Monsanto’s business model relating to the INGARD® technology in Australia

In his very interesting post Tobias Thornblad, an IA/IP expert within Agrobio, deconstructs Monsanto’s commercialization of its INGARD® technology in Australia. This is an interesting example of a complex business model where the boundaries of the firm are replaced by contractual terms in an area where regulatory approvements makes or breaks businesses. I will describe Monsanto's business model in relation to INGARD®, based on Thornblad's analysis of the IAM/IPM system.

Monsanto's development and marketing of genetically engineered seed and bovine growth hormone, as well as its aggressive litigation and political lobbying practices, have made the company controversial around the world. I will not discuss the company or its methods as such, but focus on the business model I have seen in variations in different industries.

The most interesting part of the business model in relation to the INGARD® technology according to me is the use of Technology users’ agreements. Usually the seed market is a high volume low margin business but Monsanto has developed a business model in which it combines payment for seed with licenses for the technology itself to both external partners and end-users (farmers). The Technology users' agreement is both a source of revenues and other benefits for Monsanto, and a strong control mechanism enabling a financially sustainable model. I will end this post with a short discussion on how this method can be used in other industries.

Background

Cotton is naturally vulnerable to pests and managing these pests is a major problem for many cotton farmers. Monsanto has developed a genetically modified cotton plant that expresses the Bt toxin, targeting pests such as cotton bollworm and budworm. Cotton containing a Bt gene has been commercialized in Australia by Monsanto under the trademark INGARD®.

External partners

The main challenge in business models relating to Agrobio is the overlap between public and private sector activities, and the need for relationships to provide support both for the cost of research and development and for the regulatory approval processes. Monsanto has, besides the farmers, three major external partners in its business model:

• The Commonwealth Scientific and Industrial Research Organization (CSIRO) is the principal public sector research institution in Australia, with a wide range of activities and specific expertise in agronomy and plant biotechnology. More than 90% of Australia’s cotton is grown from seed developed by CSIRO. Varieties of cotton containing the Bt gene were developed by Monsanto, CSIRO and Cotton Seed Distributors (CSD). The research institution owns variety rights on cotton germplasm, necessary for Monsanto to develop new varieties of cotton bearing the gene for production in Australia. CSIRO is Monsanto’s main research partner in Australia and it has R&D contracts with Monsanto to undertake research using the BT gene and promoter sequences.
• Cotton Seed Distributors (CSD) is Australia’s largest supplier of commercial cotton seed, a grower-controlled organization that has been developing new varieties of cotton since it was established in 1967. It has an exclusive license from CSIRO for its cotton varieties and a separate license from Monsanto to use the Bt gene promoter in cotton varieties and sells seeds to farmers.
• Deltapine operates the oldest, continuous private cotton breeding program in the US and was the first company to introduce transgenic cotton seed featuring the Bt gene technology under license from Monsanto. It imports cotton varieties from overseas and has a local breeding program to develop varieties suitable for the Australian market. Deltapine also has a license from Monsanto to use the Bt gene promoter in cotton varieties and sells seeds to farmers.
  

Value recipients

There are four main value recipients in this model:

• Farmers growing cotton
  
• Development partners
• Seed distributors
• Australian society

Value propositions

For each of the value recipients, I assume the following value propositions:

• Farmers - Monsanto primarily creates value for farmers lowering the risks of pests thus lowering costs and other harms related to toxic chemical sprays.
• Development partners - Monsanto creates value by providing research and development resources, funding for regulatory approvements and rights to develop and commercialize cotton plants containing the Bt gene.
• Seed distributors -Monsanto creates value by investments in marketing and by providing rights to develop and commercialize cotton plants containing the Bt gene.
• Australian society - Monsanto creates value by reducing the need for toxic chemicals sprays.
  

