out on a

passenger’s lap. Later, other industries followed, like medicine, manufacturing, and

the energy industry—to name three sectors in which Siemens is active.

So, in the meantime, disruptive change has also arrived in industries that are not

as easy to digitalize—whereby the consumer sector is also influencing industrial

business fields. Robust digital solutions are already being used in various areas:

• From mechanical configuration of machines to virtual commissioning

• From large-scale, centralized power plants to small, decentralized power

generators that are networked as virtual power plants

• From analog X-rays to digital imaging and analysis

• From scheduled maintenance to sensor-supported, predictive, flexible, and

demand-based maintenance and guaranteed availability

In these complex areas, industry has not yet arrived at all-encompassing

solutions such as those offered by Facebook, for example, for social life. But the

trend is clearly moving in this direction. Here, too, the Internet is acting as an

accelerator of business processes and is revolutionizing global business operations.

From Data to Business: A Paradigm Shift in Industry 143

It is enabling companies to work closer and faster with partners, communicate

directly with end customers, and meet their specific requirements.

Digitalization’s radical transformation of manufacturing methods is often

described as “Industrie 4.0” or the “Fourth Industrial Revolution.” What is meant

here is the fourth sea change in manufacturing and production processes, after water

mills were replaced by steam power in production, after the division of labor and

assembly lines were introduced in mass production—originally in the

slaughterhouses of Cincinnati and later in Henry Ford’s automobile factories—and

after electronics and IT were used to automate production processes.

Virtual product development and, parallel to that, digital production planning

can already today increase the efficiency of industrial companies. Industrie 4.0,

however, will make it possible to create an integrated digital representation of the

physical supply chain in which all stages of manufacturing are seamlessly

integrated and linked. It will be a digital twin of the product and the factory and

all its processes. During the design of a product on a computer, all of its production

requirements are already visible. Machines communicate with other machines and

optimize the work processes in the factory or production line; findings from service

and maintenance—such as characteristic weaknesses of a product—flow directly

back into the product development. The ultimate goal is to ensure a continuous

improvement process.

And the products themselves will also change: They will not only be planned

virtually but will be upgraded to “smart” products with sensors and embedded

software. They will then be now identifiable and locatable. They will contain their

history, their current condition, and their target condition. Industrie 4.0 will not only

be the creator of a seamless, continually optimizing, global value creation network;

it will also be general practice.

In multinational companies today, development and planning, machine-tool

construction and production, maintenance, and parts warehouses are not necessarily

consolidated under a single roof, but are often distributed around the globe.

Thousands of suppliers and customers are involved when a company brings a

new product to market. And even small firms draw on the worldwide offerings of

producers and service providers. The digitalization of the entire value chain will

enable the full integration and coordination of a variety of participating businesses,

machines, and systems.

3 Technological Leadership Isn’t Enough: Customer BenefitIs Key

For companies introducing digital business models, there is a fundamental question:

What is the customer benefit based on data, information, and know-how? Only on

this basis are innovations viable, only then will they be profitable.

The potential customer benefit from intelligent business models paired with

innovative technologies is enormous. Numerous application cases analyzed by

Siemens have shown that customer benefit can be grouped in four categories:

144 J. Kaeser

First: enhancing performance. For example, by shortening time to market, in

other words, the time span between the first idea for a product and its market

introduction. Time is a critical factor, since product life cycles are getting shorter

and shorter and suppliers must therefore react faster to changes in the market.

Another example is increasing the flexibility and individualization of products to

not only better satisfy customer needs but also to respond faster to market volatility

and trends. A batch size of one plus all the advantages of mass production and

scalability is not only conceivable but feasible. The remark attributed to Henry Ford

about the Model T that “you can have any color, as long as it’s black” is obviously

outdated. Today, a virtually endless number of options are possible and can be

ordered from nearly every automaker.

Second: reducing costs. This applies to nonconformance costs and also to costs

saved by increasing process efficiency and reducing capital employed.

Third: increasing energy and resource efficiency. Efficiency is a critical factor

for all industrial companies, and energy costs are a major cost factor. Furthermore,

every company also has the social responsibility to use resources sparingly.

Fourth: avoiding risks and ensuring greater security of one’s own systems. This

enables compliance with legal regulations but also supports quality management in

the digital age and guarantees high product security and sustainable protection

against cyber attacks.

Analysis—that is, the intelligence with which data is compiled, evaluated, and

utilized—is the prerequisite for benefit. This isn’t about big data, about collecting

enormous amounts of data—that’s basically a trivial task. The decisive factor here

is the diligent processing and analysis of data so that it provides customer benefit

and meets customer expectations. That’s how “big data” becomes “smart data.”

And that is precisely the purpose of MindSphere, a cost-effective, scalable cloud

platform designed as an open operating system for the Internet of Things. With

MindSphere, the enormous amounts of raw data collected from production plants,

transportation systems, power grids, and many other assets can be gathered,

analyzed, and then used to improve the design, performance, and availability of

such systems. MindSphere includes a broad range of applications for different

purposes and usages (MindApps), and customers and third parties can develop

their own applications for the platform.

MindSphere combines technologies for the integration, administration, analysis,

and visualization of data, and data collected by people can be integrated in the

platform as well. This combination of capabilities makes it possible to turn big data

into smart data. That facilitates the development of new digital services and

business models that give customers a competitive edge, for instance, in the form

of guaranteed availability of machines, optimized resource usage, and increased

productivity.

In the future, smart data offering concrete benefit will be as valuable as

technologies and patents are at present. It will also be necessary to develop

innovative licensing models for this smart data.

A strong competitive advantage can be gained by intelligently combining

competency in data analytics with a comprehensive understanding of customer

needs and proprietary expertise in product development. The formula for success is


those who best understand the value chain (ideally better than their customers) will

be the winners of the digital transformation, and those who have the most customer

experience, those who can identify and provide customer benefit, will prevail in the

business arena. The winners here are those who are the fastest to adjust to new

situations, to develop new business models, and to continually adapt them to a

changing environment.

4 What Makes a Business Model Innovative and Viable?

Siemens’ definition of business model is very clear, and it’s based on many years of

research and empirical validation in the B2B environment across all industries and

patterned after the definitions of economists like Thomas Bieger and Stephan

Reinhold (Bieger et al. 2011): A business model describes how a company creates

value for customers and pursues the goal of generating sustainably profitable

business.

Three examples here:

• “Freemium” business models make expensive, innovative technologies attrac-

tive to new customers by offering a product to a large number of customers free

of charge and charging a “premium” from a smaller group of customers for

advanced applications, as is the practice at Skype, for example.

• With “pay-as-you-go” business models, no products as such are sold, but rather

services such as operating hours. These models are attractive for customers

because they can shift investments and operating risks to providers. Providers

thus earn money only when customers earn money. This type of business model

is common in the aircraft engine business.

• “Razor blade” business models, on the other hand, establish long-term customer

relationships and stable revenue flows by selling a product at a favorable price

and subsequently generating steady income from replacement parts. Typical

examples here are printer cartridges or razor blades.

Is there a pattern for innovative business models? Or to put the question another

way: What do innovators of business models have in common—and in what way is

their approach different from approaches of the past (Fig. 1)?

To better recognize business opportunities in a market environment shaped by

digitalization and smart data and to more quickly develop and market business

models and their ecosystems, Siemens uses the strategic tools BizNet and BizMo™for systematic business innovation. These tools help management analyze the

markets, identify the business opportunities they offer, and systematically develop

business strategies for them. With this methodology, external business models and

ecosystems of various industries are also evaluated and systematized, and the

success factors are evaluated for applicability to Siemens. After all, we, too, can

learn a lot from other industries.

The BizNet business innovation methodology is a tool that enables managers to

acquire a basic understanding of new business networks and their design. For this

146 J. Kaeser

purpose, new options are explored for engaging in partnerships that create sustain-

able advantages for all parties involved and for evaluating these partnerships in a

structured and systematic process. Customer benefit is at the center of all

considerations.

In the complementary BizMo™ tool, the focus is on how a specific player with a

specific business model earns money. Here, solutions are worked out with the help

of systematic questions, such as by defining customer groups and the specific value-

add that the business model can deliver to them. The tool makes it possible to

determine how customers can best be addressed and what prices are feasible for

specific offerings; which resources, skills, and suppliers are needed to successfully

implement the business model; and how much it all costs.

Together, BizNet and BizMo™ ensure that Siemens obtains a comprehensive

picture of the new digital business world and its opportunities by providing a

perspective broader than the company’s own business areas. That raises the proba-

bility of developing successful, innovative business models, implementing them

and, above all, continually adapting them to new conditions.

Why it’s important to analyze business models can be summed up in three basic

points. First, it helps in comprehensively analyzing the company’s own current

business models and, if necessary, make adjustments, Second, it is essential for

triggering new ideas for future business models. And third, the timely analysis of

business models helps explain how the company creates value to stakeholders in a

concise way. That’s why a company like Siemens highly values these tools for

analyzing business models and the structured approach they provide (Fig. 2).

The “smart data to business” data value chain has six blocks for generating

customer benefit from data:

1. Value creation. Think from the customer’s perspective. That means thinking in

terms of the four categories outlined above: enhanced performance, energy

savings, reduction of costs, avoidance of risks, and increased security.

Fig. 1 Strategic tools for systematic business innovation (own presentation)


2. Business models, ecosystems. The focus here is on the logic with which profit

can be made and how to create benefit for both customers and for Siemens.

Business models are adapted and new models are designed. In addition, dynamic

and diverse groups of players—with their own respective business models—are

linked together in networks. These groups share a vision for creating customer

benefit that none of the players could deliver on their own.

3. Business intelligence. Based on evaluations enriched by smart data, managers

can improve, accelerate, and automate decision-making processes. For example,

the head of operations at a power plant can use the data to optimize operation and

increase the plant output.

4. Data analytics. Data is analyzed. However, that alone isn’t sufficient. Knowl-

edge only becomes benefit-generating knowledge when it is enhanced by

domain knowledge and product knowledge and made available to businesses.

That’s how “big data” is turned into “smart data,” and that’s how it becomes

valuable.

5. Data assets. “Things” have digital interfaces and are linked with the network.

They serve as the sources of data and deliver static or dynamic data (data

streams).

6. Processes, physics. Work procedures and processes are digitalized. Analog

content is converted into digital content to create “big data.”

I’d like to illustrate how the “smart data to business” data value chain is already

creating customer benefit with examples from our own company.

5 Industry Business: Condition Monitoring for MachineTools

Preventing downtimes was the issue at the highly specialized production plant of

Schwabische Werkzeugmaschinen GmbH. The supplier to the automobile, hydrau-

lic, and aerospace industries turned to Siemens for servicing and maintenance.

Fig. 2 “Smart data to business”—a six-step innovation approach (own presentation)

148 J. Kaeser

Thanks to Siemens’ Machine Tool Analytics Services, the company can now

help customers in China, the United States, and elsewhere directly from the

company’s plant in Waldm€ossingen, Germany. Availability and service are deci-

sive success factors for a globally operating machine-tool supplier. And

Schwabische Werkzeugmaschinen GmbH realized at an early stage that Internet-

based IT solutions offer opportunities to further improve service. However, the

company didn’t want to invest in a new IT architecture and preferred using an

existing solution. Machine Tool Analytics Services delivers data for calculating the

total costs of machines over their life cycle. All data from the 2500 networked

machines is encrypted and transmitted via Internet links. The standardized services

are grouped in two areas:

• Asset Reliability Services entails designing and optimizing service processes as

well as providing online access to the machine controls for service technicians so

they can correct faults. In addition, fault diagnostics can be carried out via data

and notification services, such as SMS and e-mail.

• Condition monitoring entails designing and optimizing maintenance processes

as well as the condition monitoring and evaluation of machine components. In

addition, the planning and execution of preventive and/or maintenance measures

can be optimized.

With the help of Machine Tool Analytics Services, the customers of

Schwabische Werkzeugmaschinen GmbH can better plan the maintenance and

servicing of machines throughout their entire life cycle. Reliably scheduled main-

tenance shutdowns don’t jeopardize delivery deadlines and make maintenance

costs more calculable over the long term because with detailed condition data on

key components, the customer always knows exactly when repairs or replacement

parts are needed.

6 Energy Business: Flexible Maintenance Contractsand Tailored Solutions for Customers

Thanks to digitalization, attractive business models can also be established in the

energy business. One example is Flex-Power Services™, which enables Siemens to

offer tailored solutions to customers like Kraftwerke Mainz-Wiesbaden. This

German municipal utility is now able to react to changing energy market conditions

and deliver electricity faster and more flexibly when it is needed. With the Siemens

solution, the power plant’s startup time could be reduced to less than 30 min after an

overnight shutdown. The spread of renewable energy sources is sharply changing

conditions on the energy market, and this is fueling demand for more flexible

operation of combined cycle power plants. Siemens can optimally meet this partic-

ular demand with Flex-Power Services™. By intelligently analyzing data from

turbine sensors and analyzing fleet data—that is, comparing machines of the same

type operating under different conditions—maintenance intervals and servicing can


be adjusted to meet specific customer needs. This increases plant availability and

efficiency and clearly provides added value for the customer.

7 Mobility Business: Top Reliability and Availability

Reliability, sustainability, and efficiency are key issues in the mobility business. In

Spain, 26 high-speed Velaro E trains run between Madrid and Barcelona and

Madrid and Malaga on a daily basis. Siemens manages the complete maintenance

of these trains. In order to guarantee their availability and reliability, 160 service

employees provide around-the-clock service. This business model could be called

performance based. Availability higher than 99.94% is possible only because train

components are continually inspected for wear and tear and because maintenance

and the system as a whole are continually improved. This results in greater

profitability. In turn, the operator Renfe can offer passengers a money-back guar-

antee in the event of any delay due to technical reasons that exceeds 15 min. The

consequences are clear: Trains serving medium-range connections, such as between

Madrid and Barcelona, are more competitive. In this example, Renfe was able to

increase the number of passengers by more than 30%.

8 Medical Engineering: Cloud-Based Platformfor Radiologists

Healthcare is one of the industries in which highly relevant data volumes are

generated—primarily in medical engineering, by public and private HMOs, by

specialized service providers such as laboratories, and in all work related to

patients. Archiving and accessing this data are a technical challenge per se. The

full value of this data for physicians and patients can only be realized when the

data—subject to data security regulations—is combined into meaningful informa-

tion. Today, more than 200,000 people worldwide are diagnosed or treated every

hour with Siemens products alone. In the course of these processes, our customers

generate millions of data records day by day, and only a small fraction of this

information is currently used.

With the cloud-based “teamplay” platform, Siemens has taken a first step toward

providing value-added data analytics and preparations for decision-making. In the

network, information generated in radiology departments—such as scanner utiliza-

tion, examination protocols, or radiation dosages—is compiled, evaluated, and

compared with reference points. Data from the networked imaging systems is

transmitted and analyzed practically in real time. The result is that examination

routines and utilization profiles of the installed scanner fleet can be optimized. As a

result, data produced by medical imaging systems will be even more usable in the

future. That will provide an ideal basis for early, well-founded decisions pertaining

to patient care as well as hospital operation.

150 J. Kaeser

9 Digital Market Success Increasingly Dependson Networking Business Models in Ecosystems

The key to success in the digital age is understanding that a company is part of a

larger ecosystem. A silo mentality and attempts to seal oneself off from the outside

world inevitably lead to marginalization. Only those who think and act in networks

have a chance to shape the digital transformation.

Digitalization requires the capabilities of IT companies as well as those of

players from industry. Companies like Siemens, ABB, GE, Rockwell, Schneider,

and Philips are at home in the world of electrification and automation. Companies

like Microsoft, Google, SAP, Atos, Oracle, and IBM operate in the world of IT. As

the real and digital worlds converge, previously unimaginable potentials are

emerging—for both technology and business.

To be successful, companies have to know both worlds. That’s why strategic

partnerships and alliances, enabled and strengthened through digitalization, are

playing an ever greater role—such as in the partnership between Siemens and

Atos. It’s also important to create platforms that make competitive business models

possible and that are attractive to third-party participants. The strategic advantages

are obvious: the capability to establish and shape new markets, to open up new sales

channels, to create added value for customers, and to gain access to resources and

competencies. This includes activities on political and association levels, for

instance, when it comes to establishing uniform standards for Industrie 4.0.

Those who want to operate successfully in complex ecosystems must be able to

manage the networks of partners. One thing is sure: It is definitely not enough to see the

value chain as a linear process with suppliers at one end, then Siemens, and then end

customers on the other end. That is neither possible in B2C nor in B2Bmarkets. Today,

business is about creating intelligent networks in which interactions with customers

and suppliers take place on various levels and at every stage of the value chain. In such

networks, customers are involved in the development of products, and their input is

sought throughout the entire life cycle of products, from development through mainte-

nance to recycling. In short, customers are partners much more so than in the past.

10 Ownership Culture as a Success Factor in the Digital Age

I believe that digitalization must be accompanied by a culture change—in the

direction of an ownership culture as cultivated by well-run family-owned

enterprises. One guiding principle of our company culture is “Always act as if it

were your own company.” This means that each employee, regardless of his or her

function, should assume personal responsibility for the company. A second maxim

is “You never walk alone.” This means that employees should have the chance to

try out new things and enrich the company with their ideas—even at the risk of

being wrong. Because an unshakable and optimistic entrepreneurial spirit is ulti-

mately based on a trial-and-error culture, that’s crucial for the innovation power of

a company like Siemens. And this applies to technologies as well as to business


models. In the digital world, embracing such an “ownership culture” is a prerequi-

site for success and for ensuring that Siemens becomes a successful “digital

company” that serves society.

A company has the responsibility to serve society. That principle has been

embedded in Siemens’ culture since it was founded 1847. Sharing responsibility

for society for future generations is what I call “business to society.” And to me,

that is the legitimization of a company. A company that contributes no value to

society should not exist. However, to create value for society, a company has to be

competitively profitable. In the end, only companies that sustainably generate profit

can contribute to society—be it in the form of investments, jobs, training positions,

taxes, innovations, or through philanthropy.

What do we stand for? What distinguishes us? How do we intend to be successful

over the long term? These three questions can be correctly answered only by those

who recognize the paradigm shift early on, who adapt fast enough, and who know

how to create successful business models and seize the opportunities offered by

digitalization. Those who find the right answers to these three questions will succeed

over the long term—and hand over a stronger company to future generations.

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152 J. Kaeser

Engineering the Intangible: StrategicSuccess Factors in the Luxury WatchIndustry

Georges A. Kern

1 Introduction

Nobody needs a mechanical watch. In an age where we are surrounded by ultra-

precise, internet-synchronized devices that handle every one of their functions more

precisely, more accessibly, and much more affordably, the watch industry is

enjoying its period of greatest prosperity since the invention of the pocket watch.

The mechanical watch has never been more obsolete but so much sought after. And

this is despite the fact that there is no rational justification for buying a mechanical

watch.

In this article, we will explore reasons and motivations behind the demand for

mechanical timepieces that go far beyond the physical product. We will explore the

unique nature and mechanisms of an industry that creates not only the supply but

also the entire demand for its products through the power of branding and

marketing.

When we consider other industries, we frequently find products and services that

are called “solutions” or even businesses that are described as “solution driven,” the

suggestion being that those companies’ products or services respond to a specific

problem. The luxury industry responds neither to needs nor to problems. Not only

do we create a neatly packaged and dramatized problem-solving combination: we

actually create new “problems” that range from desire and romantic obligations

(perceived and real) to insurance risks, service regimes, and repair bills. We

literally add “complications” to our customers’ lives. What they get in return is

real emotional value—pleasure, dreams, hope, and a sense of reward and belong-

ing—reinforcing their self-image. It is this emotional value that makes all the

difference between a product and a luxury product. Ultimately, our watches are

bought for the emotional added value they provide.

