Orchard Writing

1 We Have a Problem: Revenues and Margins are Up, but Profits are Flat

In Mashup Corporations: The End of Business as Usual, the first book in this series, we explained how Jane Moneymaker, the CEO of the fictitious company Vorpal, has been very successfully moving the company into a number of niche markets using the Long Tail principle. This principle asserts that specialized niche markets in aggregate create a much bigger market than traditional mass markets, and lead to increased revenues for the company.

Enabling this transformation has been a new generation of Web 2.0 technologies, which in total have provided a platform for a number of web-based communities and hosted services. Further, Web 2.0 is not wrapped around one core product or technology. If anything, the core product or technology is people, particularly web-literate users with the ability to find innovative ways to use technology to pursue a wide variety of interests—everything from professional pursuits to engaging with fans of favored sports teams. These technologies have provided novel and rather powerful opportunities for people with common interests to build connections around those interests and create web-based services that reflect those interests. This is what has made the Long Tail effect possible.

At the beginning of our story, Hugo Wunderkind, former marketing manager at Vorpal, but now the company’s director in charge of online marketing efforts, came up with a novel idea while at home watching a New York Jets football game. The idea was that it would be fun to have a popcorn popper with his team’s emblem on it. He also thought that other people might be interested in such a product, and wondered why not sell Vorpal’s brand of popcorn popper, the Pop-Matic, in a way that would allow any fan to place an image of their favorite sports team on the side of the popper?

Wunderkind garnered the help of a friend to build a web application that would allow users to select a team emblem or image and render that image onto the side of a popcorn popper. He then placed this application on his personal blog for people to access. In this way, by creating a web application that combined his blog entries on the Jets, and football in general, with a service that would allow visitors to his blog to customize their Pop-Matics as well, he created a prototype mashup.

This “toy” of Wunderkind’s sparked something of a craze, and soon he had people trying to place orders with payments for their team’s emblem on his blog. As the marketing aspects of his creation became apparent, he went to Moneymaker.

Seeing the reaction Wunderkind received from merely posting his toy on his blog, she realized that providing a web-based service, leveraging online communities to sell customized poppers, could prove helpful for improving the company’s stagnant sales and marketing share in a flat and unchanging market.

Josh Lovecraft, Vorpal’s CIO, was concerned about the negative effects of allowing anyone that much control over even this one aspect of Vorpal’s IT environment. After first overcoming this concern, Moneymaker very quickly moved forward on the initiative. Soon Vorpal was transformed from mass marketing one brand of popcorn popper into marketing customized poppers in many niche markets.

Success with this one product line was met with similar success using the same method with Vorpal’s other products. Soon Moneymaker and Wunderkind had sparked something of a revolution at Vorpal.  The basis was selling customized products via web-based services and connecting with various sales channels—communities of people with common interests—via Web 2.0 technologies. In all, Vorpal was succeeding at creating a unique and personal experience for its customers around its products.

However, as the story moves forward there are storm clouds on the horizon and Moneymaker is wondering if she has unleashed something that she may not be able to control. Yes, her efforts have met with success, but not without some issues that are now beginning to worry her and her CFO, Frank Cashtender.

As we pick up our story it’s Monday evening, and Moneymaker is at home waiting for delivery of yet another dinner of take-out. She is talking on the phone with her long-time friend and business school roommate Hannah Grant…

“Sometimes I wish I had taken a slightly easier path than the corporate world. I mean, perhaps I should have followed your example and opened a flower shop,” Moneymaker says, leaning back into her rather plush couch. She has her shoes off and is relaxing for the first time that day. A glass of wine sits idly on an end table and her husband has yet to arrive home.

“Yeah, well flowers do sometimes die,” says Grant.

A sharp nervous laugh blows past Moneymaker’s lips. “I suppose, too, that I wouldn’t have been happy with just one shop. I would have had to have been the Starbucks of flowers, one on every corner.”

“This is true,” says Grant with an impish lilt to her voice, “you always were something of an overachiever in school, which stands in stark contrast to me. I am more than happy with my modest little flower shop.”

“Modest? Little?” says Moneymaker softly mocking her friend’s false humility.

“Please, you must allow me my petite idiosyncrasies,” says Grant jokingly. “But yes, I suppose business is doing well and it doesn’t matter in my humble industry whether I am the Starbucks of florists or not—people are still pulling a few dollars from their purses for a nosegay.”