Assets, Capabilities and Activities

The business model is primarily based on the technology developed and patented by Monsanto. The main activity performed by Monsanto is of course the major investment of resources in research and development since its first cotton plants with Bt toxin genes was developed in 1988. Another important activity performed by Monsanto has been to obtain the necessary regulatory approvals from the National Registration Authority, the Genetic Manipulation Advisory Committee and the Australian and New Zealand Food Authority. If any of these regulatory bodies had not approved the marketing of Bt cotton, Monsanto would not been able to commercialize its INGARD® technology according to this business model in Australia. Lastly, Monsanto performs license management and collection of data from farmers to comply with the regulatory approvals it has.

Cost structure

Monsanto's primary costs in relation to the INGARD® technology is most probably the approximately $100 million spent on research and development and approximately $5 million on product development and regulatory requirements.

Control Mechanisms

The main control mechanisms in relation to the INGARD® technology are the patent portfolio with key patent AU638438, the plant breeders’ rights for some new cotton varieties that use the Bt gene, the financial power to uphold rights, the different trademarks such as the word INGARD and the combination mark with word and logo, and the Technology users’ agreements.

Monsanto’s Bt-containing seed may only be used by farmers who have a signed an agreement which governs how the Bt technology has to be used. Any use of the technology that contravenes the agreement is subject to claims of patent infringement and/or breach of agreement. The Technology Users’ Agreement was developed in order to enable Monsanto to track how the crop is used and its impact on the environment. The agreement requires users to manage the technology, including applying a Resistance Management Plan in which for example the licensee must perform post-harvest crop destruction and removal of germinating volunteer cotton. This makes the licensee (farmer) dependent on buying new seeds every year.

Revenue/Benefit Model

Monsanto generates revenues from technology licenses, royalty payments from distributors and from Technology Users’ Agreement with cotton growers. Other benefits generated by the business model and Technology Users' Agreement is the technology improvement grant-back, Infringement reports from technology users and crop management data/records.

Similarities from other industries

The technology users' agreement share similarities with the contracts used primarily in the software industry. When you buy software in a store and install it in your computer you often accept a license agreement with the software developer with clauses on issues such as how you can use, copy, back-up or sell the software.

I have also seen end-user agreements controlling improvements and other issues, in more traditional industries such as manufacturing where technology developers license technology and IPR to companies manufacturing and selling products. When the products produced are being sold they are bundled with license agreements to the technology developers.

Switching Costs

Switching costs are the costs associated with changing from one value provider to another and can be costs relating to learning, finding alternatives, compatibility costs, uncertainty costs, psychological costs, transaction costs, or contractual costs. It is a control mechanism that exists in most markets and can be real or perceived costs such as frequent flyer programs, in which passengers don't want to lose credits earned in one program by switching to another.

Switching costs give the value provider market and pricing power, thus current adoption or market shares become important determinants of future success. Social networks such as Facebook and Twitter base their business models on future revenues generated from a large base of user and developers that won't switch to another social network due to real or perceived switching costs.

Understanding switching costs is a key component to create sustainable business models for both incumbent firms and start-ups trying to break into an existing market or build a new one. I will follow-up this post with identified strategies on how to use switching costs as a value provider and how to manage own switching costs in relation to external partners and suppliers.

Not limited to customers

The traditional way of looking at switching costs is between the value provider and paying customer but I believe the concept is valuable also in relation to other stakeholders. When companies develop strategies in relation to suppliers, government/regions, own employees, developer communities, companies providing complementary products and service etc. switching costs are an important factor to include. The economic downturn makes this kind of reasoning evident for many suppliers and governments.

Switching costs and network effects

In most cases switching costs go hand in hand with network externalities or network effects. If adoption by different value recipients is complementary so that each value recipient's adoption payoff, the incentive to adopt increases as more others adopt. Thus, the more users of a communication service such as Skype, the more valuable the service is to each user and the higher the switching cost to switch to another communication service bringing all users or friends.

Switching costs and standards

Almost everything is affected by standards, in relation to different forms of compatibility, interoperability, safety or quality. Standards can be both a solution to avoid high switching costs and a source of the same. Standards are most often developed to reduce switching costs in having several products or systems based on the same principles, technologies or formats.