G.A. Kern (*)

IWC Schaffhausen, Schaffhausen, Switzerland



DOI 10.1007/978-3-319-48938-4_11

153

Our mission as a luxury watch manufacturer, therefore, is not simply to create

beautiful products but to create captivating and lasting experiences that touch our

customers’ lives.

As we will discover in this article, conjuring up evocative dreams and desirable

products is not so much an analytical process as an essentially emotional and intui-

tive act of creation. While there are many rational success factors in the luxury

industry that work as catalysts for growth, profitability, and commercial success,

the heart of what a luxury watch brand has to do is ultimately creative, mysterious,

and much harder to grasp. Understanding its clients, the products they desire, the

dreams they aspire to, and the trends that influence them is, at the end of the day,

people based rather than process based. These characteristics shape the luxury

watch industry: they represent both unique risks and uniquely attractive oppor-

tunities but also phenomenal barriers to entry.

2 What Is Luxury?

Who are we? What are the values we live by, our dreams and aspirations? Where do

we seek affirmation of our ideas and find a home? In the West, traditional social and

moral value systems, such as nation states, aristocratic classes, and religious com-

munities, have been largely replaced by the all-encompassing and highly pervasive

force of globalized consumerism. Against the background of the phenomenal,

peaceful, and truly global success of consumerism, it can be argued that brands,

and especially luxury brands, represent the modern key providers of social identity

and have become a powerful and globally valid frame of reference for personality,

cultural identity, and social status. In a globalized world, notions such as “French,”

“white,” and “Christian” become diluted and lose their power of identification and

differentiation, while attributes like “Aston Martin driver,” “very Chanel,” and

“Patek Philippe collector” have become powerful and perhaps more precise refer-

ences to our identity, beliefs, and values. If the social value systems of the past were

highly collective and vague, our social and personal self-perceptions today are a

unique and very precise footprint of our consumption patterns. These are embodied

in the brand mix we buy and identify with, the people we follow on social media,

the media we consume, and the events we attend. These consumption patterns are

thus an integral part of our identity, and this frame of reference has become truly

international through the power of globalization. Luxury products, more than any

other category, allow for self-expression beyond the functional.

Luxury can and must be defined both in absolute and relative terms. To fully

understand a luxury product or experience, we have to go beyond the absolute and

understand the social context and frame of reference. Mankind has always been

inspired by the concept of luxury. However, one and the same item can fulfill very

different functions in different social settings, and it is this versatility and fine

nuancing in the ownership and use of luxury products that makes the industry and

its success factors so very unique.

154 G.A. Kern

Luxury products in general could be defined as unnecessarily well-crafted,

beautifully designed, rare, and expensive items that go beyond the merely func-

tional to provide their owner with an experience that does more than simply fulfill a

need. As such, luxury products can exist in any category, either as the most

elaborate and rare/expensive version of a specific item or as stand-alone, such as

a piece of jewelry, which is by its nature inessential and has no cheaper, utilitarian

counterpart. Beyond fulfilling a functional requirement, the abovementioned user

experience, or self-expression, is one of the essential characteristics of luxury

products.

Outstanding aesthetics and design are equally important features. World-leading

designers are employed to create design trends that often become classics and are

copied across different product categories and price levels. The elaborate manu-

facturing of luxury products reinforces their quality and longevity and suggests that

more time than necessary has been invested in their production. Luxury products

offer superior quality because they are made of better materials using more elabo-

rate skills and processes. They symbolize human accomplishment and the preser-

vation of artisanal skills and cultural know-how from one generation to the next.

Additionally, luxury brands foster an aura of exclusivity by stressing their per-

ceived scarcity and restricted accessibility to their products. Measures such as

limited production, selective distribution networks, and comparatively high price

points, among others, can be instrumental in achieving this.

However, a comparison of different luxury brands reveals that each of the brands

is distinctive and has a specific set of characteristics that make it unique to its

customers, allowing for a more individual form of self-expression through brand

choice in a specific product category. Depending on the brand in question, it is clear

that not all characteristics can or need to be given. Hublot (founded in 1980) or

Roger Dubuis (founded in 1995) are two cases in point. Both names are perceived

as luxury brands, even though they are both relatively young when compared with

say, Blancpain (founded in 1735) or Vacheron Constantin (founded in 1755).

Luxury cannot exist in isolation. The perception of rarity, exclusivity, and

desirability needs to be shared by a relevant target group if an object or activity is

to be perceived as luxurious. It can never exist in silence and solitude. Rare vintages

of fine wines, for example, would simply be a fine tipple, were it not for a shared

perception of rarity and value. Vintages, availability, and auction prices, among

other things, are widely publicized in connoisseur and luxury lifestyle circles, and

select wines receive a collective stamp of approval that transports them into the

realm of “luxury.” Whether or not they are actually superior has only limited rele-

vance when their mere ownership or consumption signifies luxury, wealth, and

status to the relevant “knowledgeable” target group.

The luxury industry has been very smart in selling such product knowledge as

“sophistication” and cultural education. To know which wines and vintages com-

mand eye-watering auction prices is nothing more than consumer knowledge, but

such knowledge apparently elevates the wine connoisseur above his less-educated

peers, who may choose their wine based on personal preference.

Engineering the Intangible: Strategic Success Factors in the Luxury Watch. . . 155

Beyond the various technical definitions of luxury across the ages, luxury has

typically referred to differentiating products or activities whose ownership or

exercise sets one person apart from the masses and elevates him or her above the

perceived average or “normal.”

To work as a differentiator, at a very basic level, a luxury product or activity

must be considered beautiful and desirable, expensive, and/or rare. This can be both

absolute and relative and depends on the perceived norm within a given social

group or frame of reference. If a product or activity is not widely known and

appreciated by the target audience, it becomes useless as a symbol.

Within any given frame of reference, the basic symbolic function of luxury

products and activities is “membership”; a more advanced function is “differenti-

ation” and hierarchic positioning within that group. Simply owning a “member-

ship” item shows you belong to the group, but it does not symbolize “luxury” in the

traditional sense to that group as it doesn’t fulfill the rareness requirement as per the

definition above. Outside this group, the item may well be considered rare and

therefore very luxurious, but within the group, a much more expensive, beautiful,

and rare version of that product may be required to be perceived as luxurious and

award status.

A luxury watch could be defined in absolute terms: it has to be mechanical,

Swiss made, with a stainless-steel or precious metal case, sapphire crystal glass, and

a minimum price tag of 3000 euros, for instance. In absolute terms, this is straight-

forward. In relative terms, it becomes more complex: The basic 3000-euro, Swiss

stainless-steel watch may be perceived as a luxurious status symbol in middle-class

circles with a basic knowledge of watches. Taken out of this specific context,

however, the watch loses its symbolic function as a luxury product. Worn among

groups with no knowledge of or interest in mechanical watches, displaying the

Swiss steel watch would neither give a sense of membership nor evoke recognition

or admiration. At the other end of the scale, at a boardroom table where complicated

and rare pieces of high watchmaking are the norm, the 3000-euro steel watch from

the current collection may have completely the opposite effect and signify a lack of

sophistication and financial means. The unique combination of aspects such as

heritage, brand image, creativity, etc. defines the very soul of the luxury brand and

lays the foundation for the perceived added value customers really seek when

buying our products: the possibility to express their personality and set themselves

apart from others. The luxury product needs to be a signifier of cultural identity,

education, and sophistication. And depending on the cultural reference, the brands

are primarily associated with status, wealth, and rank.

3 Between Making and Art

As we have suggested above, luxury objects are essentially inessential. When

creativity focuses on the inessential, beauty and self-expression, rather than func-

tion, become the prime concerns. Beauty and meaning are some of the key charac-

teristics of art, and this proximity is no coincidence.

156 G.A. Kern

Throughout history, man has had the desire to decorate utilitarian objects and, in

doing so, to go beyond the essential. From early cave paintings to ornate marquetry

and high fashion, the art forms developed by mankind are rich in their variety and

depth. The shared experience of art is a large part of what we understand as

“culture” and sets us apart from all other living things on planet Earth. Art is the

pursuit of beauty through creativity as well as the longing to make sense of our

existence, to unravel the mystery of life and to convey stories and meaning through

pictures and objects. Product design, on the other hand, traditionally focuses on the

developments of objects that are particularly suited to fulfilling a certain task or

function. The resulting objects may be beautiful, but their development is clearly

analytic and methodical and focuses on performance and efficiency. Luxury

mechanical watches blur the lines between product design and art. While luxury

watches retain certain functional features, such as telling the time, a chronograph,

and a power reserve, for example, their creation, design, and development is almost

purely guided by beauty and meaning: in other words, the principles of art. As such,

the luxury watch industry fits into a group of “fusion” industries best described by

the French term metiers d’art, which synthesize art and craftsmanship.

While many industries are characterized by mass manufacturing, efficiency,

functionality, and streamlining, the luxury industry follows exactly the opposite

approach by pursuing rarity, exclusiveness, complication, and, ultimately, ineffi-

ciency in the way our products are designed, made, marketed, and sold. At first

glance it may seem surprising that our industry thrives in the digital age, but the

increasing popularity of handcrafted mechanical watches tells a story deeply rooted

in human nature. For as much as we are fascinated by the possibilities of techno-

logy, we also feel a slight unease about this progress. Ever more efficient machines

question our purpose and rule of planet Earth. Utopian fantasies portraying an

existential confrontation between intelligent machines and technology-dominated

“Big Brother” states regularly portray the last human rebellion as emotional, full of

empathy, and equipped with old-world mechanical gadgetry. In the here and now,

mechanical watches are part of this reaffirmation. Our clients live their daily lives in

a world of technology, abundance, and short product life cycles; at their place of

work, they are often subject to the rule of efficiency and digital supervision. They

seek contrast and comfort in mechanical watches: in beautiful objects that are

100% analogue, mechanical, and crafted by hand.

Throughout literature, this element of craftsmanship has been considered key to

all luxury products. The word “craftsmanship” contains the element “man” and

refers to the act of human creation by hand, thus differentiating luxury products

from machine-made, mass-produced items. Our ability to create and make

objects by hand is perceived to result in superior products, while machine-made

products—though often of high quality and precision—are perceived as “soulless.”

As luxury brands, we go to great lengths to make things less available, more

elaborate, and less efficient. The closer our production methods resemble the me-tiers d’art, the less they follow traditional methods of product design and

manufacturing. Luxury products cannot be managed: they can only be created

and admired. In the luxury industry, we capture all that is essentially human:


creativity, beauty, meaning, and craftsmanship. These values are perfectly

expressed when we insert the ignition key into a hand-built Aston Martin and are

greeted by a dashboard display reading: “Power, Beauty, Soul.”

4 Luxury Products and the Nature of Luxury Spending

The term “luxury industry” is somewhat misleading. There is no single “industry”

or product category that defines luxury. Luxury should rather be understood as a

concept, an idea, or a philosophy that can theoretically be applied to a variety of

products or services.

In almost every product category, we can find a spectrum of products with

varying functionalities, degrees of exclusivity, associated meaning, or quality of

materials and manufacture. Depending on the market offer and consumer environ-

ment, any product could be perceived as a luxury item within its respective cate-

gory. Only very few product categories are perceived as luxury goods per se;

examples include mechanical watches (haute horlogerie) or high jewelry (hautejoaillerie).

As human beings, we need and long to reward ourselves. From early toddler-

hood, we learn that positive action and effort will be rewarded. The rewards may

take the form of attention, treats, toys, television, grades in school, promotions, pay

rises, and so on. We adopt this “carrot-and-stick” approach in dealing with our own

inherent lethargy by rewarding ourselves on many levels, from that “cup of coffee

and a biscuit once I finish this chapter” to a trip to the spa after an intense period at

work. People need these alibis and as the achievements get bigger, so too do the

rewards, up to the point where the rewards require more profound justification.

For confirmation of this concept, look no further than some of the key players in

the watch industry. Rolex plays on the notion that achievements in life deserve

reward—“A crown for every achievement” translates simply as “It’s perfectly OK

to spend a formidable sum of money on a watch: it is a fully justified and meaning-

ful reward for your hard work that goes beyond the consumption of material

goods.” Even stronger is the justification provided by Patek Philippe: “You never

actually own a Patek Philippe, you merely look after it for the next generation.” In

other words, the act of purchasing a luxury watch is neither blatant consumerism

nor self-indulgence: on the contrary, it is transformed into an almost altruistic

investment in the family’s future generations, celebrating heritage, immortality,

and a great sense of care for one’s children. The self-centered consumer is elevated

to the position of preserver of an objet d’art for generations to come. How amazing

is that!

It is vital to understand that luxury purchases are usually quite well researched

across multiple touchpoints (online and offline), well considered, and well justified.

Persuading a client today to make a luxury purchase can hardly ever be achieved

solely through the product alone: it takes brand, brand universe, and appealing

products. To acquire and subsequently retain clients, a luxury brand has to commu-

nicate and bring all these factors to life: before, during, and following the actual

158 G.A. Kern

purchase, with the aim of offering repeated confirmation and justification that the

client has made “the right choice.” Nevertheless, the rational justification of gifting

or rewarding seems to serve only as a moral excuse.

Powerful and distinctive marketing measures are marshaled to charge the luxury

brand with emotion and to elaborate an aura of exclusivity and distinctiveness.

Consumers are led to believe that the consumption of these higher-priced goods as

opposed to their simpler and cheaper counterparts represents a higher level of edu-

cation and sophistication.

5 More than the Sum of Its Products: The Luxury Brand

Historically, brands have represented little more than an indication of provenance

and of the manufacturer of a certain product. Initially, products were simply signed,

stamped, or engraved by the master craftsman. Such signatures would vary and

change frequently and cannot be described as brands by today’s standards. The first

“luxury brands” we know of that used consistent marks or “logos” to identify their

wares were probably the porcelain manufacturers of the seventeenth and eighteenth

centuries, such as Royal Delft (1653) or Meissen (1710). Amongst the oldest luxury

watch brands in the world are JeanRichard (1681) and Vacheron Constantin (1755).

Many of the biggest luxury brands of today, such as Hermes (1837), Louis Vuitton

(1844), Burberry (1856), and IWC (1868), to name but a few, came into existence

as late as the mid-nineteenth century. While all these brand names initially had little

more content than a founder’s name, an origin, and a reputation for quality, it was a

lithography advertisement by British soap maker Pears (1886) that is widely

credited with initiating the key tool of modern branding—the power of association.

Overlaying the brand name with a John Everett Millais lithography of an innocent

boy watching soap bubbles in the air, the Pears ad successfully created an emotional

“brand world” beyond the product and also associated the commercial brand with

fine art—a strategy now so popular with global luxury brands.

So what exactly can a brand offer that a product on its own cannot? Some

characteristics of luxury products can be derived directly from the product itself;

materials, craftsmanship, and quality can often be appreciated by contemplating

products in isolation. Other values, however, such as exclusivity, dreams, and

lifestyle, as well as cultural and status symbolism, are communicated through a

brand. The brand helps to unify and group a wide range of products under one easily

identifiable umbrella. At the heart of any luxury brand is a promise based on an

idealized dream lifestyle which brand connoisseurs aspire to: “The notion of luxury

is tied to the selling of dreams, not wants or desires.” This promise is manifested

and enforced through a wide range of tools and rituals from brand prophets and

ambassadors to physical stores, digital presence, events, product presentations, etc.

The key difference between luxury brands and mass-market brands is the amount of

original creation inherent in luxury brands, with real aesthetic innovation often

triggering trends copied throughout the brand hierarchy.


Luxury brands have taken on the role of the dream factory, formulating highly

evocative premises to inspire and shape our clients’ dreams and aspirations. In

order to create the 360� lifestyle dreams our clients can aspire to, luxury brands

employ all the tools of humanist creative production, from art and design to archi-

tecture, artisanal craftsmanship, literature, and the performing arts. Blurring the

lines between rational, social, philosophical, and spiritual value systems, luxury

brands have learned to employ the entire toolbox of human perception to offer

highly sophisticated lifestyle premises to their clients. They continuously form,

renew, and reaffirm close ties with their clients through the act of consultation,

purchase, after-sales service, and a wide range of CRM initiatives.

As already mentioned, brands become a sort of “ideology” or value system,

helping to form social and cultural identity. In this way, they often behave very

similarly to other value systems, such as nation states or churches. Where the

Catholic and Reformed Churches may be considered as the leading “brands” of

Christianity, luxury brands are the leading brands of consumerism.

Luxury brands in modern consumerism embody a promise and prophecy broken

down into brand values as a binding link between all products and activities. The

values are very often derived from the brand vision, the founder’s personality, or

the history of the brand. The luxury brand’s promises (or lifestyle dreams) are

then expressed through system representatives (prophets, ambassadors), physical

manifestations (shops, museums), rituals (events, product launches, sales cere-

monies), and altruistic activities.

System representatives or “prophets,” such as the founder, the CEO, or asso-

ciated celebrities, are the face of a company directly linked with the brand. Luxury

brands are often understood as the translation and commodification of the founder’s

or lead representative’s personality, lifestyle, and taste. Personalities such as Coco

Chanel, Karl Lagerfeld, Ralph Lauren, or Tom Ford not only embody their respec-

tive luxury brands; they become inseparably linked with them. Due to this close

link, the brand may exist and thrive beyond the “prophet’s” departure, but it will

almost always be an entirely different interpretation.

Many of the most iconic luxury brands are aesthetically led companies where the

key creative and management functions are concentrated in a single brand repre-

sentative. As such, luxury brands tend to be nondemocratic, at times even dictato-

rial. A powerful luxury brand with consistent products and brand universes depends

on single vision control of every aspect of the business as well as a passion for

details. At the heart of the brand, creation is not a process in the traditional corpo-

rate sense so much as an act of creation shrouded in secrecy and mystery. The core

challenge in orchestrating a powerful brand experience lies in the management of

mystery versus legibility and doctrine versus dialogue.

Brand spaces such as boutiques, museums, and events in prestigious locations

are physical manifestations of the brand promise and dream and serve as a major

tool for purchase justification and brand value perception. Every translation of the

brand into media, spaces, or experiences tells part of a powerful story to enrich the

brand and its products and deliver that all-important sense of justification. It is the

content necessary to support the pricing power of the brand. As luxury brands grow,

160 G.A. Kern

more and more layers of depth need to be added to the brand story. These may range

from heritage and craftsmanship stories to brand ambassadors, editorial content,

evocative partnerships, and customer engagement. In order to supply a constant and

increasing amount of fuel to the brand, this content needs to be published at an

increasing frequency across the entire range of digital and traditional media.

Although entertaining our clients everywhere and all of the time, whenever they

so desire, has become a decisive factor at every point of the customer journey, it

should always be implemented within existing brand boundaries. It provides the

extra value that is of the essence and goes beyond the physical product. Considering

the rate and all-encompassing reach of content creation and distribution or “brand

entertainment” as a core task for luxury brands, we would argue that luxury brands

are in fact in the middle of a transformation process to become true entertainment

businesses.