A laugh bursts from Moneymaker and she remembers how much fun it can be to just chat with a close friend. “It’s nice to know that in some places brand doesn’t matter so much, you know, that people can trust and recognize the unique qualities of your busy little shop. I suppose it relates to what some of our professors in school used to say about trust models and…”

“Oh please don’t bring that up,” says Grant laughing, “I’m having a glass of wine and the store is closed for goodness sake.”

“I know, I know, but I just have to say that I may have found out why Starbucks so rigidly rejects customizing its stores and products,” presses Moneymaker.

“So now I know why you’ve called. What’s going on?”

“Was I that obvious?” asks Moneymaker taking a small sip of her wine. “I’m worried; I certainly wouldn’t say panicked, but worried that I may have unleashed something at the company that I may not be able to control.”

“A Pandora’s box kind of thing?”

“Yes, well, perhaps. You see, there is this fellow at work, Hugo Wunderkind…”

“I remember reading about him in a newspaper article about you and the things you had done at Vorpal.”

“Of course, then you’ll know that he came up with this way for people who went to his blog on his football team—I think they’re the Jets that he likes so much—anyway, he created this way for people to customize popcorn poppers, specifically the Pop-Matics that we make. This created something of a stir even though the application he built was only on his blog. It seems that other Jets fans, and then fans of other football teams, have something of a communal experience watching the games and tend to eat a lot of popcorn.”

“Yes, people do find joy in some rather amazing ways,” interjects Grant.

“And I’m glad they do,” says Moneymaker. “Anyway, up until that point people just bought a popper and that was that. We decided that if people are going to have this communal experience, why not place our product at the center of it. The way to do that is to allow them to customize the popper to their favorite team, and we expanded this to include sports other than football.  So we built our own application, which we call PopMe! and placed it on our website. We then had to work out deals with decal makers, which was easy enough to do…”

“I remember you talking about how excited you were as it was happening,” says Grant, “and it went very well, too, as I remember.”

“Yes, it did. It went so well in fact that we used these same concepts on about two dozen other products.”

“Yep, I have one of them. You can customize the design of the clock and it has a USB port so it can be plugged into a computer. When you log onto its website there are a bunch of services around that clock, such as setting it to the exact day and time, downloading music, displays, and even various alarm voices and sounds. I love mine. Every morning I wake up to George Clooney cooing ‘Breakfast time hon.’ My husband hates it,” Says Grant laughing.

“Yes, exactly, that and quite a few others…”

“And if I remember correctly from that one newspaper story—and there were a bunch of others, it seems like you and Vorpal were in just about every business magazine around, which is how I got my idea to add a customized flower pot web service to my website—but anyway, I remember you managed to post a double digit increase to your revenues,” says Grant.

“We did, and we could also charge a premium for the customization because Hugo was connecting us with all of these niche market channels. Then we opened up our technology by offering a toolkit with a common API, to essentially amateur developers in various niches, so that they could innovate on what we are already doing and add additional sales channels and volume to those that we could create on our own. This has been downloaded more than 200,000 times, which means that 80 percent of our custom appliance orders are made online, and of those only a small fraction come from Vorpal’s website. This came with some risks, as my CIO Josh Lovecraft told me over and over, but we worked out his security and operational concerns by using our various web services as something of a top layer above our internal IT architecture. The web services are our interface with these communities of people, but our internal information systems are protected. Now our customers, and even suppliers and partners, are telling us how to better serve them. We are letting them serve themselves better, and, in the end, they are better serving us, too.

“So in all, we’ve been selling not only more popcorn poppers than ever, but more of everything; the clocks, kitchen appliances, bathroom appliances, and on and on, and all of them are customized around a community with a shared interest. It has been breathtaking to see all of this activity and all of this revenue and sales growth.”

“Yeah, and? We all should have such problems,” says Grant.

“Well, then we took it a step farther. Josh realized that the kind of work that Hugo was doing on his own is probably being replicated by tech-savvy employees throughout the company. He even came up with a great term for it, which is ‘Shadow IT.’ Most of these people are our younger new employees and Josh discovered they were using technology in all sorts of interesting and useful ways right under our noses. So, being the savvy CEO that I am…”

“As always,” chimed in Grant.

“We set policies that would nurture these uses and harness them to the overall business, but would also manage risks. So we sent out a memo saying that the company and I would provide the technology and support their efforts, these ‘labors of love,’ if you will. What this did was add to what was already taking place, which was the slow transformation of our enterprise from back-office-centric IT toward using technology to change our way of doing business in the front office.”

