Imagine the frustration that people feel when they see headlines such as “Shocking Truth: 20 Percent of Health-care Expenditures Wasted in United States and Other Nations.”1 Warren Buffett, the chairman and CEO of Berkshire Hathaway, refers to “the ballooning costs of health care” as “a hungry tapeworm on the American economy.”2
The trillion-dollar health-care industry is the rule, not the exception, when it comes to economic inefficiency. Across all corners of the global economy, inefficiency is an epidemic, imposing mind-boggling costs on customers, companies, taxpayers, and governments. For example, think of the following three data points about the inefficiency that results from car ownership. First, cars remain parked roughly 95 percent of the time. Second, according to the transportation consulting firm Inrix the cost of lost time attributed to rush-hour commuting in the United States in 2017 was $305 billion.3 This means that cars spend far more time occupying space than they do moving on roads.4 Third, Massachusetts Institute of Technology (MIT) professor Eran Ben-Joseph estimates that there are 800 million surface parking spaces in the United States, which represents an area larger than the entire state of Connecticut, or roughly half the size of Belgium.5 In some cities, parking spaces take up one third of all downtown land. It is no wonder, then, that Michael Szell, a former researcher at the MIT Senseable City Lab, refers to urban parking spaces as a “huge space that’s basically wasted.” In short, the operational and opportunity costs of vehicle ownership impose an enormous burden on society, and the general public is weighing the pros and cons, as the Wall Street Journal described extensively in a 2017 feature with the headline “The End of Car Ownership.”6
Second, the belief that the advertising sector is inefficient has endured ever since John Wanamaker supposedly said, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” Fast forward to 2017, and a statement from Marc Pritchard, Procter & Gamble’s chief brand office, confirms Wanamaker’s estimate, at least in spirit: “There’s … at least 20 to 30 percent of waste in the media supply chain because of lack of viewability, nontransparent contracts, nontransparent measurement of inputs, fraud, and now even your ads showing up in unsafe places.”7
Third, think about education. One hypothesis on the sector—which spends $1.15 trillion per year8 in the United States alone from government and private sources—is that money is like “pixie dust;” that is, the more one spends on education, the better the results. An exposé by National Public Radio raised some critical questions about the definition of “success” and outcomes in education. Does success mean better test scores? Does it mean higher graduation rates, higher incomes after graduation, or other “life outcomes”?9 In the 2018 book The Case against Education: Why the Education System Is a Waste of Time and Money, George Mason University economics professor Bryan Caplan argues in favor of sharp cuts in educational spending to stop a “wasteful rat race” driven by grades and credentials rather than actual skills. Caplan also recommends more emphasis on vocational training, because “practical skills are more socially valuable than teaching students how to outshine their peers.”10
The primary cause of this waste epidemic is rooted in the very nature of commerce. Business and individual customers seek out organizations that can solve their needs and wants, and in turn organizations want to generate revenue—and hopefully earn a profit—from bringing possible solutions to market. This sets up the exchange between the two parties, but their interests are not necessarily aligned. The way organizations generate revenue typically does not match with the way customers derive satisfactions.
No customer wants to buy goods, gadgets, components, or instruments for the sake of owning them, yet these products are what most manufacturers attach their price tags to. For example, if a customer wants the benefit of clean clothes without leaving home, she generally has to purchase a washing machine and detergent. She cannot purchase cleanliness and convenience directly. Similarly, no customer wants to buy the time a professional spends on a task or project. Customers want to purchase the outcome, be it a complete and accurate tax return or the lasting repair of a leaky sink. Yet professional service firms and tradespeople insist on invoicing based on time, even when the outcome is uncertain or never achieved in full.
Inefficient revenue models are the norm rather than the exception across most sectors. Digging a little deeper, this inefficiency ultimately comes in three forms: access, consumption, and performance. These three forms or sources of waste are sequentially related, as they represent checkpoints for customers to derive value in a transaction: customers want solutions, and solutions yield value only when they can be accessed, when they are consumed, and when they perform as desired.
More precisely, access waste is tantamount to saying “Customers can’t get it” because of a financial or physical constraint. Financial constraints exist when, for example, a business lacks the necessary capital to purchase a piece of equipment or machinery, or an individual cannot afford a single large expense (a car) or many smaller expenses (a music collection or wardrobe). Physical constraints can exist when reaching or replenishing a product or service is inconvenient (effortful, time consuming, etc.). At the same time, customers may not only have trouble reaching a specific solution, but also getting rid of it. If their preferences change over time, they are stuck, and disposal can be expensive. Consumption waste, on the other hand, is tantamount to saying “Customers don’t or can’t use it.” Common forms include situations where customers are required to buy a larger quantity than they actually need, or when a single asset is underutilized. A business or individual might purchase an expensive asset that sits idle the vast majority of the time. It may also be that the customer is ready to use a product or service, but at that specific moment it is not working properly. Finally, performance waste occurs when the product or service doesn’t deliver the value expected from it. The customer has access to it and consumes it, but the end result simply isn’t satisfactory.