6 Why Mechanical Watches?

We cannot take the current success of the luxury mechanical watch for granted. In

the case of the emergence of the Asian luxury consumer, for instance, it was very

fortunate indeed that the newborn Chinese middle classes developed a strong desire

for traditional Western luxury goods, especially watches. The leadership role of

Western brands has been challenged much less in watches than in cars, fashion, or

even jewelry, where we see local Chinese trends and players emerging. Luxury

watches, on the other hand, are still Swiss; otherwise, they are not perceived as

luxury watches. This chapter will explore some of the qualities and factors that have

contributed to the success of mechanical watches.

Luxury brands have long tried to harness complex symbolic packages to all sorts

of products from riding saddles to carriages and from aged cognac to elaborate cigar

lighters. The success of the luxury watch as a complex and multifaceted carrier of

symbolism has been matched only by the car. So what makes a mechanical watch so

uniquely suited?

7 Eternity and Immortality

Time and its meaning have fascinated us humans for as long as we have been on the

planet. The passage of time and its measurement have immense symbolic value that

transcends cultures and beliefs. Time is something we as human beings cannot

control or extend, which is directly linked to life and our own mortality. The signifi-

cance of time is universally recognized, and being able to measure it gives the

watch owner a sense of control.

Death and mortality are concepts humans inherently feel uneasy about and do

not sit well within the framework of modernism, capitalism, and consumerism. The

idea that we grow, build, and improve throughout our lives and continue to amass

the material trophies of our achievements is somewhat inconveniently disrupted by


the largely ignored but eventually inevitable occurrence of our own death. This

poses a problem to consumerism: after all is said and done, there is no clear-cut path

to an afterlife through consumption. Religions, as value systems, found a solution to

this problemmillennia ago. A posthumous reward system hinged on a judgment day

to be followed by a glorious and truly heavenly afterlife makes even the greatest

suffering in the here and now more bearable. In this model, the moment of truth (the

gratification) is conveniently located just beyond earthly reach, without customer

feedback, ratings, or TripAdvisor reviews.

Although very limited by comparison, luxury watches offer a small piece of

immortality by offering longevity and the potential to become “family heirlooms”:

they hold a place among the small selection of material goods that are not quite as

ephemeral as the rest of our worldly possessions and which are deemed fit to be

handed down from generation to generation. The fascination of this is clearly visi-

ble in people’s eyes when explaining the fact that IWC’s perpetual calendars are

built to show the correct day, date, month, and year for decades. And after that?

Simply return it to one of our skilled watchmakers, and with a simple adjustment, it

will be perfectly prepared for the next 100 years to come.

Handcrafted mechanical timepieces, the fusion of tradition and innovation,

promise a high degree of immunity against obsolescence. Most of the products

that surround us these days need to be updated or replaced frequently. Whenever we

contemplate a purchase, we have to worry about software, compatibility, connec-

tivity, and integration with other things we already own. Even our cars are slowly

but surely transforming into computers on wheels, presenting us with the same

challenges. Mechanical watches are the only precision instruments and status

symbols we buy and own that are guaranteed to be “future-proof”: they require

no software, no updates, and no cables—not even a battery.

7.1 A Functional Instrument

For all the advantages outlined above, the watch remains an instrument: compared

with jewelry, watches are decidedly utilitarian, no matter how redundant their func-

tionality may be. Even though prices for high jewelry are strongly influenced by the

substantial value of the precious stones included, simpler bijouterie pieces of lowervalue require a lot more justification than a prestigious wristwatch, where most of

the cost is accounted for not by precious stones but by human creativity, ingenuity,

and labor. And it tells the time! Who can argue with that? This purposefulness, by

the way, is deeply rooted in the watch industry, which saw its first boom in Geneva

when jewelers focused on watchmaking in the wake of the Protestant revolution and

its disdain for overt displays of wealth.

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7.2 It’s Got an Engine

Men are fascinated by mechanics, by engineering, and by the idea of understanding

and controlling complex machines. It starts with Meccano and Lego sets in our

childhood and later develops into the masculine love of cars, planes, space rockets,

and generally anything complex that can be set in motion. Instinctively, men have a

distrust of semiconductors and computer chips; the complexity and mystery of

circuit board devices make us feel insecure and vulnerable. As men, we like

machines we can comprehend and have a relationship with. A mechanical watch

is exactly that, in a very compact format. It all revolves around the idea of owning

and using a complex, highly functional instrument that can theoretically be opened,

analyzed, and fixed with a few basic tools and a generous helping of human skill

should it ever fail. Try that with your smartphone or your smartwatch.

7.3 Complex, Compact, and Portable

With more than 500 parts in a 42-mm case and a wide range of materials, functions,

colors, textures, and countless movement variations, a mechanical watch is as com-

plex as a house—and can be equally complex and nuanced in its symbolism—but

fits on your wrist. Compared with the other big male status symbol, the car, this

portability is also a clear advantage. You have to park your car before a meeting,

and even if you park it right in front of the hotel entrance, people still don’t know

it’s yours. The watch is always with you, waiting to be noticed, inspected, and

talked about. The fact that luxury watches are such personal, symbolic items makes

them the perfect gifts to mark the major occasions in life, further personalized by

individual engraving.

7.4 It’s Uniquely Recognizable

Long-established iconic design codes in luxury watches make them easily recog-

nizable from far away despite their often subtle branding. We need to think here

only of the convex date glass of a Rolex Datejust, the double lugs of an Audemars

Piguet Royal Oak, or the cross-shaped dial layout of the IWC Portugieser. Such

features make these watches instantly recognizable and quickly convey their

symbolism and value. Functional differentiators such as minute repeater slides or

rattrapante push buttons further convey value within a model family.

7.5 Simply Irreplaceable

Besides that, watches have the unique ability to tell stories not only about their

inception, design, and making by the original brand but also about the wearer and

his or her experiences and memories. The moment a watch is handed over to its new


owner in one of our boutiques marks only the beginning of the story. The owner

charges his or her watch with experiences, occasions, and memories. Imagine a

father wearing his watch when teaching his son how to ride a bicycle—these unique

moments will always be precious to him and one day he will share the story with his

son. Once worn over a period of time, watches become unique and irreplaceable.

8 The Luxury Watch Brand’s Market Environment

The luxury industry as a whole and the luxury watch industry in particular are

subject to multiple macro trends and macro risks.

Geopolitical and macroeconomic events and tendencies influence our clients’

confidence, which in turn has a direct impact on their discretionary spending,

especially their luxury spending. Luxury watches are not only a reward for past

achievement but also a statement of confidence in the future. The luxury watch

industry is cyclical and marked by booms and dips. Both phases need their bespoke

set of strategies and the balancing of exposure, scarcity, exclusivity, and commer-

cial leverage.

In recent years, China has been the key growth driver for mechanical watches

and the luxury goods industry as a whole. The sheer size and global economic

importance of China and its population will continue to have a major impact on the

performance of luxury brands. Chinese tastes and preferences have already strongly

influenced the entire industry, from products to marketing and distribution. Greater

China’s domestic development, its political and social landscape, and its global

success will continue to be closely linked with the commercial success of luxury

goods manufacturers.

Furthermore, the entire luxury industry is currently entering a phase of consoli-

dation, as fewer brands take control of the market. As clients’ purchase decisions

become ever more considered and value becomes a key factor at every price point,

iconic brands and recognized, timelessly beautiful products with real value and

longevity will assume ever-greater importance. The watch and, more recently, even

the jewelry markets are moving decisively toward “brands” at both extremes of the

price scale: investment value at the top end and real value for money at the bottom.

Weak brands that are not clearly positioned will come under increasing pressure.

Another major influence on the industry is Apple. On its way to becoming the

first company with trillion-dollar market capitalization, Apple has financial

resources, cultural influence, sheer reach, and consumer insight that go beyond

that of any other commercial business. It is clear that Apple has ambitions to

transform its business into a luxury brand (or at least imbue it with a luxury

image), as demonstrated through its investment in groundbreaking creativity, the

sophisticated brand and distribution management, the hiring of experts such as

Angela Ahrendts, the launch of the Apple watch, and the partnership with Hermes.

Apple has repeatedly demonstrated its ability to disrupt entire industries. Whether

or not it will be able to achieve this in the luxury industry—and the watch industry

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in particular—remains to be seen, but it is clear that no luxury brand will remain

untouched by the “Apple challenge.”

Finally, mechanical watches are mature products with hundreds of years of

technical development and design iterations behind them. Heritage and expertise

at this level may lead to highly sophisticated products but can also be a major

obstacle to real product innovation. Against the background of the industry’s iconic

designs and China’s demand for classic timepieces, luxury watch design has

become fixated on the past and highly convergent across brands and product

families. There is now a very clear set of codes to be adhered to when building a

potentially successful product portfolio. This convergence and lack of innovation

and variety could leave the industry potentially exposed to a disruptive idea or

innovation.

9 The Luxury Watch Brand Mission

The long-term sustainable growth of a luxury watch brand is based on the conti-

nuous building of brand equity throughout every phase of the economic cycle,

resulting in increased pricing power and, ultimately, increased profitability.

A luxury watch brand needs to build brand equity in three key areas:

• Authenticity—Watchmaking heritage, expertise, and in-house manufacturing.

• Desirability—The creation of a strong brand, beautiful products, and evocative

storytelling.

• Client experience—An impeccable service experience across all touchpoints

and at every step of the customer journey.

9.1 Authenticity

A luxury watch brand derives its legitimacy from its heritage, watchmaking exper-

tise, and provenance. The brand foundations are incorporated in the brand’s heri-

tage, which is, all other things being equal, the source of inspiration and legitimacy

and credibility of the luxury brand as such. The age of a luxury brand, often indi-

cated by the presence of the founding year in the logo, is an important symbol of

permanence and longevity. Equally important is the celebration of its unique

founding story, the founder’s personality, key inventions, milestones, and historic

events.

Much symbolism is also inherent in its provenance: the country of origin or

specific region of manufacture. Artisanal skills have historically often been concen-

trated in specific areas. This is only too obvious in the case of food and wine, but

there are many other equally exclusive examples, such as glass from Murano,

leather goods from Milan, luxury cars from Germany, and watches from Switzer-

land. “Swiss Made” is such an important label that it is printed on the dial of every

single Swiss watch at the 6 o’clock position. Leading luxury brands in their


respective fields may be known for originating an entire skills base or industry in a

city or region. The close ties to a brand’s heritage and birthplace paired with the

need to grow a global business often pose unique challenges for Swiss watch

brands. Many stem from small villages in remote valleys where the roads are either

covered in mountains of snow or permanently blocked by peacefully grazing cows.

Their workshops are housed in buildings from the mid-nineteenth century that were

not designed for electricity, let alone precision CNC machining. Attracting world-

class talent to such places is as challenging as establishing state-of-the-art

manufacturing methods in facilities often in the immediate vicinity of historic

village centers. Other industries, especially the luxury car industry, work around

this problem by moving their design centers to places like El Segundo, California,

and large chunks of their manufacturing to Eastern Europe. This could never be an

option for the Swiss watch industry, where authenticity is all-important and our

clients rightfully expect to be able to see and experience all the creative and

manufacturing functions in one place, at the brand’s headquarters. Unlike other

industries, the luxury watch sector fosters growth and development by striking a

balance between a respect for tradition and the need for innovation.

9.2 Desirability

By our very nature, we want to have dreams, and luxury brands set the stage for

them. “The dream value of a brand is nurtured by its perceived luxuriousness and its

tradition, legend and historical heritage. Luxury represents the future of tradition”

(Kapferer 2015, p. 18). A luxury company creates demand—and ultimately brand

equity and pricing power—through the desirability of its brand and its products.

Building the brand universe as well as the product portfolio is a key way of

achieving this. It ultimately means continuously reinterpreting the promise and

values of the brand and translating that interpretation into physical manifestations

such as fascinating new products or boutique concepts. This process, as well as the

resulting products, boutiques, and events, is then the foundation for evocative

storytelling, which is so important in our business.

Desirability is based on several key factors. Firstly, and most importantly, it rests

on the brand, its values, and its promise. A brand name and its logo need to have a

sense of timeless gravitas: they must feel elegant and luxurious, powerful, and

unique, entirely devoid of “fashion” elements. (Think here of the industry name

creations of the 1990s, from Accenture and Novartis to Syngenta and Arcelor,

which were often derived from Latin.)

Secondly, we must create and make beautiful, iconic, and instantly recognizable

designs. The design codes developed over time become an intrinsic part of the

brand DNA. When combining inspiration from past designs with new ideas, we

strike a balance between the familiar and the unknown gradually developing a

design language over time. Whenever we consider a new design, everything

revolves around the key question: “Is this an IWC?” On a tactical level there are,

of course, trends and changing tastes in the watch industry as well. Watches get

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bigger or smaller and thicker or thinner, materials and strap preferences change, and

the perception of precious metals also changes over time. The key is to be able to

adapt a product portfolio to these changes just as they begin to happen, without ever

losing the core design codes of the brand.

Thirdly, it is all about the brand universe, about enrichment, justification,

reinforcement, and entertainment. In order to be able to embed the brand and its

products in rich and evocative storytelling, we develop moods, themes, and

partnerships drawing on the values and spirit of each product family. For example,

IWC Pilot’s Watches derive their justification from a 75-year heritage. From the

late 1930s to the present day, IWC can illustrate how the design codes and

functionality of our watches can be traced to the original functional requirements

of a pilot’s watch. This justification can best be conveyed through editorial features,

special exhibitions, and historic accounts. We thus create a romantic and highly

emotional mood world around the products, based on the idea of the heyday of

gentlemen pilots, aristocratic adventurers of the skies from the pioneering age of

aviation. This story is then told through all the marketing tools available to us, from

film and digital media to literature, visual merchandising, and events. Partnerships

with well-known institutions relevant to the theme in question—such as the

Fondation Antoine de Saint-Exupery, the Ju-Air vintage airline, or the Top Gun

US Naval Fighter Weapons School—create authentic and evocative content that

helps to further enrich the products and their universe and offer our customers a

complete dream lifestyle package. Endorsement by opinion leaders and celebrities

is the final factor in creating desirability, or as Twitchell (1999, p. 225) states, “The

celebrity is the pure confection of dream lifestyle.” IWC does this successfully

through the “Friends of the Brand” program, covering a wide range of ambassadors

from our storytelling worlds as well as film, music, and sport.

To achieve long-term desirability and long-term success, growth management

comes down to sustainably maintaining the perceived exclusivity of the luxury

brand and its products. Sustaining that perception depends on successful price

management, striking a balance between availability and scarcity, upholding a

sense of mystery and transparency, and regulating overall brand exposure. A luxury

product essentially needs to be “only just undersupplied” and “underexposed”

enough to make brand and products known and available to the chosen target

audience but never abundant and in your face.

9.3 Client Experience

In the absence of rational reasons for buying a mechanical watch, success or failure

lies first and foremost in the creation of a superb and seductive customer experience

across all touchpoints. The luxury brand uses a variety of tools to approach its

customer base. What combines all the different tools is the uncompromising pursuit

of excellence in creating true luxury experiences for our clientele. This delivery on

the brand promise needs to be excellent and flawless.


Luxury watch clients may spend many months considering and deciding on a

purchase. They may come into contact with up to 10, 20, or even 30 touchpoints in

the process—from the brand website and other digital sources to catalogues,

advertising, boutiques, and the concierge service. We cannot predict or measure

which of these touchpoints is decisive in eventually triggering a purchase, but we do

know that if a single one of them is flawed, it can prevent a purchase for good. The

key to enabling our customers to choose one of our products lies not only in creating

excellence across all service touchpoints but also in being consistent in terms of

messaging and look and feel. Customer relationship management and after-sales

service are key tools for luxury watch brands in retaining clients and creating repeat

purchase opportunities. The post-purchase service experience keeps the brand top

of mind, delivers on the brand promise, and lays the foundations for the next watch

purchase justification. In a traditionally wholesale-driven business model, all luxury

watch brands are in the process of perfecting the tools necessary to offer this

excellent and consistent service experience across the entire customer life cycle.

In the luxury industry, we often find an unexpected gap in basic CRM skills,

perfected by the FMCG retail giants of today. This can be explained not only by

the fact that luxury brands are relatively new to the retail game but also by the

traditional air of discretion and privacy linked with luxury purchases at known

multibrand retail stores. But the direction is clear: the luxury watch industry is not

only in the throes of a digital transformation; it is also changing its business model

with a view to creating genuine omnichannel brands. Online sales may not yet

represent a significant share of traditional watch brands’ turnover, but omnichannel

functionality is a basic service our customers expect, regardless of where they

finally make their purchase. Ultimately, we need to be able to allow our clients to

do anything they wish, wherever and whenever they wish it.

10 Success Factors in the Luxury Watch Industry

As in other industries, the entire value chain of the luxury watch industry contains

certain distinctive success factors. The most important ones for our particular

industry are as follows: creation, making, selling, and marketing.

11 Creation

11.1 Emotional

As we have already argued, luxury brands are not democratic. They need a central

figurehead to guide the brand’s aesthetics and overall direction and to serve as a

source of ongoing creative input. Take the example of the iconic Ralph Lauren

brand. When new products are presented for validation, the labels attached to them

read either “Ralph loves” or “Ralph hates”: nothing so spineless as “A majority of

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executive committee members have voted in favor of launching this product” or

“This finding has been tested by market research.”

The creative process involved in designing an evocative brand world with truly

stunning products is at its core intuitive and personal. Beauty can rarely be dis-

cussed, debated, or analyzed. Original results can only be achieved if a single lead

vision is realized through every aspect of a luxury brand.

In an ever-changing, polyvalent environment, it is the job of the brand prophet to

gaze into the crystal ball and decide which products and technologies to design and

develop years into the future. One of the key challenges is the balancing of fashion

and longevity, currency, and timelessness. This becomes very clear when we

consider the management of the product portfolio, which is in essence the ongoing

moderation of change versus permanence. It is equally important to maintain

stability through a core collection with iconic product designs and to regularly

introduce stimulating new products that retain the juvenescence and desirability of

the brand.

In luxury brands, the brand prophet needs to live and act out the lifestyle dreams

brand followers aspire to. The feel for trends, places, people, moods, and reactions

to our products can only be gauged and sensed “out in the field”: luxury brands

cannot be created or managed from behind a corporate desk with an Excel

worksheet.

11.2 Rational

Fostering a thoroughgoing creative culture in a luxury watch brand starts with the

creation of the right culture and infrastructure. Creative talent needs to be fostered

from the start in an in-house creative center, as well as through the excellence in

craftsmanship program. Internal apprenticeships, internships, and traineeships help

to train raw talent early and fundamentally influence design training to prepare

creative professionals for the challenges and opportunities of the luxury watch

industry. Providing a second-to-none infrastructure through design studios and

the very latest in IT and CAD/CAM software, as well as advanced rapid proto-

typing, is key to fostering a fast and iterative design process. Internalizing every

single step of the creative process from product to communication allows the brand

to develop a fast and efficient flow from the initial idea to the final result and to

ensure a strong and coherent implementation across all customer touchpoints.

Naturally, internalization also presents the brand and industry as a whole with its

own set of challenges. Creative talent often comes from other watch manufacturers,

and there is a clear risk that the established codes of an industry can potentially

hamper creativity, rather than promote it. IWC Schaffhausen pursues a program of

regular creative exchange with leading players from other industries to discuss

fresh ideas and entirely different views and experiences. Partnerships with com-

panies such as Mercedes-AMG or luxury shoemaker Santoni and the resulting

exchanges inspire us to use new materials, such as the titanium aluminide used in


Formula 1™ or the unique leather patina applied to our straps, which finds its

origins in traditional Italian leather making.