“I’m still failing to see how any of this is a problem,” says Grant.

“Well, what if I told you that while revenues are up and our margins on each item sold are higher than before—both are way up actually—we aren’t generating the profits to match?”

“What do you mean? You are selling more stuff at a higher margin. How could you not be making more money?” says Grant.

“I’m not really sure on the specifics yet, though I have a few ideas, but basically our overall costs across the business are up, way up, which is holding profits relatively flat. And if this continues as it is, this situation will slowly choke the gains the new model should be making.”

“And here you are way out on a limb, with everybody in the world watching what you are doing thanks to all of the media attention,” says Grant.

“Exactly, and worse, the head office in Amsterdam is watching, too. They haven’t really noticed yet that profits are flat because they have been so focused on growing sales revenues. We still have the rest of the quarter to at least come up with a way to deal with the spike in costs, but we, I mean, I, am running out of time and may be headed for a very big fall if I can’t turn it around.”

“So you’ve let this genie out of the bottle and it’s out there doing all sorts of things, things you wanted it to do, but things you didn’t expect it would do, and now you have to shove it back in the bottle,” says Grant.

“Well, no, I want to better control those things it is doing that I don’t like. I want to keep it out of the bottle because I think it can work, but I want it to listen to me better and I want to better understand why, and see when and where it may be doing things I don’t like. Besides, I don’t think I could force it back into the bottle anyway.”

The doorbell rings.

“Hannah, thanks for listening. I’m getting my team together tomorrow to work on this, but right now I’m tired and my dinner has finally arrived.”

“No problem, my dear. Best to you.”

It’s early the next day—Tuesday—and Moneymaker has called a meeting of her core team. They are gathering in her executive conference room, which she jokingly refers to as her “home field advantage.” Josh Lovecraft, Vorpal’s CIO; Frank Cashtender, the company’s CFO; David Firehammer, the CTO; Wendy Chiselpenny, VP of operations; David Wannamaker, VP of sales and marketing; and Sarah Brown, VP of customer service, are already there. Hugo Wunderkind is lagging as usual, but walks through the door with a cup of coffee in one hand, his laptop under one arm, and his BlackBerry in his other hand just as Moneymaker is closing the door.

“Hugo you made it in the nick of time,” says Moneymaker with a faux look of sternness on her face.

“Well, I was just finishing up a few things at my desk, but I know you like to bolt the door at the precise hour so nobody can sneak in late,” says Wunderkind impishly. “By the way, the system seems a bit sluggish this morning, has anybody else noticed?”

“No, not really,” says Chiselpenny, leaning forward and opening her laptop.

“My computer was practically swimming,” says Cashtender, leaning back into his chair and crossing his legs.

“Hugo, it’s probably because our system isn’t designed for you and your friends’ workstations doing about 10 to 15 things at the same time,” says Lovecraft, sharing a chuckle with Firehammer. “I swear, with the way I’ve seen you work you’re carrying on about five instant message conversations with one hand, sending three or four emails with the other, and bouncing around Facebook, MySpace, and Lord knows what other websites with…well I’m not sure what’s left.”

“Alright then,” says Moneymaker cutting in with the slightest suggestion of a smile at Lovecraft’s remark, “Well, it’s good that all of you were free this morning on such short notice.”

“Yes, I only got the memo yesterday, which was lucky that I got it at all, as I was in a phone conference with the head office in Amsterdam about some changes to some of the reporting templates we’re using,” says Cashtender, brushing an imaginary bit of lint from his shirt sleeve.

“Sorry about that Frank, but I wanted us to meet before our regular Thursday get-together to sum up a few things with regard to the changes we have been through, and to talk about what we need to do next.

“As you all are very aware of, we have been through a lot of changes over the past year and by most accounts it seems as if we have been doing very well. Starting with the PopMe! web application, and then extending on to nearly every line of products we have, we are allowing our customers to customize our products to their tastes, thereby supporting their interests. This has included a variety of product details, different finishes, and the participation of a wide array of designers, so that our kitchen and home appliances are creating new experiences beyond the ones that people originally got them for.

“In fact, I was just talking with a friend last night and she loves our customizable line of clocks, to her husband’s distress,” she says with a smile.

“Have we heard anything from corporate about all of our efforts?” asks Wannamaker.