Marketing guru Theodore Levitt hinted at this misalignment between organizations and customers when he famously observed that people “don’t want to buy a quarter-inch drill, they want a quarter-inch hole.”11 A revenue model that emphasizes the transfer of ownership of a product or service from the organization to customers presumes that there is a direct, strong link between the amount spent on a purchase (buying the drill) and achieving the desired outcome (the hole in the wall). This is evident also in the public sector. It drives the thinking that higher teacher salaries and better facilities improve education, that greater investment in police makes a city safer, that more spending on medicine makes a society healthier, and that investment in infrastructure makes a city or region more attractive and economically viable. However, greater spending does not necessarily lead to greater satisfaction, directly or even indirectly. Ownership in and of itself does not guarantee access, nor does it guarantee consumption. It certainly does not guarantee performance. In fact, ownership may represent a hindrance to customers, deterring some from entering the market altogether and exposing others to unnecessary risk.
In an oft-cited passage from the mid-1960s, Peter Drucker described this issue and the awkward compromises made to resolve it: “The customer rarely buys what the business thinks it sells.” The rest of that passage, however, is far more revealing and important to understand how selling ownership can be inefficient: “One reason for this is, of course, that nobody pays for a ‘product.’ What is paid for is satisfactions. But nobody can make or supply satisfactions as such—at best, only the means to attaining them can be sold and delivered.”12
Customers thought they were paying for satisfactions (clean clothes, holes in a wall, etc.), but in reality they were paying for washing machines, drills, and the promise that they would work. Buyers want satisfactions, but sellers can neither deliver it directly, nor charge for it directly.
The time has come for organizations to accept the idea that much of the inefficiencies we observe across many parts of the economy is the direct result of misaligned incentives. It follows, then, that striving to narrow the gap between the way organizations earn revenue and the way customers derive value can mitigate waste, or even eliminate it. That is what we mean when we talk about leaner commerce. The greater the alignment between organizations and customers, the leaner (more efficient) commerce becomes.
Thanks to the technological breakthroughs we described in chapter 2, firms now have a spectrum of revenue models to choose from in order to drive this change. Firms can do much better than simply sell ownership. Similarly, customers can do much better than simply play along with what organizations have to offer and hope for the best. Specifically, one step removed from ownership models are what we call access models, which tackle access waste, financial or physical, by breaking down a purchase that may be onerous or hard to complete into a periodic expense, and ensuring that the product or service is available to customers for the duration of the relationship. The increasing popular options of subscriptions and memberships clearly fall into this category. We discuss access models in greater detail in chapter 4.
Next, consumption models tackle both access and consumption waste by allowing the customers to pay only when they use the product or service. Flexible consumption comes from unbundling the product or service, metering an individual customer’s usage, or allowing owners to share otherwise underutilized assets such as cars, clothes, or dwellings with others. We focus on these three options in chapter 5. Finally, performance models tackle access, consumption, and performance waste because the customer pays based on the extent to which an outcome was achieved. The ultimate outcome, of course, is value. Commerce is at its leanest when the metric the company uses to earn revenue is the actual satisfactions that customers derive from their purchases. The conception and implementation of these models, however, present several challenges. We show several successful examples in chapter 6, then elaborate on the challenges in part III of the book.
When firms choose a revenue model that corrects the misalignments we have described, they attract more customers by lowering barriers to purchase and boost willingness to pay by progressively taking on the risk inherent in the exchange. They can also get more benefits from their investments in innovation and differentiation, because the value they create is more closely aligned with what the customer pays for. Customers who pay for “ends” (or a good proxy for them) instead of “means” are less susceptible to the risks of lower-cost, lower-quality products. They spend their money on proof, not on promises. These revenue models deliver these benefits, however, only when firms hold themselves accountable to them. Achieving and maintaining that level of accountability is a long-term journey, not a quick fix.
The health-care industry has begun to take the right steps. If 20 percent of health-care spending is indeed wasted, the potential benefits from reducing that inefficiency are staggering. The Organization for Economic Co-operation and Development, which sponsored the underlying study that came to that conclusion, argues that recognizing the extent of this waste is the first step in getting all stakeholders involved to change their behavior.13 An article published in the Harvard Business Review was straightforward about what must happen next: “What leads to cost savings is reorganizing care around the delivery of health rather than health care.”14 In other words, the ultimate resolution for this immense inefficiency in health-care systems is a focus on outcomes rather than the means of achieving them.