The product portfolio, as well as the underlying technologies, needs to be conti-

nuously optimized. Case ergonomics, wear comfort, proportions, assembly tech-

niques, strap attachment systems, bracelets, clasps, etc., are subject to continuous

improvement and development. In the luxury watch industry, exhaustive develop-

ment and testing and time to market are of paramount importance. The only way to

ensure that our clients can always purchase the best timepiece possible is to work

rolling design changes and facelifts into existing models. This is similar to what we

know from the car industry but with much greater longevity.

12 Making

12.1 Emotional

The making of our precious timepieces needs to be the focus of our attention. The

heritage of fine watchmaking is deeply embedded in Swiss history and economic

life. Our job is to foster and translate this heritage into the present. Throughout the

entire production process, the use of industrialization and state-of-the-art techno-

logies needs to be balanced with the skill and expertise of our watchmakers: “The

tools that are used must be perceived as an extension of the human hand, obeying it

as the chisel obeys the sculptor, and not autonomous, like the assembly-line robots

of mid-range car factories. [. . .] Productivity must be achieved through organi-

zation (assembly procedures, templates, etc.) and not through mechanization”

(Kapferer and Bastien 2012, p. 212). Product perfection is always the central goal

in fine watchmaking. When the manufacture of luxury products becomes an art

form, perfection and functionality naturally overrule all other considerations. In the

end, however, perfection remains a pursuit. Perfection may be achieved from an

engineering perspective, but in the artist’s eye, nothing is ever perfect. And thus the

quest continues.

The reality of today’s luxury industry demands that we strive to achieve genu-

inely transparent manufacturing processes. Everything we do—from the materials

we source, process, refine, and finish to shipping and sales—needs to be communi-

cated openly and honestly to ensure that our clients can experience the complete

consistency in our brand values as an authentic and honest watch manufacturer.

The electronics and mass car approach of “designed-by-X-in-Y” and then

“manufactured-wherever-we-can-find-the-lowest-cost-base” can never work in

the luxury watch industry.

This level of transparency means that our manufacturing facilities are often

designed with communication and factory visits in mind. Many brands plan their

buildings and the way they use them to reflect their heritage as well as their spirit of

innovation. One of the key sources of emotional justification described above is to

pair a visit to the factory and workshops with a museum tour or a watchmaking

class. These not only give clients a full and live experience of the fascinating world

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of watchmaking but also help them to appreciate the complexity of the process and

ultimately the price of the products.

Another crucial factor is compliance with modern internal and external CSR

standards. The industry needs to provide assurance that the materials and compo-

nents we process are in line with international standards and regulations. However,

CSR applies to much more than mere supply chain management: it should be

understood as a comprehensive approach to improvement of both society and the

environment.

12.2 Rational

Historically, Switzerland’s watchmaking industry has always been based on the

Swiss model of decentralized workshops. With independent suppliers for dials,

hands, movements, and other fine mechanical components, this led to a high level of

diversity. Components were sourced from a wide range of external suppliers, and

assembly itself was entrusted to skilled artisans who lived in farms and villages

throughout the region. IWC’s founder Florentine Ariosto Jones established the very

first centralized watch manufacturing operation in Switzerland in 1868, triggering a

transformation of the Swiss watch industry that eventually all but a few watch-

makers would follow. Despite these advances in manufacturing and assembly,

specialist suppliers for certain parts remained the norm. Depending on the type of

component, the number of suppliers has traditionally been very limited. That factor,

in turn, has likewise been one of the major obstacles to growth in the luxury watch

industry.

Many brands in the watchmaking industry have gone to great lengths to make the

value chain in their centralized production models as vertical as possible. But a

limited supply of specialist skills as well as the extensive development process

required to perfect manufacturing know-how often meant that advances in vertical-

ization and the resulting manufacturing output were still unable to keep pace with

demand and growth. Only now is the industry slowly achieving a balance between

demand and capacity. This is due to the double supply effect of increased internal

skills and capacity as well as an enlarged external supplier base serving all aspects

of the watch industry.

For image reasons, the 100% in-house production of components and move-

ments will always be the goal for specialist watchmakers, but only where and when

feasible. As in other industries, the degree of internally produced components and

elaborate finishing will depend on economic realities.

The high unit value of luxury products as well as precious metal content that is

subject to variations in valuation once it is part of the balance sheet makes the

efficient forecasting and planning of production quantities a key factor at every

stage of development. Inaccurate forecasts can result in too much capital being tied

up in inventory. Striking a balance between bound capital and production flexibility

remains a challenge, as large areas of the production process rely on workforce


rather than machinery. One way to meet this challenge is the implementation of

efficiency and industrialization principles where useful (e.g., Kanban or LEAN).

The ongoing pursuit of excellent product quality is part of the mindset that needs

to prevail in the luxury industry. Despite economic success, the growth and scaling

of production numbers needs to be well balanced in order not to compromise

quality.

Finally, an impeccable after-sales service is another important aspect of the

manufacturing process in the luxury watch industry. Due to the pronounced lon-

gevity of the product, a single watch may literally have “multiple lives” with differ-

ent owners over generations. From a value maintenance perspective, it is absolutely

essential to ensure that our products’ provenance remains fully traceable and, in

particular, that expensive watches can be serviced and repaired as and when neces-

sary, both now and in many years to come. As the watch industry as a whole conti-

nues to grow and strive for ever more complex and highly functional mechanical

movements, the sheer volume of scheduled maintenance and repairs presents a

considerable challenge. Within a few years, the industry will service more watches

each year than it actually produces. Since watch servicing is highly labor-intensive

and costly for manufacturers as well as clients, a key future success factor will be a

brand’s ability to innovate in the field of extended maintenance cycles, abrasion,

lubrication, and precision. The balancing and optimization of the two seemingly

contradictory goals of complexity and reliability is one of the most formidable

challenges facing the watchmaking industry.

13 Selling

13.1 Emotional

It is through a luxury watch brand’s distribution network that the brand promise and

values most obviously come to life. As physical manifestations of the brand, all

points of sale must fully reflect the brand and deliver on its promise. You only get

one chance to make a first impression, and the impact of a client’s first interaction

with a point of sale, whether internally operated or not, can have a profound effect

on the ultimate purchase decision. As confirmed by recent studies, physical stores

and window displays remain some of the most important influencers in the client

journey. Sales associates are our most important ambassadors, and investment in

their training and fascination for the brand is one of the most important investments

and differences we can make.

Due to the nature of our product and the quality of sales environment required,

the distribution of a luxury watch brand will always be selective, exclusive, and

graded according to location. Many brands would love to operate a network made

up exclusively of internal flagship stores, which would give them full control over

brand image. However, they have to realize that the capital investment and person-

nel required to operate the stores, as well as the risk inherent in prime shopping

location leases, suggest a pyramid approach where regional beacon stores offering a

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full and immersive brand experience radiate out to cover smaller stores in high

traffic locations.

Today, the industry has stopped thinking in terms of countries and started to

recognize the existence of luxury hubs, a collection of around 50 cities, places, and

regions that form the core of our distribution strategy. Often these hubs have little in

common with the wider areas, regions, or even countries they are located in. Today,

differences in wealth, culture, and consumption patterns are pronounced in many

countries, and our task is to address those differences appropriately through the

spread and fabric of our distribution network. Differences in taste and culture are

further accentuated by the fact that most of our clients travel extensively. This poses

unique challenges to catering for different audiences. We find ourselves not only

having to address different audiences, tastes, and preferences in different hubs but

also often having to differentiate within those places. In Europe, for example, we

are experiencing a high influx of Asian luxury travelers who seek our boutiques in

iconic street locations. With western domestic clients now often seeking a quieter

and more personal shopping experience, we are beginning to open boutiques aimed

specifically at those clients in more secluded city locations with less tourist footfall.

Luxury boutiques also need to respond to their settings both in terms of archi-

tecture and functionality. As luxury brands have become globalized, we need to go

beyond the mere translation of brand identity into one consistent, globalized POS

concept. Traveling clients seek to experience our stores as destinations in their own

right, to be entertained by a new experience, and to add the uniqueness of place to

their purchase experience and resulting memories. The nondescript mall boutique is

a concept of the past: the post-globalized luxury shopping experience focuses on the

bespoke and personal, through and through. As a result, IWC, for instance, is

blending its corporate identity with key design codes and themes together with

furniture and decoration that give each store location its own identity, embedding it

into its local context while clearly retaining the brand spirit.

In terms of functionality, we need to recognize that different types of shopping

have fundamentally different requirements. The browsing and sales procedure

associated with the sedate setting of a metropolitan maison boutique is very differ-

ent from the “quick purchases” associated with airport boutiques, where clients

complete a purchase they have often previously researched and contemplated. In

both cases, the setting needs to enable a specific type of sale rather than prevent it.

One of the key characteristics of luxury brands is exclusivity. In terms of

distribution, this means that the availability of products has to be balanced with

exclusivity of the brand as a whole. Regardless of the brand’s economic success,

oversupplying the market with products would be detrimental to the brand’s luxury

image. Supply and visibility need to be controlled and modulated, ideally keeping

supply just below demand to suggest rarity and increase desirability. Luxury, by

definition, cannot be everywhere. Our key “emotional” sales challenge is to balance

growth against exclusivity.


13.2 Rational

In the luxury watch industry, growth is not linear. In the past decade, the tremen-

dous growth of the luxury industry has been achieved mainly through geographic

expansion into thriving regions such as China, Russia, or the Middle East. In the

past, growth has come in stages, with building blocks or product packages marking

each new launch cycle. Iconic best sellers across product lines provide the anchor

and driving force for extended product families and special editions to foster desir-

ability across a wider target group and promote sales. There is no reason to suppose

that this will not be the case in the future.

Traditionally, the luxury watch distribution model has focused on wholesale to

external distribution partners. While this approach minimizes risk, it poses chal-

lenges not only for quality control but also in terms of inventory management. In

the volatile economic environment in which we operate, inventory control has

become a key requirement if we are to maintain the integrity of the selective distri-

bution concept as well as limit discounting and parallel market activity. Over the

last 10 years, the growing market and shift toward “brand consciousness” have led

to the previously discussed advances into retailing and a changed role for the tradi-

tional watch retailer or jeweler. In the future, then, the most likely model will be a

balanced mix of retail and wholesale with fewer partners but more partnership, all

of them rallying in pursuit of excellence.

The success of any point of sale, but of internal boutiques in particular, depends

largely on the right management and sales staff. This can only be achieved through

sustainable retail talent acquisition, retention, and in-house development. A vast

majority of purchases are made away from home. As a result of that, we need to

focus on intercultural training and carefully structured incentive programs.

Luxury, of course, is not only about the sales floor but also about highly efficient

back-office operations, which means excellent logistics, sales infrastructure, and

systems. The proper implementation of these points will be crucial for the next step

in luxury distribution, which is providing luxury customers with an immersive

e-commerce experience that dovetails smoothly with existing channels. The result

must be a seamless, omnichannel experience allowing the customer to switch easily

between online and offline channels when interacting with the brand. A recent study

by McKinsey estimates that the total share of e-commerce across all channels for

the luxury industry will account for 20% of annual turnover by 2020. Whether this

is the case or not—omnichannel marketing is an inevitable key success factor in

offering our clients the seamless service they rightfully expect from us: the ability

to do everything, everywhere, all of the time.

174 G.A. Kern

14 Marketing

14.1 Emotional

A luxury brand needs to create and foster a compelling corporate identity that

emerges throughout all its activities. The corporate identity will then serve as an

overarching umbrella under which distinct product universes can be generated. The

brand as such is timeless and will not change drastically at its core over time, but the

aesthetic development of the product universes may serve as a vehicle to support

innovation, evolution, and change. As already mentioned, brand enrichment, con-

tent, and storytelling provide the major basis for purchase justification and per-

ceived emotional and physical value of the product. Brand enrichment upgrades and

lifts products emotionally as well as in real value terms in the pre-owned and

auction markets. The key to compelling brand storytelling lies in the creators’

ability to add infinite levels of storytelling to the brand universe while keeping

the overall communication compact and consistent. A new client with limited

experience needs to be able to experience and understand the key brand message

easily at every touchpoint. At the same time, the seasoned connoisseur and potential

repurchaser who is brand literate and experienced needs to find new elements and

layers to the story that stimulate his continued fascination with the brand. Luxury

watch communication is all about creating excitement and retaining the magic of

the brand without ever losing consistency and clarity.

Powerful partnerships, associations, and endorsements are key sources of brand

storytelling. Real celebrities or fictional characters are highly publicized incar-

nations of a brand dream lifestyle that we aim to share and emulate. Partnerships

and shared activities unite the values and attributes of these individuals and the

brand they represent. Key opinion leaders and relevant multipliers need to be identi-

fied to establish successful and pervasive communication about the brand and its

products.

The image of a luxury brand largely depends on evocative, consistent, and

compact storytelling across all activation channels. This requires a 360� approach,which leads to a consistent image across all customer touchpoints. At IWC

Schaffhausen, for instance, our unique stories cover a wide range of brand charac-

teristics from heritage engineering to state-of-the-art technology, from historic

writing to the latest in music and film, and from classic elegance to sports.

In this context, it is crucial to understand that customer interaction is radically

changing from one-way communication to a digitally driven dialogue with our

customers. Where the number of relevant channels was relatively limited in the

past, the increasingly high relevance of digital media requires broad orchestration

across all relevant channels as well as a much-increased frequency of content. In

stark contrast to traditional content cycles marked by major product launches, we

are in the middle of a content transformation that will ultimately require brands to

deliver fresh content for different audiences at least on a daily basis. This develop-

ment is further exacerbated by the growing weight of mobile computing and the

frequency set by today’s blogs, which has changed the “monthly” content habit set


by magazines to “daily” or even more frequent. With consumers checking social

media on their smartphones up to 15 times a day, there is only one way this will be

heading. A proficient and successful content generation and distribution model,

embedded in a comprehensive customer engagement and CRM strategy, will be one

of the most critical success factors for the near future.

14.2 Rational

Luxury watch brands, in top-line turnover terms, are not car manufacturers. The

resulting limited marketing spend available globally necessitates a careful modula-

tion of pan-global investment in brand image with local sell-out-driven initiatives.

It balances long-term growth of awareness and appreciation versus short-term

commercial results. Communication activity is often phased and focused on

selected regions to reflect this reality.

Global campaigns need to focus on key brand values, stories, and product

launches, while local campaigns need to be tailored to reflect the nature, demo-

graphics, and maturity of the respective market. A couple of communication or

marketing themes remain regional and their meaning varies across cultures: casual

recreation and sports-focused campaigns tend to be more suited to the western

world, while many Asian markets still prefer campaigns centered on classic ele-

gance and luxury codes which are anything but relaxed and feed traditional notions

of success and personal wealth.

Marketing is not only about creating dreams but also about establishing lasting

processes and structures that allow for the consistent implementation of excellence.

Finally, there is no magic without systematic and disciplined implementation

and creative execution. As with world-class stage productions, movies, or leading

hotels, keeping the dream alive in everything we do comes from excellence in

implementation. Controlling the experience through globally applied standards,

detailed aesthetic controls, and extensive training is the key to a globally consistent

client experience. The greatest script and the greatest show are only as good as our

performance on the night.

15 Digital Transformation

Although digital transformation is a strategic success factor across all the areas

described above, we need to single it out in order to highlight its specific importance

for the luxury watch industry. In the face of an increasing number of smart-watch

offers, some might argue that the mechanical watch industry faces a second quartz

crisis or, rather, a “silicon crisis.” The true challenge, however, lies in the industry’s

ability to drive digital transformation in its organizations within a timeframe that

ensures competitive advantage.

Due to its association with timelessness and longevity, the luxury watch industry

is naturally very traditional and intrinsically lethargic when it comes to adopting

176 G.A. Kern

new technologies and trends. Luxury brands have enjoyed a long period of one-way

communication with their clients in a rather aristocratic and high-browed fashion.

The adoption of social media as a marketing tool came later, while web and

e-commerce implementation has been notoriously slow. The brands in question

may have dismissed the digital world as too democratic (i.e., not exclusive or

luxurious enough), but our clients have moved on.

Luxury customers have an affinity to the digital media. Studies have shown that

they have possessed the technology longer than any other segment, use multiple

devices, and spend up to 15 hours a week online in their leisure time. The number

and importance of digital touchpoints are continuously changing, and a wide range

of platforms such as social media, websites/blogs, e-commerce, music, and media-

streaming services are now used extensively. Purchase decisions are already mas-

sively influenced by online interactions, and the importance of e-commerce cannot

possibly be neglected in the context of a well-rounded distribution strategy. There is

a pressing need to rethink the way customer touchpoints are designed and how the

luxury industry drives demand. Digital technologies have had a profound impact on

our entire society and indeed how we conduct business, yet the vast majority of

established luxury maisons are lagging behind when it comes to true business

model adoption.

One of the biggest drivers of traffic to the boutiques of luxury brands is their

digital presence where customers can see the collection, engage with the brand

content and storytelling universe, and, ultimately, find a boutique. Our customers

do not perceive brands channel by channel, but as an integral whole. We have to

accompany our customers across all relevant touchpoints (retail, e-commerce,

contact centers, etc.) and provide them with a seamless and coherent omnichannel

experience. In practice, it means that we need to make a holistic reassessment of the

way we interact with our clientele in today’s world and in the future.

True and authentic customer engagement is one or our most crucial missions. It

is becoming increasingly important to provide customers with the standard tools

and services they are used to from big digital players such as Amazon or Net-a-

Porter. Apart from that, we need to better understand our customers by analyzing

available customer data. Once we have that knowledge, we need to put it to effec-

tive use through best-in-class CRM activation and a personalized communication

approach. Using predictive models and demand analysis, we can give our product

and service offering a meaningful timeframe.

Digital transformation is far from limited to the realm of marketing, communi-

cations, or e-commerce and applies to the full 360� scope of the business, affectingall functions: sales, HR, manufacturing, supply chain, after-sales service, etc.

This implies a fundamental change in the requirements of the ideal organization.

A dedicated digital unit should be a stand-alone team reporting directly to the CEO

and not be governed by the IT function, which obviously has a different modus

operandi and set of priorities. This business unit would need to have both a deep

understanding of the business requirements and technological potential that could

be leveraged.


Profound and proactive digital transformation is one of the biggest threats and

opportunities our industry has seen since the quartz crisis. The status quo will only

be maintainable for a short time or for as long as no major brand has fully embraced

and implemented that transformation. Once a first mover has emerged within the

segment and changed successfully, the status quo will instantly become unaccept-

able, and the entire market will have to move.

16 Conclusion

The luxury watch industry is in a unique position due to its phenomenal barriers to

entry. Only few relevant players have emerged in the past years, and their emer-

gence has been made possible only through the legitimacy derived from their

founders’ personalities. Building an iconic brand and establishing iconic products

takes considerable time, effort, and capital, and many have failed on the way.

Existing barriers to entry are currently being made more difficult to surmount by

a clear shift toward “brands,” which favors established specialist brands of proven

value and further stacks the odds against new or smaller players. This is particularly

evident when we consider the multiple attempts by fashion brands to make inroads

into the luxury watch market. Despite their iconic brand names and giant marketing

budgets, their value and goodwill cannot be fully transferred to the realm of mecha-

nical watches. As a result, the fashion brands’ watch collections fall far short of

their core business equivalents.

The market is dominated by fewer and fewer established players who possess the

heritage, credibility, and creativity that are the quintessence of success in

watchmaking.