“You’ve been unusually quiet David. I was wondering if you had your Bluetooth tucked behind your ear trying to make a sale…” says Moneymaker.

“Well, you know, always have to be closing,” he responds, to a few quiet chuckles.

“No, I know, keep up the good work. But to answer your question, the head office is, I think as you have been told, very pleased with the way our sales revenue and market share is rising,” says Moneymaker. “If this carries on, I imagine the board will start wondering if the same approach could be used across the whole group, even though I’m sure they aren’t exactly sure what that approach is. They seem to be mostly focused on results at this point, as opposed to learning the details of how we are doing it, but that likely will change. So, don’t be surprised if you and Hugo start getting calls from your counterparts in the UK and Europe.

 “Anyway, where was I?” says Moneymaker leafing through a couple of papers in front of her. “Oh yes, alright, just as we found with the initial idea for the PopMe!—various communities came to us via Hugo’s blog—we are finding that the Web is a tremendous marketing channel for us. And we have a variety of websites up that are introducing our products to new communities, finding new audiences for us. As a result, we’re selling a lot more products than we ever have before.

“I want to emphasize here, though, that the great news is that this Long Tail, niche-type business is growing much faster than our traditional mass market efforts were, and the margins, well they make me smile. So I imagine, Frank, that you are pleased as well.”

“Actually Jane…” says Cashtender, leaning forward with a rather earnest expression on his face.

However, Moneymaker cuts him off saying, “Frank I’m aware of your concerns, which is the primary reason I called this meeting, but if you could just hold off for a moment.

“Hugo, could you give everyone a brief explanation as to how we’re finding these new markets and revenue streams?”

“Yep, well, as most of you may already know, every week we are able to identify new groups—essentially people with whom we could build a relationship, who may have some form of constituency that would be interested in one or more of our products, or who may help us find ways for our products to connect with them. Then we have something of a back and forth where we show them a product or products; we show them other sites that we’re working on; and then we brainstorm with them about how we can bring it all together to develop that relationship.

“We are also starting to actually put together new niches that involve not just our products and the person who understands the niche, but also other products as well. For example, we are talking with representatives from a famous chef-slash-personality. I’m not able to say who yet because it’s still in development, but this person has a line of what are essentially designer bread recipes using organic whole-grains and that sort of thing. So, we’re 'working with the chef’s company and the owners of a chain of organic markets so that we can link the recipes to the organic markets’ ingredients and our bread-makers, via an online distribution system.

“When we put it all together, the customer will be able to go online, or make orders at the various market locations, or via this person’s website—she will also promote these products on her show—and purchase the recipe and ingredients and one of our bread-makers, customized to the person’s tastes, such as how it makes the bread as well as certain design elements and finishes.”

The room looks slightly stunned after hearing all of this.

“Who’s the personality?” asks Brown, somewhat eagerly.

“Can’t say yet as we are still developing the deal,” says Wunderkind.

“Thanks Hugo,” says Moneymaker, again with the slightest hint of a smile.

“Okay, now, not to diminish anyone’s spirits, but there is some bad news to report and this is where we really need to focus our efforts, to resolve these issues,” says Moneymaker, quickly shifting into a rather serious and stern demeanor. “As well as we are doing, there are some clouds on the horizon and they may be rather big ones. We have some problems we need to deal with that have to do with the way in which we keep score in this company, which is through making money for our investors. If they are happy then we can be happy.

“We are owned by Jabberwocky. They are who we report to, ultimately, and let me tell you, I am going to have some rather bad news about some of our numbers at the end of this quarter. I can’t believe it, given our growth in revenues and sales margins on the products, and I don’t completely understand it yet, but it looks like our revenues will rise by about 25 percent while it doesn’t look like we are going to do much more than 2 percent of profit.

“I don’t know why this is so, but I asked Frank to take at least a cursory look at it. Again Frank, sorry for the short lead time, but as you know, we need to attend to this situation with all due haste.”

“Well,” said Frank, “what I have here is a rather informal report, as I was rushed, but, as Jane said and I began to say earlier, the revenue situation looks very good, but the costs of operating our business are rising in an unusual way. For example, all of our central services that support sales, manufacturing, and et cetera, are all going over budget. It seems that the indirect support costs for each line are higher than we allowed for and are eating into the profits on these products. Basically, the extra margins we thought we would see were based only on the direct costs we expected to incur for labor and materials, which is why I blanched a bit when Hugo described his latest effort. It’s great and I don’t want to diminish his efforts, but we obviously need to figure out how to make these new types of deals work better for us, and we need to do it quickly.