Efforts to focus on outcomes will not only benefit society by reducing waste, but also offer a huge upside for companies that make that journey. In the health-care sector, “Winners … will be those that build a sustainable competitive advantage through better access to, and analysis of, clinical data [and] through deeper insight about how to improve outcomes,” the Boston Consulting Group concludes.15 In the same report, the Boston Consulting Group describes the consequences for suppliers that fail to focus on outcomes: “Hospitals, drug companies, and device makers that cannot demonstrate that their procedures, medications, and products genuinely add value will suffer.”16
The companies and institutions investing in these solutions will not necessarily come from within the existing set of suppliers. In January 2018, Amazon, JP Morgan, and Berkshire Hathaway announced an ambitious long-term effort to address the cost of health care. Both Warren Buffett and Amazon CEO Jeff Bezos used the word “outcomes” in summarizing the challenge they have taken on. “We share the belief that putting our collective resources behind the country’s best talent can, in time, check the rise in health costs while concurrently enhancing patient satisfaction and outcomes,”17 Buffett said. Bezos noted that “hard as it might be, reducing health care’s burden on the economy while improving outcomes for employees and their families would be worth the effort.”
The pursuit of leaner commerce has begun. It will forever change the nature of markets and society at large. Firms that build their revenue models around outcomes—and hold themselves accountable to them—are poised to reduce or eliminate billions if not trillions of dollars in waste from economies around the world, with social and ecological consequences we can only begin to imagine.
1. N. Koukakis, “Shocking Truth: 20% of Health-care Expenditures Wasted in US and Other Nations,” CNBC, January 13, 2007, https://www.cnbc.com/2017/01/12/shocking-truth-20-of-health-care-expenditures-wasted-in-us-and-other-nations.html; Business Wire, “Amazon, Berkshire Hathaway and JPMorgan Chase & Co. to Partner on U.S. Employee Healthcare,” news release, January 30, 2018, https://www.businesswire.com/news/home/20180130005676/en/Amazon-Berkshire-Hathaway-JPMorgan-Chase-partner-U.S.
2. Business Wire, “Amazon, Berkshire Hathaway and JPMorgan Chase & Co. to Partner on U.S. Employee Healthcare,” news release, January 30, 2018, https://www.businesswire.com/news/home/20180130005676/en/Amazon-Berkshire-Hathaway-JPMorgan-Chase-partner-U.S.
3. INRIX, “Los Angeles Tops INRIX Global Congestion Ranking,” news release, February 5, 2018, http://inrix.com/press-releases/scorecard-2017/.
4. D. Morris, “Today’s Cars Are Parked 95% of the Time,” Fortune, March 13, 2016, http://fortune.com/2016/03/13/cars-parked-95-percent-of-time/.
5. A. Long, “Urban Parking as Economic Solution,” International Parking Institute (December 2013), 42–45, https://www.parking.org/wp-content/uploads/2016/01/TPP-2013-12-Urban-Parking-as-Economic-Solution.pdf.
6. T. Higgins, “The End of Car Ownership,” Wall Street Journal, June 20, 2017, https://www.wsj.com/articles/the-end-of-car-ownership-1498011001.
7. L. Johnson, “Digital Advertising Is Facing Its Ultimate Moment of Truth and Billions of Dollars Are at Stake,” Adweek, September 4, 2017, http://www.adweek.com/digital/digital-advertising-is-facing-its-ultimate-moment-of-truth-and-billions-of-dollars-are-at-stake/.
8. U.S. Department of Education, “The Federal Role in Education,” May 25, 2017, https://www2.ed.gov/about/overview/fed/role.html.
9. National Public Radio, “Can More Money Fix America’s Schools,” All Things Considered, April 25, 2016, https://www.npr.org/sections/ed/2016/04/25/468157856/can-more-money-fix-americas-schools.
10. B. Caplan, The Case against Education: Why the Education System Is a Waste of Time and Money (Princeton, NJ: Princeton University Press, 2018), back cover flap.
11. T. Levitt, as quoted in A. Gallo, “A Refresher on Marketing Myopia,” Harvard Business Review, August 22, 2016, https://hbr.org/2016/08/a-refresher-on-marketing-myopia.
12. P. F. Drucker, Managing for Results (New York: HarperCollins e-books, 2009), Kindle, 94.
13. OECD Health Division, Tackling Wasteful Spending on Health (Paris: OECD Publishing, 2017), https://www.oecd.org/els/health-systems/Tackling-Wasteful-Spending-on-Health-Highlights-revised.pdf.
14. L. S. Dafny and T. H. Lee, “Health Care Needs Real Competition,” Harvard Business Review, December 2016, https://hbr.org/2016/12/health-care-needs-real-competition; emphasis added.
15. J. Clawson, P. Lawyer, C. Schweizer, and S. Larsson, “Competing on Outcomes: Winning Strategies for Value-Based Health Care,” Boston Consulting Group, January 16, 2014, https://www.bcg.com/publications/2014/health-care-payers-providers-biopharma-competing-on-outcomes-winning-strategies-for-value-based-health-care.aspx.
16. Clawson et al., “Competing on Outcomes.”
17. W. Buffett and J. Bezos, as quoted in Business Wire, “Amazon, Berkshire Hathaway and JPMorgan Chase & Co. to Partner on U.S. Employee Healthcare,” news release, January 30, 2018, https://