Success in this industry is elusive. Achieving it calls for a long-term view that

goes beyond short-term economic and geopolitical realities. After many years of

strong growth, the industry would do well to bear in mind Warren Buffett’s

contention that CEOs need “the ability to fight off the ABCs of business decay,

which are arrogance, bureaucracy and complacency. When these corporate cancers

metastasize, even the strongest of companies can falter [. . .]” (Buffett 2015, p. 36).Long-term success in our industry ultimately pivots on building brand equity and

exclusivity in questioning the existing, considering the new, and creating the

unknown.

Growth at any cost is detrimental in the luxury watch industry. The luxury watch

industry works from the bottom up: you need to create beautiful products, charge

them emotionally with the power of marketing, and sell them globally through a

second-to-none distribution network with excellent customer service. This will

build brand equity and generate long-term organic growth.

The bottom-line commercial figures are the result, not the driver, of such a stra-

tegy. Key strategic decisions are informed by what is right for the brand, not pri-

marily by KPI considerations.

As society’s and clients’ preferences change, so too will the ways in which we

engage, emotionalize, and, finally, entertain. In our quest to keep the brand relevant

178 G.A. Kern

and desirable for an ever-growing global client base, we will continue to evolve

from a purely product-driven company into an experience-based “entertainment

company.”

In the end, as a luxury watch brand you can do everything right and still get

nowhere. Success is not based on rational or analytical factors and cannot be

achieved on the basis of weighted decision criteria in an Excel sheet. Success

depends on the emotional factors, continuous creative impulses, and consistently

excellent implementation. At its core, the “X factor,” which makes the magic

happen and determines whether a brand is hot or not, cannot always be rationally

captured or explained. It is the intangible that we are striving to engineer every day,

through every act of creation, every step of production, every campaign we design,

and every boutique we build. It is an instinct and a passion inspired by a dream we

continue to share with our clients.

Acknowledgments I would like to thank Christoph Grainger-Herr and Lukas Honold for their

invaluable and inspiring contributions to this article. And I would like to thank Franco Cologni, my

mentor during my early days in the watch industry, for teaching me to think.

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180 G.A. Kern

Industry Expertise in the Digital MediaIndustry: Specialization vs. Disruptionof Online Business Models

Clemens Trautmann

1 Introduction

Recent economic history is strongly influenced by the digital transformation of

many business models and processes, including (and especially) in the media and

creative industries. To ensure that value in the digital space is created as success-

fully as formerly in the analogue world, it is imperative for management to have an

intimate knowledge of products, customers, and adaptable technology. Against this

background, the idea of a renaissance in industry expertise at first sight seems

obvious. At the same time, however, a tendency by industry representatives to

assess their own industry-specific knowledge at a particularly high degree, or even

to overstate it, is quite unmistakable.

Both trends can already be observed in a statement by Axel Springer at the

foundation stone ceremony of his company’s offset printing plant near Hamburg in

1982; this was during a period of intense technological development, and the

statement reflected the innovativeness of his publishing house: “My opinion has

always been that a newspaper or magazine publisher should have a journalist at the

helm. Almost all the managers in my company come from journalism. This might

be different in the industry as a whole. Very often, a manager of a steel company

can move on to chemistry or mining. This would not be possible here.”

In times of accelerating transformation of business models, however, the half-

life of industry knowledge is naturally shorter. In addition, there is a convergence of

industries that appeared to be completely separate a decade ago in terms of value

creation: for example, automotive manufacturers and information technology

Based on discussions with Dr. Mathias D€opfner, CEO Axel Springer SE

C. Trautmann (*)

Deutsche Grammophon GmbH, Berlin, Germany



DOI 10.1007/978-3-319-48938-4_12

181

companies are equally involved in the development of driverless vehicles. There-

fore, the antithesis also seems to be readily defensible—that generalist management

skills, transfer thinking, and experience in change management are more important

factors than industry expertise. This is even more compelling, as the capacity for

organic innovation of large companies and more mature industries is known to be

limited. Lastly, the success of prominent industry changes, such as Thomas

Ebeling’s switch from Novartis to ProSiebenSat.1 in the field of media and enter-

tainment, supports a preference for generalist skills.

An examination of the importance of industry knowledge must therefore involve

these conflicting priorities from the outset. Arriving at a viable response also

requires a definitive conclusion regarding which elements of management knowl-

edge are attributable to true industry expertise and what operational factors and

indicators may seem to be industry specific, but are irrelevant to the actual creation

of value. This paper first presents the factors that lead to a growing importance of

industry knowledge for the media industry (2.) and then balances them against

generalist requirements for management (3.). Finally, the synopsis results in a

differentiated conclusion and a plea for an approach that makes maximum use of

industry know-how, but does not lead to resistance against change and to an

impediment of innovation (4.).

2 The Growing Importance of Industry Expertise in DigitalMedia

2.1 Differentiation and Specialization due to Technology

In the media industry, digital transformation is accompanied by increasing special-

ization and differentiation of job profiles. Thus, our industry is following a general

trend. According to a study by McKinsey, the number of required skill sets has

increased fivefold within 3 years (Mourshed et al. 2012, 68)—from 178 in 2009 to

924 in 2012—and the trend is likely to have continued since. A brief look at the

current job openings in the marketing and communication sector of the StepStone

job portal, which belongs to Axel Springer Group, confirms this and is very

illustrative for our industry: among other things, companies are looking for a

“B2C CRM campaign manager,” an “expert for statistics in product management,”

and a “customer life cycle management specialist.” This diversity is in marked

contrast to the situation about a decade ago, where a more generic concept of online

media prevailed and was hardly differentiated by business model, marketing

channels, or orientation toward end or business customers. Accordingly, a job

description of “online marketing expert” or “web analyst” sufficed. The labor

market in the digital media was also far more transparent, both for managers and

professionals. All that was needed was to produce evidence of any online experi-

ence. Quite a few pioneers of digitalization were curious generalists; some of them

had absolutely no IT background.

182 C. Trautmann

A key driver of recent differentiation was the technological development which

can be roughly characterized by the following keywords: mobilization of Internet-

enabled devices, infrastructure for fast data transfer, algorithms for the analysis of

huge amounts of data, geo-based services, and networking of individual objects to

the so-called Internet of things. As a result, the IT challenges for the various online

business models, and therefore the competence requirements for the staff of media

companies and—at least indirectly—their management differ considerably. At

Axel Springer, this can also be seen in the break-up of various business segments

“paid content models,” “classified ads models,” and “marketing models,” which

incidentally, until two years ago, were collectively described as “digital media” in

the company’s financial reporting and investor relations communication.

In terms of technology, content offerings, for example, require tools such as a

powerful text and content management system for cross media distribution, a high

bandwidth for video or audio streaming, and algorithms for the meaningful aggre-

gation of content, while for online classifieds marketplaces, a database structure,

which enables a more convenient and relevant search, and a CRM solution for

efficient customer acquisition and service are critical success factors. Depending on

the subject matter of the business, the compatibility and interfaces to industry-

standard software solutions need to be considered and ensured. For example, a real

estate portal such as SeLoger or Immowelt requires interfaces to common property

software tools (or ideally provide the software themselves), while a job board like

StepStone needs to communicate with the talent management software of recruiting

companies.

In addition, there are IT specialization trends that affect all digital business

models alike. For example, the booking and bid management tools for search

engines and social media marketing have become more complex and allow ever

more precise addressing of target groups. Many platforms that emerged about a

decade ago and that have evolved into monoliths due to continuous new code

require refactoring and are needed to evolve into modularized service-oriented

architectures. In addition, technology needs to be implemented for user tracking

and the collection and analysis of large amounts of data.

In summary, those factors result in specialist knowledge that is industry specific

or is even differentiated according to individual online segments. While it is not

imperative that media executives have all this competence available themselves,

they must at least be capable of assessing and evaluating cases. This is particularly

true because software in the digital world has become a part of the creative product

and not—unlike, say, a printed product—primarily a carrier medium. Moreover, it

is just as important for managers to identify opportunities arising from novel

technologies. The functionality and adaptability of the respective hardware or

software needs to be understood for this purpose, however, which in turn requires

a precise knowledge of the problem which the manager’s own industry or

customers want to have solved. This touches upon an essential point: user- and

product-centric business models.

Industry Expertise in the Digital Media Industry: Specialization vs. Disruption 183

2.2 User- and Product-Centric Business Models

Attributing the increasing importance of industry expertise only to technology,

however, would be too simplistic. This is because an evolution of online business

models has occurred at the same time: while in the initial phase of digitization, a

website often served only as a marketing tool for the generation of (offline)

transactions—such as subscribing a newspaper, buying a concert ticket, or ordering

a CD or DVD—practically the entire value chain, from customer acquisition to the

provision of services as well as to the payment, evaluation, and generation of

subsequent transactions, takes place directly online today. This is where the real

challenge for management lies: the intimate understanding of customer needs and

preferences and overall user behavior across the various process stages and points

of interaction, also known as “customer journey.” And it should not be

underestimated that the underlying back-end processes must also be carefully

considered. Thus, in order to develop user-centric business models, one needs to

have explored the industry’s value drivers and processes intensively—not neces-

sarily in terms of technical or management responsibility, but possibly also as a user

or customer.

In the digital media industry, the concept of user-centric business models has

become ever more relevant in recent years. In essence, it means that the product is

consistently focused on the utility value for the user and that external stakeholders,

in particular customers, are included in the upstream development and decision-

making processes (Hienerth et al. 2011). User tests with prototypes have become

common. Again, technology has created the conditions for this by establishing

rapid virtual prototyping methods and Web 2.0 applications. The concept “design

thinking” represents an important agile framework for innovation. It is

characterized by the fact that design and implementation overlap: depending on

how successful prototype testing was, the team can once again start at the beginning

and redefine the problem, return to an intermediate step, and incrementally improve

a function of the prototype. Since decisions (such as “go,” “kill,” or “rework”) need

to be taken constantly in such iterative approach, product managers must be able to

quickly and deeply empathize with the needs of customers.

The need for a consistent customer and product orientation has been further

exacerbated by the fact that competing digital offers can be directly compared and

that customer loyalty decreases in general, especially as the user can switch with a

simple click or swipe. As Voltaire put it: “The better is the enemy of the good.”

Focus on the product is certainly not specific to digital media; it has traditionally

been pronounced in publishing, where there have always been direct comparability

of the titles (e.g., at the kiosk), intensive market research, and transparency about

paid circulation. Ultimately, the management’s own expertise and passion for the

product have always been essential. The statements that Axel Springer repeatedly

made about industry expertise should be understood in this sense, especially one

during the celebrations for Ullstein’s 100th anniversary in 1977: “The essence,

centre, and soul of a publishing house is the editor.” And 10 years earlier: “I have

always regarded it as a matter of course that the journalist is the first man in the

184 C. Trautmann

newspaper state.” In essence, the entire digitization strategy of Axel Springer in the

past decade has been based on the fact that the core competencies of a publishing

house and its staff are transferred from the analogue world to the digital space and

become independent of the medium: creating attractive content, marketing the

resulting mass coverage to advertisers (marketing), and establishing marketplaces

for the classifieds.

The consequence of this approach is, however, to bid farewell to the activities for

which the management lacks self-evident and indisputable customer and product

expertise. In the pre-digital era, this was for Axel Springer the painful disposal of

the investment in the logistics service provider PIN AG. Whereas generally in the

digital economy business models such as eCommerce, advertising technology

(AdTech), and gaming are important segments, Axel Springer lacks a long-term

experience horizon for them, or there are strategic investors who can create

even more value. Therefore, Axel Springer has divested activities such as

SmartAdServer or Gamigo as well as the sports app Runtastic, whose rapid growth

Axel Springer initially supported with its network and which was ultimately

acquired by Adidas in autumn 2015. This phenomenon can also be seen as an

indication of the increasing relevance of industry expertise, in this case from the

investor’s perspective.

Lastly, the customer and product focus is a guiding principle in hiring executives

and filling CEO positions in particular. For example, during the search for a CEO

for the @Leisure Group—which was acquired by Axel Springer at the end of 2014

and which operates vacation property portals throughout Europe—a central require-

ment was that candidates were experienced in the travel market. In contrast, more

general skills in establishing and developing high-reach online marketplaces were

desirable, but not mandatory. Another illustrative example is the international

expansion of Bonial Group—in which Axel Springer has a majority stake—to

France and the United States. The business model of Bonial is providing local

brochures and shopping solutions on mobile devices; so to speak, the online

equivalent of retail inserts in newspapers and magazines. Here, it was less critical

that the local market CEOs had expertise in mobile product management or

performance marketing (especially since these skills are centrally available at the

headquarters in Berlin), but are familiar with the domestic retail business in detail.

In France, Bonial Group was able to hire the long-time CEO of the world’s second

largest retail group Carrefour and former president of France Telecom, Michel Bon,

as the head of their advisory council; for the US business, the vice president of

marketing services of the Sears Holding retail group and the long-standing chief

marketing officer of the US retail chain Kohl’s took on leadership in the early stage

of the expansion. Finally, when the management positions for the newly founded

digital news platform Upday (operated in cooperation with Samsung) were to be

filled, the decision was consciously made not for representatives of the start-up

generation, but for the editor-in-chief of WELT/N24 and the chief marketing officer

of Axel Springer, whose experience and excellence extended to the critical success

factors: journalistic product quality and development of new marketing potential.


2.3 Data-Driven Decision-Making

Heinrich von Pierer once quipped: “If Siemens only knew what Siemens knows.”

His statement is traditionally perceived as the dilemma of knowledge management

in companies, which is also reflected in the statement by Peter Drucker: “You

cannot manage knowledge. Knowledge is between two ears and only between two

ears.” In the era of Big Data, this statement is false and remains true at the same

time. On the one hand, data on various business transactions are kept in central

enterprise data warehouses and—depending on the organizational culture and rights

management—are available to a large part of the staff. On the other hand, a benefit

arises from the data only if the collection and the underlying business model are

understood.

One might be inclined to believe that it is the main objective for an executive to

know all the metrics and benchmarks of the respective industry and to assess figures

immediately against that background. Such knowledge is certainly helpful for data-

driven management, but not fundamental (and is therefore proof of industry exper-

tise only to a certain degree), because it can be acquired relatively easy and quickly.

At best, it helps improve speedy decision-making (see Sect. 2.4).

Above all, in order to achieve a measurable benefit from Big Data, a definition of

meaningful data sets and relevant analyses is crucial. The data expert and director at

LinkedIn, Lutz Finger, speaks aptly of “actionable insights” (Finger and Dutta

2014). This, in turn, is possible only with a deep understanding of the business

model and the ability to ask the right questions, to identify the truly relevant

metrics, and to draw conclusions from them. In a Big Data study, McKinsey

has determined that the United States needs approximately 150,000 data scientists

by 2018. Compare this to the need for 1.5 million managers—i.e., ten times as

much—whose job is to use their business and market knowledge to generate

actionable insights from the data and analyses (Manyika et al. 2011).

One challenge is to move away from a pure reporting approach in the

evaluation of data and to attain a deeper analytical level. A practical example of

the digital classified ad business of Immowelt Group, in which Axel Springer has a

majority stake, illustrates this: a reporting of the number of available properties per

region—reproduced with color gradients on a heat map—revealed that the portal

had major gaps in an area in southern Germany. Another reporting showed that

there certainly were marketable properties in the region, but which had so far not

been listed on the portal. A logical conclusion at this point would have been to

launch a regional marketing and sales campaign and to convince the local real

estate agents to place ads. But such an approach would have ignored the business

model: the added value for the paying estate agent or property owner is not the mere

listing, but obviously only the requests from interested parties mediated by the

portal. Therefore, the assessment of reportings becomes a meaningful analysis only

if the demand of people looking for properties in the corresponding region, which

can also be displayed on a heat map, is mapped onto the property listings. In this

specific case, it was found that the demand in the region was far below average as

well. If Immowelt had executed a B2B marketing campaign in that region,

186 C. Trautmann

inevitably the paying property agents and owners would have been disappointed

about too few contact requests, and the customer would have been quickly lost

again, which would have frustrated the overall marketing effort.

2.4 Short Product Launch Times and Life Cycles

In the digital economy, a short time to market has become a key success factor.

Oliver Samwer, founder and CEO of Rocket Internet, is often quoted as saying:

“We simply just love speed like in Formula 1 racing.” His incubator also succeeds

in rolling out business models in a variety of markets within a few weeks. The

average product life cycles have also shortened drastically. While in the traditional

sense, a product life cycle has four clearly separable components, i.e., introduction,

growth, maturity, and decline, the latter three stages are in fact merging in the

digital media economy due to fierce competition, high innovativeness, and easy

imitability of unique features. For example, while the WELT and BILD newspaper

websites relaunched only every few years until approximately 2010, this interval

has since been reduced to 1–2 years, leaving aside continuous minor rebrushes; due

to the high diversity of mobile and desktop products, relaunches occur more or less

every few months or weeks.

In such rapidly changing environment, subject-specific knowledge shortens

supply and development times significantly. One communicates literally “in the

same language” and can assess performance indicators more quickly and accu-

rately. However, learning processes and training modules are also more difficult to

integrate in such a context.

2.5 Informal Networks

Established and formalized networks have lost more and more appeal and binding

force for the digital media industry in recent years. Many young companies are no

longer represented in the relevant associations; in particular, many of the new

representatives of digital publishing are absent from domestic or international

publishers’ associations such as the European Newspaper Publishers’ Association.

Conversely, the digital economy hosts a vast number of informal industry events,

some of which are accessible by invitation only and which require a personal

network.

The most prominent and most important forum is probably the Sun Valley

Conference, organized by boutique investment bank Allen & Company, to which

300 founders and CEOs like Bill Gates, Mark Zuckerberg, Jeff Bezos, and Elon

Musk and media executives such as Rupert Murdoch and Bob Iger are invited every

year. The invitees meet at workshops and lectures, but especially at informal

outdoor activities. “Random conversations often lead to more significant results

than planned ones” is the assessment of Ron Conway, one of the most influential


business angels in Silicon Valley and an early-stage investor in, among others,

Google and PayPal (Keese 2014, 46).

Without such informal conversations and networks, which typically arise from a

long industry affiliation and a high degree of personal acceptance, more substantial

transactions or business partnerships are difficult to implement. Axel Springer’s

first investment in Silicon Valley, in Airbnb, was ultimately a result of

conversations with founder Brian Chesky at the Sun Valley Conference. And

informal networks played at least an equally important role as the formal M&A

process in the course of Axel Springer’s strategic acquisition of Business Insider,

which once started out with of a minority stake.

2.6 Sector-Specific Regulation

A final factor heightening the importance of industry expertise is sector-specific

regulation. The intensity of regulation in the media industry has already been high

in the pre-digital era: besides the general requirements, there have been state press

laws and—in addition to the general antitrust laws—media concentration law. As

part of the digital transformation, the issues of privacy and copyright have become

significantly more relevant today. Legislation take place on the national level (e.g.,

intellectual property rights) and increasingly on the European level (e.g., the

General Data Protection Regulation and, most notably, the legislative activities

relating to the Single Digital Market).

In this context it is no longer sufficient for a responsible manager to passively

familiarize himself with the rules and guidelines that are set by legislators for

entrepreneurial activities, which would be a more traditional compliance under-

standing. It is advisable for a media executive to become actively involved in

political discourse—only in this way can lawmakers be informed of disruptive

developments and critical issues, which in turn impact legal evaluation and design.