When a company manage to get a dominant position for its technology, products or services, by tradition, enforcement, or market dominance, it is said to have a de facto standard. A classical example is Microsoft Office that is believed to have a perceived switching cost of over $1000 thus buyers are paying hundreds of dollars for Microsoft Office even when free alternatives exists. In the case of Microsoft Office almost all different forms of switching costs occur. What would be the alternative? Would this be compatible with everyone else that are using Microsoft Office? Can I transfer my templates? Would I learn fast enough to work in the same pace? Would I miss any functions or features? etc.

Switching costs and competitive pricing

Switching costs shift competition away from a single value recipient's needs in a single period to needs over time, thus the outlook of higher profits later provides a strong incentive to buy adoption today. Each value provider faces a trade-off between investing in adoption by charging a low price or give away something for free to attract new value recipients or on the other hand charging a higher price reflecting the value of what is being offered. When network effects exist the share of adopters makes a valuable asset, reflected in strategies such as penetration pricing. Examples of aggressive competition for market share before the customers have developed switching costs are banks providing free banking services to students, online poker sites offering cash bonuses when opening accounts or free access to proprietary databases with training material to schools to make students used to tools and available data.

Smaller actors often have a stronger incentive for price competition than larger ones as they can enlarge their customer base without hurting their revenues from their current customer base that is small. Larger actors on the other hand, have little incentives to cut prices because this hurts more with their current (larger) customer base.

Switching costs varies over time depending on the business model

The switching costs vary over time and depending on the business model it can either increase or decrease over time. If you sell a computer storage device the value of the device depreciates over time and the customer might chose another brand when it is time to replace it. If you sell online storage, the service will become increasingly valuable to the customer over time as it gets dependent on the increased amount of stored data and relating services such as back-up, mobile access or file sharing possibilities. With the increasingly popular concept of cloud software and platforms, that in some cases uses nonstandard APIs and proprietary technologies, some companies will probably find themselves facing high switching costs in the near future.

Switching costs and lock-in

When the value recipient is dependent on a single value provider or cannot move to another value provider without substantial costs or inconvenience, the value recipient is said to be locked in to the value provider. Lock-in is seldom absolute but when lock-ins is created by dominant companies and there are too high barriers to market entry, it may result in antitrust action.

Further reading

What is a control mechanism?

Further External Reading

Higher Profits Through Customer Lock-In by Joachim Buschken

Information Rules: A Strategic Guide to the Network Economy by Carl Shapiro and Hal R. Varian

The Profit Zone (1997)

The Profit Zone: How Strategic Business Design Will Lead You to Tomorrow's Profits by Adrian J. Slywotzky and David J. Morrison

This is a quick read and according to me a rather good book in the quick-read-business-genre. It is divided into three parts where the first part discusses business models and how profit happens. The second part is about successful business design reinventors such as Jack Welch (GE), Nicolas G Hayek (SMH) and Roberto Goizueta (Coca-Cola). In the third part the authors summarize its customer-centric and profit-centric thinking in what they call The Profit Zone Handbook. I will only present some of the ideas from the first part which I find most useful.

The Customer and Profitability in focus
The customer-centric view is dominant in the book and the main recommendation is to truly understand the customer behavior, decision-making process, price sensitivities and preferences, and design the business model accordingly. Businesses must be designed for profitability and as the arena in which high profit is possible keeps changing, so must the business model. The main questions repeated several times are:

• Where will I be allowed to make a profit in this industry?
• How should I design my business model so that it will be profitable?

The authors define the concept of business design (but also use the term business model) as composed of four elements or dimensions that are all linked to the others:

Customer selection

• Which customers do I want to serve?
• To which customers can I add real value?
• Which customers will allow me to profit?
• Which customers do I not want to serve?

Value Capture

• How do I make a profit?
• How do I capture, as profit, a portion of the value I created for customers?
• What is my profit model?

Strategic Control

• How do I protect my profit stream?
• Why do my chosen customers buy from me?
• What makes my value proposition unique/differentiated vs. Other competitors?
• What strategic control points can counterbalance customer or competitor power?