“There are also a number of new suppliers of many different items and their relative costs are higher than we estimated, based on those we already achieve under a more traditional business model based on our longstanding volumes.

“The call center is doing far more in direct support because people are accessing our products’ sales online, and, because we are selling more products, we are also seeing more in returns and other related services. I have a feeling some of this may be due to higher expectations among customers in these new niche markets.

“Then, because we sell so many customized products and a very wide variety of products to match all of the markets Hugo is finding, our inventory is much larger than it ever has been before, which is driving up warehouse costs. Based on this knowledge, I can already anticipate that a host of similar incidental costs that we didn’t predict, or expect, are going to be up as well.

“Also, because everything has an IT function attached to it, our IT costs are growing too. I suspect it may be symptomatic of what is happening elsewhere in our business, or maybe it’s even the direct cause with these new ideas of Hugo’s.”

“Could you explain that a bit more for me please, Frank?” asks Moneymaker.

“Well, as you mentioned a moment ago, Jane, we have all of these websites,” says Cashtender, “but we have to design them and host them and manage the various functions and applications they support. Content has to be populated onto the pages and updated. They have to be managed in case, say, one goes down or gets hacked. So, our IT costs are quite a bit more. But, once again, it is showing up in the unallocated indirect costs, while the allocated direct costs for each product suggest that we should be earning very good margins.”

“Thanks Frank, that was better than I thought you could do on short notice,” says Moneymaker. “Look, so what’s different? When we did the PopMe! by itself, we did very well. Now that we are doing it in 20 different niches we are having these serious and, really, fundamental issues. Any ideas on what could be causing the problem?”

“Well for one thing,” says Brown somewhat sheepishly, “We’re interacting with a lot more customers in a lot more ways, and we have to be able to respond to them in ways that are aligned with the particular niche they fill. After all, the people who watch football and buy the Pop-Matic and our Wing-Dipper chicken cooker are not the same as the people we will see with the bread-maker and the organic recipes.”

“If I may,” says Chiselpenny,VP of operations, “the number of suppliers has gone up, which has also placed a much larger emphasis on the mechanisms we use to manage our supply chain. Every niche we go into is its own small market that, so far, has required a new supplier of some sort, or a new relationship with a current supplier.”

Wannamaker, VP of marketing, raises his hand and Moneymaker gives him a nod. “Margins may be much higher, but the volumes are lower with a much briefer product cycle. There are only so many Jets fans interested in a customized popcorn maker, so perhaps there is something we’re doing there that could shed a little light.”

“On its surface,” says Cashtender, “What you are describing means that the business has to run faster and faster to keep up with markets, but our people, and perhaps even our systems, simply can’t keep up.”

Lovecraft chimes in, “Is anything really tuned into all of this? Have we really thought through how different everything is that we do now as compared to a year ago?”

“I think I am starting to see the big picture here, at least,” says Moneymaker breaking in. “We have been so busy running after this new way of doing things that we haven’t really looked at how it would affect the company from a more holistic perspective. We have just been chasing the money, and I have been the one telling you to do that, and we are getting it. But then it’s going out the door, through a number of drafty doors and windows. I think we need to take a bit of time to consider what is going on here within our respective areas.

“I want everybody to go back and analyze your departments with what we have discussed in mind. Don’t make a lot of noise, but do as thorough a job as you can to find out how and why things are different in this new world we seem to be inhabiting. Then let’s meet again in two weeks on that topic. We’ll still have our Thursday meeting, but we have some other agenda items we can talk about while you people go out and gather this information.

“Thanks everybody, this has been great. I think we are going to get hold of this genie before it escapes us.”

“What?” asks Cashtender.

“Oh, nothing, it’s just something a friend said to me the other day.”

[Sidebar – Questions for Further Explanation

Later in this book we have included a section of questions and answers that cover the specific issues raised in each of these chapters. The questions are intended to spur further consideration and explanation of the points raised so that the reader may take these ideas and find innovative ways of their own to apply them to their business.

The questions for this chapter are:

1)      An Overview of Mashups and Mesh

2)      Who Owns What as You Transform the Role of Technology in Your Business?

3)      How is the Long Tail Different from Other Business Models?

4)      What are the Challenges of Pursuing a Long Tail Strategy?

5)      Where is the Long Tail Growing?

[End of Sidebar]