Without such participation in the political discourse, the objective of a level playing

field can hardly be achieved, especially in view of the precedents created everyday

by international technology companies. As the exchange with political decision-

makers is becoming more and more relevant for top management, this obviously

requires a profound understanding of the industry-specific legal framework, while

expertise from other industries can be used only to a limited extent.

3 Offsetting Factors

3.1 Continued High Intensity of Change and Possible Disruption

Success is little more than a snapshot in the digital economy. Darwin and

Schumpeter are the cultural-philosophical heralds when it comes to the systematic

and creative transformation of business models at the expense of established market

participants. According to the “Digital Vortex” study by IMD Lausanne and Cisco,

188 C. Trautmann

the representatives of various industries believe that, as a result of digital disruption,

four of the current top ten businesses (according to market share) in each industry

will be replaced in the next 5 years (Bradley et al. 2015, 3). Particularly in the media

sector, only 13% of the surveyed industry representatives rightly believe that the

barriers for disruption are high or even insurmountable (Bradley et al. 2015, 15) and

see an above-average risk (>41%) of an existential crisis (Bradley et al. 2015, 3);

the predominant threat is not from established market participants, but from

industry-internal start-ups and, to a degree, also from start-ups outside the industry

(Bradley et al. 2015, 9). Despite significant changes in recent years, media/enter-

tainment—after the technology sector itself—ranks second among the industries

most at risk of disruption.

Although Axel Springer generated more than 60% of sales and 70% of earnings

with digital services in 2015 and—as shown by a Stanford University case study—is

regarded as one of the leading practical examples of the transformation from print to

online, there is no reason for satisfaction or even complacency. The pressure for

change stems partly from the large technology companies such as Amazon,

Facebook, and Google and partly from many disruptive digital publishers with the

momentum of start-ups such as Vox Media, Huffington Post, BuzzFeed, or Vice,

which compete fiercely and may force old brands and publishers to simply disap-

pear. New and exponentially growing social communication networks such as

Snapchat, which promotes the distribution of editorial content with its new product

“Discover,” can also play a role.

The music industry is an instructive example of a media sector that had to cope

with disruptive developments twice in a decade. It was digital platform

technologies outside the industry that first put the business model into question

around the turn of the millennium—and which stabilized it again shortly thereafter:

first peer-to-peer file sharing networks such as Napster, which launched in 1999,

and, starting in 2003, Apple with the iTunes music store, which made digital music

consumption in the form of downloads convenient and legal. Around half a decade

later, the next disruptive platform came onto the market in the form of the Spotify

music streaming service, triggering a new and still acute need for change within the

industry. One could even argue that the business model in use until now is put even

more fundamentally into question: until now, the distribution of music only differed

in the carrier medium (LP, MC, CD, or download file), but not in the underlying

model of individual item sales. In contrast, streaming services are based on a

subscription model in which the generation of single or repeated transactions is

less important than sustainable user acquisition, the conversion of free trial periods

to paid services, and smart churn management. The long-standing experts in

subscription business models, however, are not music executives, but much rather

publishers.

The listed examples from the media and creative industries demonstrate that an

idea potentially threatening an industry’s business model frequently comes from the

outside—and often from entrepreneurs who do not have a particularly strong

relationship with the industry, or at most an indirect one. They are able to recognize

inefficiencies and discover solutions that insiders cannot see themselves. In


contrast, innovation that is based on industry experience is often incremental and

generally optimizes existing business models or processes. Tesla founder Elon

Musk sees the analogy-based thinking of management in established companies

as the core problem for a lack of innovative capacity. If companies derive all

decisions from a treasure trove of institutionalized experience and knowledge,

they may be facing an innovation disconnect (Keese 2014, 100).

The risk of “groupthink” is also typically higher in the homogeneous structures

of established industries. This is how behavioral and organizational science refers

to the phenomenon that dissent is not accepted due to overestimation of the group

and the pressure to succeed (the Challenger and Columbia disasters, in which

NASA engineers self-righteously ignored the thoroughly well-known technical

problems, are considered prime examples of this). Groupthink is sometimes

regarded as the “dark side of teamwork.” The exposure to groupthink in digital

media is often mitigated by organizational measures such as diversely composed

teams and creativity techniques such as mind maps or bulletin board cards. Never-

theless, the risk remains latent.

Incidentally, it often happens that, although innovators come from outside the

industry, they certainly have a certain proximity to the industry, e.g., as users or

customers, due to their professional past, or as their hobby. A good example is

Henry Blodget, the founder and CEO of Business Insider—a leading global com-

pany for digital business journalism—in which Axel Springer has had a 100% stake

since autumn 2015. During the first internet boom at the turn of the millennium,

Blodget was a prominent senior analyst for technology investments on Wall Street.

Due to conflicts of interest between investment recommendations and private

equity trading, however, he had to permanently give up his job in 2003 as a result

of prosecutorial investigations. Blodget then applied his undisputed expertise to

journalistic formats and founded, together with former DoubleClick CEO Kevin

P. Ryan, Business Insider in 2008—with the impulse that the financial and eco-

nomic reporting of established press outlets had been too cumbersome. Today, the

US teach of Business Insider is about twice as high as that of the Wall Street Journal

and Bloomberg.

Closely related to the topic of disruption, one can observe a convergence of

various industries, which is also contrary to the postulate of industry knowledge. A

study conducted by the Institut der Deutschen Wirtschaft K€oln and the IT industry

association Bitkom shows that the business of 50% of all companies in Germany

now largely depends on the internet. If one consults the Digital Readiness Index,

however, a large part of the transformation is yet to come for many industries. It is

by no means certain that their transformation will be successful. Interestingly,

KPMG titled a recent study “Survival of the smartest—which companies will

survive the digital revolution?”

Accordingly, more than half (61%) of the companies in Germany

expect new competitors by 2020 due to rapidly progressing digitization—not

from their own industry, but from others. Within the framework of triple- or

quadruple-play models—consisting of (mobile) telephony, Internet access, and

entertainment—telecommunications companies are increasingly becoming

190 C. Trautmann

providers of media content. Netflix and Amazon have enriched their pure sales

platform for digital film and video content with self-produced TV series to deliver

attractive, exclusive content and so give the platforms a USP. And if German

carmakers promote the concept of connected cars and linking-up with the transport

infrastructure in order to increase safety by using swarm intelligence, they will

suddenly find themselves competing with Google and their “Driverless Car” project

or the Uber mobility service.

Innovation often takes place at interfaces: between different industries but also

at the interface between private and public research institutions (such as the

development and commercialization of the MP3 format). In the end, we should

not ignore the fact that the Internet itself evolved from military communications

systems that have been adapted for civilian use.

3.2 Divergent Organizational Cultures Within One Industry

Peter Drucker’s statement “culture eats strategy for breakfast” has become a dictum

to describe the importance of corporate culture in comparison with measurable

success factors or established management methods. The concepts with which

social science and organizational theory attempt to record and describe corporate

culture are almost as diverse and heterogeneous as their object of study itself. The

sharpest definition of corporate culture is also the fuzziest: “This is how we do

things around here” (Bright and Parkin 1997, 13). It is not very helpful either

that the concept of corporate culture has been borrowed from anthropology.

Accordingly, the discussion of it—both in academic research and in practical

management—is characterized by analogies and metaphors. Thus, “artifacts and

rituals,” “strong and weak cultures,” “bread-and-circuses culture,” and

(neologistically) “adhocracy culture” are among the terms in usage, which gives

us a taste of the colorful cultural diversity.

Interestingly, however, corporate culture is generally not industry specific. In fact,

it is mostly dependent on matured beliefs, practices, and preferences of management

and the employees. In particular, an organizational culture is shaped by the

management’s strategic vision or mission, its risk tolerance, adaptability and the

degree of employee involvement, the incentives and decision-making structures, and

the long- or short-term nature of the orientation. Although digital media companies

do not diverge fundamentally in some of these dimensions—for example, they

usually have high adaptability—the differences in other culture-shaping elements

can still be serious. Compare, for example, a sustainability—oriented privately

owned media company with one that is backed by an exit-oriented financial investor

or venture capital.

The relevance of an organizational culture for the personality profiles of its

members has been proven in many studies. For example, the likelihood is increased

by one-third that one finds comparable leadership skills in two employees working

at the same company in completely different positions, rather than in two

employees working in a similar position at different companies (Kell and Carrott


2005, 22). Conversely, this also means that not every manager within an industry is

compatible with any company. Although this is a truism and the so-called cultural

fit is often overstated, in practice boards do not always sufficiently take this factor

into account when filling management positions, as opposed to supposedly hard

criteria including industry expertise.

Certainly, an organizational culture is not static and can certainly be shaped by

the management. However, industry expertise in terms of “having the right pedi-

gree” can in turn be a hindrance to credibly promoting a cultural change process.

The relatively slow change process of change at Deutsche Bank and the frequent

reshuffle of the management board may be indicators of this. Ideally, any change in

organizational culture serves as a key to an innovative business model and

enhanced performance. This is the objective that Axel Springer has been following

by intensifying and accelerating cultural change since 2012. The company was

among the very first European enterprises to establish a branch in Silicon Valley for

research fellowships of executives and employees as well as for early-stage

investments in digital content companies. The New York Times characterized

this decision as “electroshock therapy” and took note of the fact that Axel Springer

did not hire a consulting firm, but drove that change process from within (Clark

2015). It proved helpful that this approach could be traced back organically to the

existing corporate culture of Axel Springer which held entrepreneurship in high

esteem, as the founder himself exemplified from the 1950s onward.

4 Summary and Outlook

In principle, the industry expertise has become ever more important in the digital

media industry through the interaction of various factors: technological specializa-

tion, user-centric business models and product development frameworks, and the

need for understanding processes in data analysis as well as through informal

networks and increasing regulation. This tendency clearly provides opportunities,

especially by optimizing business models and products so that they have even more

benefits for the customer.

However, emphasizing industry expertise one-sidedly comes along with the risk

of insufficient readiness to innovate. The digital transformation of media business

models is not yet at a final stage (and is expected not to be complete for a long time).

On the contrary, the probability of disruption—also due to a convergence of

formerly completely separate industries and value chains—has increased. If the

permeability between sectors decreases in recruiting, as industry expertise is in

stronger demand, creative entrepreneurial potential would be lost. The top manage-

ment should therefore retain a generalist orientation, but must at the same time find

new ways of working with industry experts (such as reverse mentoring) in view of

the increased requirements.

In conclusion, the sum of specialization trends should be balanced with an

organizational culture that encourages regular questioning of industry-specific

assumptions and reflects trends with representatives of other industries. Only the

192 C. Trautmann

Paranoid Survive is the apt book title of former Intel CEO Andrew Grove. Thus,

industry expertise should never be equated with organizational blindness. Ulti-

mately, the central question is whether the company continues to create value for

its customers. This is the best stress test for any business model, even highly

specialized digital ones. Answering that question can lead to two options: either a

stronger industry orientation in case that the added value results from a more

precise understanding of specific customer needs and processes. Or otherwise the

conclusion may be to consciously leave the supposedly safe haven of one’s own

industry behind and innovate the business model with concepts from adjoining or

even remote fields.

References

Bradley, J., Loucks, J., Macaulay, J., Noronha, A, Wade, M. (2015). Digital Vortex—How digitaldisruption is redefining industries. Study by IMD Lausanne and Cisco

Bright, D., & Parkin, B. (1997). Human resource management: Concepts and practices. BusinessEducation: Sunderland.

Clark, N. (2015, Dec 20). An old-media empire. Axel Springer Reboots for the Digital Age.

New York Times.D€opfner, M., & Trautmann, C. (2013). Kunden- und Leserorientierung in einer digitalisierten

Medienwelt. In: R. Stadler, W. Brenner, A. Herrmann (Eds.) Erfolg im digitalen Zeitalter.Finger, L., & Dutta, S. (2014). Ask measure learn. Sebastopol, CA: O’Reilly.Hienerth, C., Keinz, P., & Lettl, C. (2011). Exploring the nature and implementation process of

IT-based user-centric business models. Long Range Planning, 44, 344–374.Keese, C. (2014). Silicon valley. Munich: Albrecht Knaus.

Kell, T., & Carrott, G. T. (2005). Culture matters most. Harvard Business Review, 83(5), 22 ff.

Manyika, J., Chui, M., Brown, B., Bughin, J., Dobbs, R., Roxburgh, C., et al. (2011). Big data: Thenext frontier for innovation, competition, and productivity. San Francisco: McKinsey Global

Institute.

Mourshed, M. Farrell, D., Barton, D. (2012). Education to employment that works: Designing asystem that works. McKinsey Center for Government.

Trautmann, C. (2014). Digitalisierung und Unternehmenskultur—Trends und wirtschaftsethische

Dimensionen aus Perspektive der Praxis. In E. Kempf & K. Lüderssen (Eds.),

Unternehmenskultur und Wirtschaftsstrafrecht. Berlin: De Gruyter.


Royal Dutch Shell in a Changing World:Navigating Uncertainty

Ben van Beurden

It is with good reason that the twentieth century is known as the century of oil. In

the years since 1859, when Colonel Drake first drilled for oil in rural Pennsylvania,

the industry’s impact on civilization—on commerce, transport, communication,

agriculture, medicine, and manufacturing—has been astonishing.

A raw material initially valued for generating artificial light today enables us to

power homes and businesses, to transport people and goods by road, to fly between

continents, and to manufacture materials like plastics that are now a vital part of

everyday life.

As such, the contribution of the oil industry to human progress is arguably as

great as any other industry.

That contribution continues, with natural gas now playing an increasingly

important role as the world moves toward cleaner sources of energy.

Indeed, a global energy transition is underway, as society tackles the dual

challenges of meeting growing demand for energy to power homes, businesses,

and transport while significantly reducing carbon dioxide (CO2) emissions.

There are other forces shaping the strategies of companies across many sectors.

The rise of digital technologies, for example, is transforming the business land-

scape. Political and economic volatility is creating an uncertain operating

environment.

Shell’s business model has evolved over the past 100 years: from a group with

two parent companies and largely autonomous local businesses to one with a single

parent company and a global structure and strategy. Demand for our products from

crude oil and natural gas, including liquefied natural gas (LNG), to transport fuels,

lubricants, and chemicals has grown as hydrocarbons have increasingly powered

the world’s development.

Today, as society seeks to meet energy demand and reduce carbon emissions,

it’s clear that Shell’s long-term success will depend on our ability to adapt to a

B. van Beurden (*)

Royal Dutch Shell plc, The Hague, Netherlands



DOI 10.1007/978-3-319-48938-4_13

195

changing world. Specifically, we must continue to transform ourselves from the

powerful incumbent of old into a simpler and more agile, profitable, and customer-

focused business, one that is flexible enough to anticipate and respond to the needs

of local markets, while retaining its global strengths.

In the years to come, Shell may not look as it does now, but we intend to remain a

leading energy provider for the rest of this century and beyond.

1 Understanding Shell

Let me set out some essential facts about Shell today. Shell is a global group of

energy and petrochemical companies. We rank among the world’s largest interna-

tional oil and gas groups in terms of market capitalization, operating cash flow and

production. Our upstream business explores for and produces crude oil and natural

gas and operates the infrastructure necessary to deliver oil and gas to markets.

In our integrated gas business, we focus on LNG and gas to liquids (GTL),

including LNG trading. In our new energies business, we are investing in

low-carbon energy including hydrogen, wind, and solar. The downstream business

manages Shell’s refining and marketing activities for oil products as well as the

manufacturing and sale of petrochemicals. It also trades Shell’s hydrocarbons and

other energy-related products and provides shipping services.

The projects and technology division drives the delivery of Shell’s major

projects, as well as research and innovation and the deployment of technology

across the company.

In 2015, Shell employed around 93,000 staff, as well as several hundred thou-

sand contractors, and had operations in more than 70 countries.

In a bold and compelling move, we acquired UK-based oil and gas company BG

Group plc in February 2016. The deal reshapes our company and our industry and

marks a key strategic decision to strengthen our already growing LNG and deep-

water businesses. It adds significantly to our oil and gas reserves and boosts our

production of oil and gas.

The deal also creates a springboard for making Shell a simpler, more focused,

and resilient company during a period of volatility in oil and gas prices.

As we simplify our business, we are selling assets and postponing or canceling

projects that we no longer consider competitive.

At the same time, we are working to streamline our organizational structure

while reducing the amount of money we spend on suppliers. Profitability, and not

size or volume, will be the best indicators of the future growth of our company.

196 B. van Beurden

2 Strengths

The new Shell has many strengths. Firstly, we remain an integrated energy

company—meaning that our activities cover all aspects of the industry, including

exploring for and producing oil and gas, trading, and selling transport fuels,

lubricants, chemicals, gas, and electricity.

Secondly, our strong balance sheet and diverse portfolio allow us to manage

large-scale, long-term risk and invest in projects that will deliver energy resources

to help meet demand for decades to come.

Thirdly, our global reach, underpinned by more than a century of experience and

a powerful brand, allows Shell to build partnerships with other oil and gas groups,

governments, and companies outside the energy industry—an increasingly essential

feature of the global energy landscape.

Shell continually seeks to innovate in areas such as technology, commercial

activities, and customer service and has the expertise to complete game-changing

projects such as Prelude, a pioneering floating facility we are building to produce

and process LNG off the coast of Australia.

The capacity to innovate has been crucial to Shell’s success since our story

began. The company commissioned the world’s first bulk oil tanker, the Shell SS

Murex, which sailed on its maiden voyage through the Suez Canal in 1892. Bulk

transport substantially reduced the cost of oil by increasing the volume that could be

carried in a single journey.

Shell helped launch the global market for LNG, providing the technology for the

first commercial onshore export LNG plant in Algeria in 1964 and shipping the

plant’s first commercial cargo to the UK in the same year.

We have filed over 3500 patents in developing the GTL technology that

transforms natural gas into synthetic oil products for transport fuels and everyday

necessities like plastics, detergents, and cosmetics.

In 1993, we opened our first commercial GTL plant in Bintulu, Malaysia. And by

2011, we had completed the world’s largest GTL plant, called Pearl, in Qatar. The

plant makes enough cleaner-burning synthetic diesel to fuel over 160,000 cars a day

and enough synthetic oil each year to make lubricants for more than

225 million cars.

Innovation continues to be vital in creating competitive advantage for Shell—not

just in technical research and development but also, for example, in collaborative

partnerships, marketing, and customer service. It is integral to Shell’s goal of

becoming the world’s most competitive and innovative energy company.

Safety is central to Shell’s business approach as we continue to work toward our

goal of having zero fatalities and no leaks or other incidents that harm employees,

contractors, or neighbors.

Our approach to safety is part of the company’s aims to operate responsibly.

Shell’s core values of honesty, integrity, and respect for people and the environment

underpin all the company’s work and the behavior of our employees. These

principles matter not just for their own sake, but because of the impact they have

on our ability to do business. We are judged by how our people behave.

Royal Dutch Shell in a Changing World: Navigating Uncertainty 197

3 Evolving Business Model

To understand today’s Shell, and where we are heading, we should start at the

beginning. The roots of Shell’s corporate structure date back to 1907, when 60%

owner Royal Dutch Petroleum Company, an oil production company in the Dutch

East Indies, merged with 40% owner Shell Transport and Trading, a London-based

kerosene merchant.

Riding rapid economic growth around the world, the company quickly expanded

from its base in Asia to Romania, Russia, Latin America, and the USA. But

continued expansion after the First World War, as well as diversification into

chemicals, started to put pressure on the group’s dual nationality structure.