Scope

• What activities do I perform?
• What products, services, and solutions do I want to sell?
• Which activities or functions do I want to perform in-house?
• Which ones do I want to subcontract, out-source, or work with a business partner to provide?

This is somewhat similar to my approach to business models; starting at who the value is created for, how the value is created and captured, and how the value creation and capture is controlled. The traditional way, presented in most literature about business models and in Exhibit 2.2 in the book, is to start from assets/core competencies and go through inputs/raw material, product/service offering, channels and finally the customer. The authors define their customer-centric model by starting on the customers' needs and priorities and then move in the other direction of the chain ultimately to the assets/core competencies needed to satisfy the customers' needs.

Strategic Control Point Index
As I find very little literature about business models looking at control mechanisms, I am happy to see what the authors call Strategic Control Point that is similar to my reasoning about Control Mechanisms. "Every good business design has at least one strategic control point. The best business designs have two or more."

In Exhibit 3.4 the authors present 10 different Strategic Control Points:
Own the standard, (High profit-protecting power)
Examples: Microsoft, Oracle
Manage the value chain, (High)
Examples: Intel, Coke
String of superdominant positions, (High)
Example: Coke internationally
Own the customer relationship, (High)
Examples: GE, EDS
Brand, copyright, (Medium)
Examples: countless
Two-year product development lead, (Medium)
Example: Intel
One-year product development lead, (Low)
Examples: few
Commodity with 10 to 20 percent cost advantage, (Low)
Examples: Nucor, SW air
Commodity with cost parity, (None)
Examples: countless
Commodity with cost disadvantage, (None)
Examples: countless

Identified profit models
How and why profitability occurs varies significantly from one industry or company to another. Slywotzky and Morrison have identified 22 profit models and shortly explain how profit is made in each of the models. These are:

1. Customer Solutions Profit
2. Product Pyramid Profit
3. Multicomponent Profit
4. Switchboard Profit
5. Time Profit
6. Block Buster profits
7. Multiplier Profit
8. Entrepreneur Profit
9. Specialization Profit
10. Install Base Profit
11. De Facto Standard Profit
12. Brand Profit
13. Specialty Product Profit
14. Local Leadership Profit
15. Transaction Scale Profit
16. Value Chain Position Profit
17. Cycle Profit
18. After-Sale Profit
19. New Product Profit
20. Relative Market Share Profit
21. Experience Curve Profit
22. Low Cost Business Design Profit

It is a quick read and if you read the book I look forward to your comments!

Control mechanisms in business models

Developing a successful business model without strong control mechanisms will only generate temporary profits. The purpose of control mechanisms in business models is to protect the created values and profit streams from being reduced by competitors, partners or strong customers.

The last decades have shown a rapid growth in customer power at the same time as new technology and services are being replaced faster. Even though control always has been an important part of the business model, today it is crucial. Predictability is an important factor in analyzing business models, and the greater control mechanisms, the greater the predictability. It is common that more than one control mechanism is used to protect the profit stream from being reduced.

Different types of control mechanisms are used more in some business models and industries and less in other. An important thing to remember is that the goal should be to choose the control mechanisms that maximize the value, not the ones that maximize the protection.

Different control mechanisms

The examples below are simplifications to exemplify different mechanisms.

• an implemented standard (Adobe)
• a strong position in the value network (Coca-Cola)
• an end-customer interface (Microsoft)
• scale of users and partners (Google)
• scale in purchasing (Wal-Mart)
  
• a customer base with switching costs (Microsoft)
• a large development community (Linux)
• a strong brand (Louis Vuitton)
• a development lead (Intel)
• a short product development cycle (Zara)
• a strong IPR portfolio (IBM)
• a cost advantage (Ikea)
• contractual agreements (Apple)

Using control mechanisms in business models is not the same as controlling each part of the business model

Increasingly companies are using open business models for collaborative and external innovation, product development, content creation and commercialization. Still, companies using these models, need to control parts of their business models, to protect the values and profit streams that are being created from being reduced by competitors, partners or strong customers.