In response, Shell’s management strengthened what it called a matrix organiza-

tion at the end of the 1950s. Under this structure, local operating companies had

responsibility for profits, while two central offices in The Hague and London played

coordination and advisory roles in areas including exploration, production,

manufacturing, marketing, and chemicals. Shell was run by a committee of manag-

ing directors with collective responsibility for overall coordination and

collaboration.

The company went on to become a thriving group of more than 120 national

operating companies. Structurally, Shell was one of the most flexible companies in

the world because of the independence of its businesses.

Strong local management of the national companies helped further boost expan-

sion because it helped Shell gain permission to build refineries or petrochemical

complexes and adjust quickly to the needs of local markets.

By the late 1980s, Shell had become the world’s largest international oil

company in terms of production. Yet compared to many rivals, Shell’s individual

companies still had considerable autonomy.

Corporate strategy, as we know it today, did not exist. So, for example, when

Shell’s Scenarios planning team wanted to share its views of how the energy world

could develop, the team would embark on a 2-year world tour to meet with the

heads of the different operating units. Those business leaders would then decide to

what extent they would feed the insights into their own strategies.

This local autonomy helped Shell seize growth opportunities in Eastern Europe

as communist regimes collapsed in the early 1990s. Strategic ventures in Russia

offered opportunities for joint production agreements as well as opportunities to sell

oil and gas products.

But the dynamics of Shell’s business were changing under pressure from glob-

alization, new technologies, and the liberalization of energy markets. Major

airlines, for instance, wanted to have global fuel contracts, rather than deal with

many different country organizations around the world.

Shell also faced competitors that did not have the onerous overheads of so many

individual country organizations. And the oil price was falling.

The downturn in the oil price sparked a major reorganization at the company in

the mid-1990s, aimed at introducing more centralized strategies and policies. Shell

dismantled the matrix system, replacing national and regional management with

198 B. van Beurden

five businesses spanning operations around the world (with the exception of North

America): exploration and production, oil products, chemicals, gas, and coal. Shell

later sold its coal business.

As the oil industry started consolidating with a series of megamergers in the late

1990s, and as a growing number of national oil companies expanded into the

international arena, Shell saw the increasing significance of scale and set about

making the most of its own global reach. We used our size as an advantage by

devising global processes and structures to become more efficient and by building

large and complex projects.

The structure of the two parent companies survived until a crisis of governance

triggered by overbooked reserves led to a new evolution of the company. In 2005,

Shell underwent a major structural change with the creation of a single new parent

company, Royal Dutch Shell plc, that acquired Royal Dutch and Shell Transport

and Trading.

For the first time, Shell had a single board, a single chairman, and a single chief

executive officer.

4 Simpler Company

Shell gained many advantages from its move to a global operating model, including

the creation of a universal set of standards in areas of expertise such as exploration,

projects, technology, manufacturing, transport, and marketing. We are now able to

deploy this expertise across the group where we need it and to make critical strategy

and portfolio decisions that weigh the balance of our full range of global activities.

Today, Shell continues to evolve. We are becoming a simpler, more focused

company: a company that is able to take decisions and actions more rapidly in an

era when local governments and local policies increasingly drive changes to the

energy system.

Indeed, one of the key strategic questions facing companies like Shell is how to

weave the strengths of a locally driven approach into the fabric of a global

company. We must be sure that our company is competitive in every market

where we operate and these markets will be increasingly shaped by local

regulations and the needs and choices of local customers.

5 Evolving Business Environment

Shell must remain sensitive to the constant shifts around us. As a large global

company investing in oil and gas projects stretching decades into the future, it is

essential that Shell understands the evolving business, political, and economic

landscape.

Our business model is built on the premise that the world will need more energy

resources in the future to meet demand from growing populations in Asia and

Africa, where living standards are also on the rise. In fact, Shell’s Scenarios team


expects that in the next 50 years, global demand for energy could be 60% higher

than its 2015 level.

Natural gas will continue to be a crucial part of the energy mix and an important

part of Shell’s business strategy. The International Energy Agency expects global

demand for gas to increase by 47% in the period between 2013 and 2040, largely

driven by demand from China, India, and the Middle East.

But we cannot simply deliver energy without working to reduce the environ-

mental and social impact of energy production and use. Shell’s strategy must

remain robust as the world tackles climate change and energy markets make a

transition to low-carbon technologies. We expect these transitions will unfold as a

series of relatively rapid local changes.

The question is no longer whether these transitions are taking place, but how and

when they are happening and what role the oil and gas industry can play in helping

to build a more sustainable energy future.

As the 2015 Paris UN Global Climate Change agreement showed, governments

around the world are seeking ways to develop the policy and cultural changes that

will drive low-carbon business and consumer choices.

6 Lower Emissions

Modern renewable sources of energy such as wind and solar could supply five to ten

times as much energy in 2065 as in 2015, according to estimates by Shell’s

Scenarios team.1 Yet despite the clear and collective will to lower emissions, the

facts suggest that demand for hydrocarbons will remain strong for many years

to come.

The production of chemicals and plastics, for example, will continue to rely on

hydrocarbons. And where especially dense energy is required, such as in air travel,

marine freight, and long-distance road freight, the world will almost certainly see

the continued use of the combustion engine for the foreseeable future.

The environmental benefits of using natural gas to generate electricity will make

gas vital to any pragmatic and affordable plans to reduce CO2 emissions in both

developing and developed countries. A gas-fired plant produces around half as

much CO2 and one-tenth of the air pollutants as coal when burnt for electricity. Its

flexibility makes it an ideal partner for intermittent renewable energy sources, like

solar and wind power.

There remains significant uncertainty about a wide range of other issues related

to world energy systems—including the future of government-led carbon-pricing

1Shell Scenarios are part of an ongoing process used in Shell for 40 years to challenge executives

on the future business environment. We base the Scenarios on plausible assumptions and quantifi-

cation. They are designed to stretch management thinking and include events that may be unlikely.

Scenarios, therefore, are not intended to be predictions of likely future events or outcomes, and

investors should not rely on them when making an investment decision with regard to Royal Dutch

Shell plc securities.

200 B. van Beurden

systems and carbon capture and storage (CCS). CCS captures CO2 from industrial

sources and stores it deep underground. It could be a critical technology in the

transition to a low-carbon future.

But political backing and government-led carbon-pricing systems will be needed

to help drive the wider use of CCS. Shell is involved in two major CCS projects

around the world, including Quest in Canada that we launched in late 2015. We also

have a 25% interest in the Gorgon LNG project in Australia, which will have one of

the world’s largest CCS facilities, capturing between 3 and 4 million tonnes of CO2

every year from gas fields off the coast of Western Australia.

7 Political and Economic Uncertainty

Like many companies, Shell is operating in an era of volatility and transition, driven

partly by increased connectivity. As the world has become more prosperous, so the

movement of goods, ideas, and people has reached previously unimagined levels.

These connections are crossing not just national boundaries but also the traditional

boundaries between the private and public sectors, and they are spanning different

industries and sectors of the economy.

The result is a more socially and economically turbulent world, one that creates a

challenging, complex but invigorating operating environment for Shell. The trends

and uncertainties that we see today are shaping our strategic decision-making and

how we manage the risks to our business model.

For example, political tensions and instability have increased in major

hydrocarbon-producing regions such as the Middle East and in countries such as

Russia and Venezuela. We need to try to understand the potential shape of these

geopolitical situations and their long-term implications for global energy supplies.

Another key uncertainty relates to the pace of economic growth in China, which

is widely agreed to be the single most important driver of global economic growth

in the coming decades.

8 Digital Technology

Other trends, such as the development of digital technology, are disrupting tradi-

tional business models. Already, app-based companies like the taxi firm Uber, or

accommodation agency Airbnb, are using digital technology to reinvent and chal-

lenge how businesses work.

Shell is increasingly bringing digital technology into our business. For example,

we have partnered with PayPal to be the first fuels retailer in the UK to offer mobile

payments at the pumps through our Shell Motorist app. We are also developing

digital capabilities, with other partners, to develop technology in cars that can

connect directly with our Shell sites, giving our customers the choice of paying

for fuel and convenience items from their cars.


Digital technology helps to improve the safety and efficiency of our operations.

For example, we send robots with sensors and cameras to inspect pipes and valves

in our oil and gas fields. We have sophisticated sensors built into our wells and

pipelines that monitor temperature and pressure. And we are using high-

performance computing to process higher volumes of seismic data.

In this fast-moving digital environment, the integration of energy systems will

become more important. New business models could include energy sold to

customers in a package that covers storage, electricity, heat, and demand manage-

ment, for example.

9 Strategic Choices

Shell aims to deliver more energy in ways that are economically competitive as well

as socially and environmentally responsible.

We plan to grow as an integrated energy company with an industry-leading

performance from the businesses that generate most of our cash today, including

conventional oil and gas and integrated gas and oil products. At the same time, we

are stepping up activities in areas that are priorities for growth such as chemicals

and deep water.

The company is also investing in future opportunities, which are shale oil and

gas, and exploring the emerging low-carbon energy system to find new areas where

we can build expertise and help achieve scale. This includes building on our

existing activities in low-carbon biofuels and hydrogen, as well as looking for

new opportunities in wind and solar energy.

Shell sees an important role for the oil and gas industry in the energy transition.

As a company, we aim to provide commercial returns which are acceptable and

attractive to investors. And we want to make a constructive contribution to efforts to

tackle climate change.

10 Making the Most of Shell’s Strengths

Today’s industry conditions pose significant challenges for companies like Shell.

Shale oil and gas aside, for example, most new oil and gas resources are in harder-

to-reach locations, increasing the costs and risks associated with projects. The

prolonged period of low oil prices from late 2014 has further stressed the financial

performance of the industry.

Being highly competitive is more important than ever in the current low oil price

environment. Shell will continue to evaluate our businesses carefully to make sure

we have the competitive advantages and proven operational performance to deliver

the profitability we need. Innovation will continue to be important, but even

potential game changers have to be cost-effective.

In short, we are cutting capital spending and halting projects that are no longer

critical to our strategy and investing in areas where we are stronger. In 2015, for

202 B. van Beurden

example, we reduced capital spending by $8.4 billion compared to the previous

year, to $29 billion.

The acquisition of BG Group in February 2016 accelerates the delivery of our

strategy by bringing new growth potential, as well as attractive returns and cash

flow. For example, the deal expands our LNG business, with more supply coming

from countries such as Australia and Trinidad and Tobago. This gives us greater

flexibility and strengthens our ability to meet growing global demand for LNG. It

also adds considerably to our global deep water activities, especially in Brazil.

With bigger positions in these areas, Shell is able to apply our technology and

expertise on a larger scale and at a lower cost. Success in both the LNG and deep

water businesses requires financial flexibility as well as commercial skills, which

play to our strategic strengths.

11 Key Capabilities

In order to execute our strategy successfully, Shell has identified what we call

winning capabilities which we expect will give the group a competitive advantage

and make it more agile in a changing environment.

Shell’s winning capabilities emphasize five important themes: a customer-

focused approach, a drive to produce commercial value across the group, a com-

mercial approach to technology, a focus on more profitable and less capital-

intensive projects, and sustaining operational excellence in all assets.

The first theme highlights the importance of understanding our customers and

tailoring our services and products to match their needs and budgets. Our customers

include retail and business buyers of transport fuels and lubricants as well as buyers

of natural gas and electricity. They also include our partners that own major oil and

gas resources, which we produce on their behalf under a range of commercial

agreements.

This approach is important at a time when consumers are better informed, for

example, because of the wealth of information over the Internet, and at a time when

consumer interest is shifting, albeit at varying levels, toward lower-carbon sources

of energy.

The drive to produce commercial value across the group, meanwhile, spans all

our activities, from upstream to downstream. The energy system is becoming

increasingly complex and interconnected, and it’s more important than ever that

our company understands how to create value for our shareholders and customers.

Maintaining a sound overview of the competitive landscape and our entire value

chain, from the source of the energy to the customer, will help us consistently

position the company for profitable growth opportunities.

Shell also seeks to deliver more value from the profitable deployment of

technologies across the group. We will continue to focus on selective research

and development activities, in line with our legacy of technological firsts, such as

our work on GTL. At the same time, we will increase our ability to integrate and


deploy currently available technologies, with the aim of lowering development and

operating costs.

Providing energy to meet the world’s increasing demand, enabling more people

to have a better standard of living, will remain a capital-intensive business. Shell’s

capital budget is tens of billions of dollars every year.

Sustaining Shell’s growth therefore depends on our ability to turn opportunities

into profitable businesses. That means becoming more effective at managing

projects so that we define the most competitive options and then complete them

more quickly and with lower costs.

Finally, the goal of operational excellence reflects our will to continuously

improve, to find ways to reduce costs and generate higher returns through the

consistent and reliable execution of our work in all our operations, everyday. The

cash we generate today will fuel our future investments and make Shell more

resilient during this time of transition for the world’s energy systems.

12 Conclusion

Shell will continue to rely on the strengths that have historically served us well.

These include our geographical reach, the range of our oil and gas businesses, and

our project-management expertise. Our ability to forge and maintain partnerships,

our financial muscle, and our capacity to innovate are just some of our other

advantages in a hugely competitive landscape.

But as I have explained, Shell is operating in a continually shifting environment.

The world is undergoing a transition toward lower-carbon energy, and the political

and economic environment is increasingly volatile. Digital technology is

reinventing business models while presenting new opportunities both for Shell

and our competitors.

Shell is changing too. We are making our company simpler. We are becoming

more agile. And the expansion in deep water and LNG leaves the enlarged group

resulting from the acquisition of BG better-placed to focus on scale, profitability,

and growth potential.

Shell will face many challenges along the way, such as turning sound strategy

into more profitable businesses around the world and maintaining and building the

company’s brand and reputation.

But Shell’s reinvigorated focus on competitiveness and our core strengths gives

me every confidence that we are in a strong position to overcome those challenges

and thrive well into the future.

Disclaimer Ben van Beurden is the Chief Executive Officer of Royal Dutch Shell plc (RDS). His

views do not constitute an offer to sell or issue or the solicitation of an offer to buy, acquire, or

subscribe to shares in the capital of Royal Dutch Shell plc. There are certain risks associated with

an investment in RDS securities. Readers are urged to read RDS Form 20-F and consider the risks

described there before investing in RDS securities.

204 B. van Beurden

Case studies: LNG and Retail

LNG: Making Innovation Count

Shell helped launch the global LNG industry, providing the technology for the

world’s first commercial plant in Algeria to chill and condense natural gas into

liquid for shipping to other markets. In 1964, we brought the world’s first commer-

cial LNG cargo to the UK, opening up a global trade.

LNG has reshaped the natural gas business as it allows the gas to be transported

around the world. So, for example, a power plant in South Korea can generate

electricity with natural gas originating from Nigeria. One-quarter of Japan’s elec-

tricity is now generated from imported LNG.

Shell has continued to innovate and improve the technology for producing LNG.

For example, when we helped build Russia’s first LNG plant, we introduced a

technique that chills the natural gas with a special air-cooled refrigerant system.

This takes advantage of the subarctic conditions on Sakhalin Island and makes the

LNG plant more energy-efficient than most.

Shell’s innovation in LNG continues today. Prelude, moored some 200 km off

the northwest coast of Australia, will be one of the world’s first floating facilities to

produce and liquefy natural gas, operating without the need for pipelines and an

onshore plant.

We plan to use the technology and techniques we have demonstrated during the

construction of Prelude in other floating LNG projects. For example, we are

working with our partners on another potential project in Australia.

LNG is an attractive market for Shell because of its high growth prospects. We

expect global LNG demand to increase by around 5% a year well into the next

decade, more than double the growth rate of natural gas as a whole.

Some 20 countries currently export LNG to around 30 countries, with those

figures set to reach 25 and 50, respectively, by the middle of the decade.

Shell is involved in every stage of the LNG process. Our company finds and

extracts the gas, liquefies it, ships it around the world, markets and trades the LNG,

and turns it back into gas before distributing it to our customers.

LNG has been used traditionally to heat and light homes and businesses and

power industries. But other markets are opening up, including using LNG as a

cleaner-burning alternative to diesel and heavy fuel oil in shipping and road

transport. This is an emerging sector with enormous potential.

In 2012, Shell bought a Norwegian company which provides LNG fuel for ships

and industrial customers primarily around the Norwegian Shelf and the Baltic area.

In addition, we have agreed to be the first customer to use the new LNG terminal at

the Port of Rotterdam, in the Netherlands.

Maintaining Shell’s position in LNG will require us to develop new gas fields

and deliver big projects efficiently and on time. We will also need to drive our

growth by understanding and engaging with our customers as the number of uses

for gas increases.


Retail: A Local Approach in a Global Network

Shell operates the largest single-branded retail network in the world with around

43,000 sites in more than 70 countries. Around 25 million customers visit these

outlets every day.

Understanding and anticipating customer needs, as well as acting on these

insights, is critical to our success. Increasingly, that means tailoring our products

and services to different markets.

Consumers around the world, for example, want the convenience of being able

to buy food while refueling. To help meet this need, we have partnered with

companies such as Costa, Starbucks, Migros, and Waitrose to offer products that

cater to local markets.

We also aim to provide customers with a locally tailored service, one that will

make their visits both welcoming and convenient. For example, we have introduced

a program called Welcome to Shell, which encourages staff on Shell-branded sites

to offer a more personal and friendly service.

The strategic diversification of Shell’s retail network across different markets

and a range of operating models is another part of our strategy.

It’s important to have sites in the most accessible locations. Shell has actively

managed its portfolio to achieve a strong presence in key urban markets around the

world. Looking forward, we have anticipated rising fuel demand by expanding in

future growth markets such as China and India.

Despite our wide global reach, Shell applies different operating models to our

sites depending on local market conditions and opportunities. Our most widely used

model is a network of sites owned by Shell, which are operated by retail partners

under business agreements.

We also use branded fuel supply agreements to partner with independent service

station owners and large distributors. By adapting the terms of our agreements to

meet specific needs, we aim to ensure that partnering with Shell is an attractive

business opportunity, helping us attract strong retail partners.

Another way we have achieved our leading retail position is through continuous

innovation of high-performance premium fuels tailored to meet the needs of some

customers, such as our Shell V-Power brand. This fuel is a direct result of signifi-

cant investment in research and development and technical partnerships with

leading car manufacturers such as Ferrari.

Our premium GTL motor oils, meanwhile, are based on the conversion of

natural gas into clear oils.

Looking forward, Shell is also investing in the research and potential commer-

cial development of alternative fuels such as hydrogen and advanced biofuels that

are made with nonedible plants and crop waste.

206 B. van Beurden

Further Reading

Shell Annual Report, Shell investors handbook, Shell sustainability report—all available at: http://

www.shell.com/global/aboutshell/media/reports-publications.html

Shell general business principles—available at: http://www.shell.com/global/aboutshell/who-we-

are/our-values/sgbp.html


http://www.shell.com/global/aboutshell/media/reports-publications.html

http://www.shell.com/global/aboutshell/media/reports-publications.html

http://www.shell.com/global/aboutshell/who-we-are/our-values/sgbp.html

http://www.shell.com/global/aboutshell/who-we-are/our-values/sgbp.html

Into the Future on the Digital Highway

Dieter Zetsche

Gottlieb Daimler and Carl Benz developed the automobile independently of each

other around 130 years ago. It is an interesting exercise to consider at length how

far-reaching the social consequences of this invention were—for the way in which

people work, consume, maintain contacts or take a vacation. Previously, Europeans

traveled an average of only around 20 km per year. Nowadays, the figure is over

30 km, but per day, and usually by car. Neither is it possible to imagine life without

commercial vehicles: Trucks and vans are essential to modern delivery systems,

whether for fresh foodstuffs supplied to supermarkets or packages ordered from

online shops. And around the globe, buses are an absolute mainstay of passenger

transportation systems. The car has lost none of its importance as a driver of social

change: Individual mobility is only just picking up speed in many emerging

economies. This means that the car industry is and will remain a growth sector: It

is expected that global automobile sales will increase by around 30% between 2015

and 2025.

When we talk about fundamentally life-changing technologies nowadays, we are

usually referring to digitization. It is estimated that one third of the world popula-

tion will soon have a smartphone. And it is not only people who are communicating

virtually, as the so-called “Internet of things” is becoming increasingly networked:

The heating system can be controlled by an app, the printer automatically reorders

toner, the washing machine only runs when power is at its cheapest. Experts expect

that by as early as 2020, around 50 billion “things” will be networked worldwide.

So what happens when the automobile and digitization join forces?

In an economic context, the term “Industry 4.0” is frequently used to mean the

combination of the physical and digital world. It means the digitization and

interlinking of the entire value added chain. In our case, from research and

D. Zetsche (*)

Daimler AG, Stuttgart, Baden-Württemberg, Germany

Mercedes-Benz Cars, Stuttgart, Germany



DOI 10.1007/978-3-319-48938-4_14

209

development to the first design sketch for a vehicle, then manufacturing and sales

and marketing. Services relating to the products are also a part of this. Although the

term was only coined a few years ago, there are already projections showing that

“Industry 4.0” is able to benefit manufacturing industry with productivity increases

worth billions.

For us at Daimler, there is no question that this digital revolution will funda-

mentally change our industry. That applies to the methods we use to develop, plan

and produce our vehicles. Also to the way in which we make contact with our

customers.

And not least, it will be apparent in the products themselves.

What does this actually mean for the future?

1 Product Creation 4.0: The Intelligent Factory

In early 2015, a stand at the Detroit Motor Show attracted particular attention,

because it did not display any specific model but rather an entire miniature factory.

The 49 individual parts of the vehicle came from a 3D printer. Is this the future of

automobile production? Just a brief glance at a modern vehicle provides the answer:

certainly not exclusively, particularly in the premium segment. The requirements

for the over 7000 parts making up, for example, a Mercedes-Benz CLS, are

simply too varied. High-strength steel alloys, aluminum, composite materials, glass,

leather, and numerous other materials ensure maximum safety, comfort, and

visual appeal (Fig. 1).

Nonetheless, we premium manufacturers will also make use of the adaptability

of 3D printing for certain components in the future. And in fact the term “Industry

4.0” is most often heard in association with new, flexible production methods. And

we will certainly need them. Why? Because of the increasing complexity in

automobile production.

New VarietyOne reason for this is that the wishes of our customers are increasingly diverse,

which is in turn partly due to growth in new markets. In 2014, China overtook

Germany as the second-largest sales market for Mercedes-Benz cars, for example.

And in many respects, the requirements of Chinese customers differ from those

of Mercedes drivers in Europe. Long-wheelbase sedans are much more common in

China, for example, as more people there are chauffeur-driven. At the same time,

demand in the traditionally important markets such as the USA or Western Europe

Fig. 1 Into the future on the digital highway (own presentation)

210 D. Zetsche

is increasing for vehicles which meet the individual preferences of their owners

down to minor details. And of course, thanks to our countless different equipment

variants, our claim is that we offer every customer a car that perfectly suits him or

her (Fig. 2).

For us, this means that not only our unit sales are growing but also the variety in

our product portfolio. Whereas we were able to cover most customer requirements

with three basic models during the 1970s, we have around ten times as many today.

The possible configurations have also increased enormously. For example, it

practically never happens that two identical examples of our S-Class leave the

production line in our Sindelfingen plant. In the case of commercial vehicles, the

sheer variety is even greater owing to the extreme differences in operating

conditions. In addition, there is now an increasing number of drive systems for

the passenger cars. Apart from gasoline and diesel engines, hybrid vehicles are

becoming more and more familiar on the roads. In the future, we will considerably

increase the number of purely electric cars powered by battery and fuel cells.

All this means that our production requires a constantly increasing degree of

flexibility. As long-term increases in raw material prices and additional product

features have an effect on costs, we need to further improve our efficiency at the

same time. And all of that without making any compromises with respect to quality.

Fig. 2 Worldwide demand for cars and commercial vehicles is growing. At the same time,

customer requirements are becoming increasingly diverse. Today, the Daimler portfolio is more

varied than ever before (own presentation)

Into the Future on the Digital Highway 211

After all, Mercedes-Benz makes its customers a simple promise: the best or

nothing.

On the Way to the “Smart Factory”Gottlieb Daimler already subscribed to this motto. We have therefore always

systematically worked to ensure that our production processes—like our

vehicles—are future-oriented. In 1972, we were one of the first manufacturers in

Europe to use a numerically controlled production robot to weld the side walls of

the S-Class. A passage in the corporate chronicle for that time reads that in view of

the ease with which the programming can be changed, “we can expect a good deal

to happen in this field in the future.” Its author was proved right: Robots are

nowadays to be found everywhere in our production—and especially where the

task in question would be particularly stressful or even ergonomically harmful for

humans.

In networking our production facilities, we are gradually ushering in a new era:

The transparency of our production data has reached a new level, processes increas-

ingly control themselves, and the plant is becoming a “smart factory.” Nonetheless,

there is no doubt that humans will always remain the centerpiece—no machine in

the world can match their flexibility, which makes the intelligent combination of

man and machine all the more important. What advantages do we expect to gain

from these changes?

First of all, we can ensure that our global production network comes together

even more closely. Since 2014, our C-Class has been leaving the production lines

on four continents, for example, because production in close proximity to the

market and customers is an important precondition for benefiting from the world-

wide growth of automotive markets. Intelligent production facilities, standardized

automatization and control technology, standard modules throughout the corpo-

ration, and new online cooperation models will allow an even more intensive

exchange of information between our plants in the future. This means that our

lead C-Class plant in Bremen can give the locations in the USA, China, and

South Africa direct support with new features. We see similar potentials for the

cooperation agreements with our suppliers. For example, problems in a production

facility can be detected, analyzed, and remedied by remote diagnosis—in the ideal

case even before they occur. All in all, closer networking within the company and

with other companies allows faster, more efficient processes and even higher

quality.

A consistently digital process chain is a further approach for networked produc-

tion. This means that all planning and process data are available in real time, from

the vehicle design stage right through to after-sales. It therefore becomes possible to

virtually enact the effects of new product characteristics on the production process.

As a result, the products can be even more systematically designed for an optimum

production process and therefore reach market maturity more rapidly.

But above all, digitization allows us to make our production much more flexi-

ble—and therefore to meet one particular challenge more efficiently: planning for

the long term while remaining able to respond rapidly to market fluctuations. The

212 D. Zetsche

key word in this context is adaptability, the ability to change. We are already able to

produce different vehicle models on the same line today. In the future, we plan to

achieve even more in this regard: We want to design our production facilities so that

they are as easy as possible to install, convert, and dismantle, so as to manufacture a

wide range of products in numerous variants.

One example of this adaptable production is the so-called object-specific installa-

tion system we use in our Rastatt plant. The idea is this: Mobile robotic systems can

be used in many areas of production without needing to technically modify the

production line or even stop it. The robots move to the line where they are

needed—in Rastatt, for example, this is to install panoramic glass roofs. They dock

at the vehicle body in question on the production line, install the panoramic roof,

separate, and attach themselves to the next vehicle—all while the line is moving.

New product variants or processes can also be integrated in this way, without having

to laboriously modify or stop the line. This not only saves time; it also makes

production more flexible. Because it allows made-to-measure automatization, tasks

are performed by people wherever this is appropriate and ergonomically favorable.

And if increased capacity is required in the short term, or assembly workers are more

urgently needed elsewhere on the line, the mobile robots go into action.

Cooperation between humans and robots on the way toward the smart factory is

a milestone that we introduced in our assembly as the first automotive manufac-

turer. What does this refer to? Nowadays, an assembly task is usually performed

either by workers or by robots. For safety reasons, the latter are located behind

protective fences. With direct cooperation between workers and robots, it is possi-

ble to optimally combine the cognitive superiority of humans with the power,

endurance, and dependability of robots. This not only improves quality; it also

leads to considerably improved productivity. And not least, it opens up new

possibilities with respect to ergonomic and age-compatible working procedures

(Fig. 3).

The current generation of robots has the necessary intelligence, irrespective of

their size and power. A new approach is possible with sensitive lightweight robots

originally designed for space travel: “robot farming,” which we use in our produc-

tion of transmissions (see Fig. 2). Depending on the required number and assembly

process, the workers select one or more robots, and use them at various assembly

stations as required or are able to work together with them in one area thanks to the

integrated safety sensors.

Many of these approaches for networked automobile production are still in their

infancy. Accordingly, we have joined forces with other companies and partners in

scientific and research fields to jointly accelerate progress in these future areas. The

name of this cooperative venture says it all, “ARENA 2036,” which stands for

“Active Research Environment for the Next Generation of Automobiles.” The year

2036 marks the 150th anniversary of the automobile.

At present, we are unable to say exactly what our production plants will look

like, or when the time to celebrate will arrive. People often express concern over

such developments: Will the factories of the future be devoid of people? Certainly

not. The future relationship between humans and robots will be more a question of


intelligent cooperation, because in many areas of automobile production, the

experience, creativity, and flexibility of our people is simply irreplaceable. What

will change fundamentally, however, is the range of tasks to be performed. Mono-

tonous tasks, and those requiring physical strength, will increasingly be performed

by machines. In return, the personnel will be given more and more planning

responsibility in an adaptable production environment. For example, they will no

longer just monitor and program the work of robots. They will work hand in hand

with them, call them over as assistants by voice control or hand gestures, and “train”

them for new tasks (Fig. 4).

Fig. 3 The machine as a “colleague”: A worker touches the sensitive robot as a signal that he

wants it to help him install a roof liner. Humans would need to perform this task with strenuous

overhead work (own presentation)


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2 Customer Service 4.0: The Digital Approach to the Car

One thing is clear: the digital revolution does not end when a car leaves the

production plant. Nowadays our customers are used to having round-the-clock

access to goods and services. They buy their jeans in an online shop, chat with

the customer center of their telephone service provider at any time of the day or

night, and “post” about their favorite brands on Pinterest and Instagram. E-books

and music streaming services have already shown us how traditional products can

be supplemented with individualized services in the digital age. In the automotive

sector, there are likewise new opportunities for tailor-made services which go well

beyond the vehicles themselves and offer added value to customers and companies.

Does this mean that in the future, cars bearing the Mercedes star might join other

products in a shopping basket? Why not? At the end of 2013, in Hamburg,

Mercedes-Benz was the first premium manufacturer to begin selling preconfigured

new vehicles via the Internet. This particularly appeals to younger people.

On the other hand, there are many among those young people who do not

necessarily want to own a car, but appreciate the advantages of individual mobility.

This is especially true in large cities. We also have something suitable for these

people: our car-sharing program car2go. Just a few years ago it was unthinkable for

a car manufacturer to rent out its vehicles. With over one million users, car2go is

now the world’s largest car-sharing business. And once again, the secret of this

success is networking: Anybody wishing to rent a car can use a smartphone app to

check where the nearest vehicle is located and book it. At the destination, the car is

simply left in a vacant parking space. As with mobile phone accounts, billing is

precise to the minute.

Another service product is our moovel app, which shows users how different

means of transportation can be combined for the best route from A to B—by

car2go, car sharing, taxi, or public transport. The price is shown at the same time.

We are therefore changing from being purely a car manufacturer into a provider of

mobility services.

The above examples show that more than ever, the decisive criterion for success-

ful services is direct and convenient access at anytime and anywhere. In line with

this approach, we at Mercedes-Benz have decided to consolidate all our services.

Indeed, we have created a separate sub-brand for the purpose: Mercedes me.

Whether users own a Mercedes-Benz, a different brand, or no car at all, their

personal Mercedes me ID gives them online access to tailor-made services.

They have access to a whole range of mobility packages, such as car2go and

moovel, for example.

Naturally, all those people who own a Mercedes will also find a large variety of

services relating to their vehicle. This begins with new forms of traditional cus-

tomer service. When a vehicle needs to be serviced or repaired, for example, a

workshop can be contacted around the clock. All the actions carried out are clearly

visible to the customer. Individual financing, leasing, and insurance packages are

also available via Mercedes me. Of course, customer services and financial services

continue to be available offline as well—we are merely opening another door for

access to us.


The vehicle itself also offers new ways to communicate. The basis is provided by

a communication module with its own, integrated SIM card. In the event of an

accident or breakdown, this allows a direct voice connection to be established with

an emergency center or the Mercedes-Benz customer center—if necessary auto-

matically. The location and condition of the vehicle are communicated at the same

time, so that responders can take the shortest route. Our vehicles now have this

communication module as standard equipment. Under the name eCall, this tech-

nology is to become mandatory for new vehicles in Europe before the end of the

decade.

An exchange of information with the vehicle is helpful also in day-to-day

driving. Anybody who has tried to find the way back to where a vehicle is parked

in an unfamiliar city knows this. With modern vehicles, the location can easily be

found by smartphone. And those who want to can activate the auxiliary heater while

making their way back to the car. Remote interrogation can also confirm whether

the doors are locked, or check the fuel level or the remaining range of an electric

vehicle.

What are the benefits of digital services in the commercial vehicle sector? There

are many. As their owners use these vehicles to earn money, they must deliver

optimum overall cost-effectiveness. In other words, they should be as safe, efficient,

and reliable as possible. Telematics-supported Internet services such as our

FleetBoard system are a help in this respect. Schedulers have a constant overview

of the locations and availability of all the fleet’s vehicles and are able to plan

accordingly. Data on maintenance and wear and tear are regularly sent to the

service partner, so that servicing work can be consolidated.

And with the accompanying driver training, the analysis of driving style reduces

fuel consumption by up to 15%. Thanks to networking, we are therefore able to

offer our customers numerous services that ensure they get the most out of their

vehicles (Fig. 5).

3 Freedom 4.0: The Connected Car

The examples also show that the car has long been part of the “Internet of things.”

In the future, it will communicate even more intensively with its surroundings—and

open up fascinating possibilities (e.g., see Fig. 3).

Within just a few years, it has become practically standard that car drivers are

able to integrate their smartphones seamlessly into the vehicle, thereby having

access to their music, apps, and contacts when on the road. However, this network-

ing goes much further still in premium cars. Using cameras and ultrasonic or radar

sensors, they can permanently keep an eye on their surroundings. And that’s not all:


216 D. Zetsche

They are able to predict how other road users will move. This is made possible by

linking the various sensor data in the vehicle.

In modern luxury-class sedans, more than 20 active assistance systems ensure

safety in this way. They recognize when the distance from the vehicle ahead is

inadequate, whether there is a vehicle in the blind spot or if the driver should take a

rest break. And they can provide assistance in many ways—from discreet steering

assistance right up to autonomous emergency braking. The whole thing becomes

even more effective when vehicles are able to exchange information about tailbacks

and hazards with each other, and with the infrastructure, because then the informa-

tion status goes well beyond the reach of onboard sensors.

It is no secret where all these innovations are heading: to autonomous driving.

Assistance systems are paving the way for this, as people are gradually finding that

they can place their trust in the technology. Mercedes-Benz passenger cars are

already able to follow a vehicle ahead autonomously in stop-and-go traffic—the

“virtual chauffeur” takes over the steering, braking, and accelerating. In 2013, we

demonstrated how far the technology has already progressed: Following in the

footsteps of the first long-distance journey in history by Bertha Benz, a near-series

S-Class covered the approximately 100-km route from Mannheim to Pforzheim

completely autonomously—with absolutely no problems, even in complex urban

and country traffic (Fig. 6).

What will be the effects of autonomous driving on our daily lives? First of all, it

will allow a completely new level of comfort, because we will be able to lean back

Fig. 6 On the way to autonomous driving: In the future, there will be new means of communi-

cation between cars and their surroundings (own presentation)


and relax in unpleasant driving situations. The car will become a private place

of retreat in a world of tight spaces and hectic activity. Those who wish to will use

the journey to work to take another look at the documentation for the first

meeting—and take a nap on the journey home. And how would it feel if the car

dropped its driver off outside a restaurant, drove off to park itself autonomously,

and later collected its driver again?

Autonomous vehicles can also make life safer for us. Most road accidents are

due to human error. Sensors, on the other hand, are immune to distraction, fatigue,

and shock reaction time—they always respond reliably and predictably. Traffic

flows could also improve thanks to the particularly safe and appropriate driving

style. So will the fun factor be left out of the equation in the future? We think not.

Wherever driving remains enjoyable, we also wish to give car lovers the freedom to

take over the controls themselves in the future.

But professional drivers also know this: Tiring, monotonous driving situations

are often the norm. That is one reason why autonomous driving is of very special

importance in the commercial vehicle sector. According to forecasts, road goods

traffic in the EU is set to further expand its share of total goods transportation over

the coming decades. On the other hand, the number of new truck driving licenses

has for years been stagnating at a low level in Germany. In other words, a driver

shortage is becoming a real problem. Autonomous trucks may be a way out: The

vehicles will become intelligent participants in a process, and the drivers will

become transport managers. They will be able to apportion their time better, take

care of administrative tasks while on the road, more easily keep in touch with

family and friends, and be at home more often following a possible review of the

regulations covering driver working and resting times. Daimler is the first manu-

facturer to have shown the way in this direction, with the “Future Truck 2025”

research vehicle (Fig. 7).

Let the Future BeginAll in all, one thing is clear: More than ever before, the car has the potential to be a

motor for social change—not least thanks to a combination of the automotive and

digital worlds. For us as a manufacturer, digitization allows more efficient and

flexible production processes plus more direct access to our customers. The

customers in turn receive tailor-made products and services. Autonomous driving

gives them completely new ways in which to spend their time. And society as a

whole benefits from additional growth potentials, improved road safety and

more efficient traffic flows.


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Naturally, “Industry 4.0” is not exempt from what happens with many future

trends: Hardly have they been identified, when analyses appear questioning whether

German industry has a leading role or has failed to notice the signs of the times. The

examples show that the German premium manufacturers are by no means on the

receiving end of “Car Industry 4.0,” but are massively driving the process of change

themselves.

Like any fundamental change, digitization is accompanied by challenges. First

on the list are data security and data protection: We want to produce not only the

safest cars for our customers, but also the most secure. To this end, we carry out

comprehensive technical and organizational security measures which we conti-

nuously improve in line with ongoing technological developments. Clear regulations

concerning data protection will become even more important in the future. A

crucial factor here will be constructive cooperation between industry, politics and

research. The same applies to aspects such as the legal parameters for autonomous

driving, the creation of an infrastructure for fast data transmission, further develop-

ment of the education system, the creation of industry standards and defining a

frequency for vehicle communication.

All these things will not come about from one day to the other. Like when the

automobile first entered peoples’ lives, the changes will come step by step—though

at a much faster pace. Current progress shows that it is by no means yesterday that

we embarked on this journey. In Germany, we have an unrivaled network of

manufacturers, suppliers and research establishments. And as the most research-

intensive industry in the Federal Republic, we have all it takes also to lead the field

on the digital highway. Let the future begin.
