BUSINESS_MODELS
.pdfIX. Business Models as Innovation
As discussed, technological innovation often requires business model innovation in order to capture value. There are of course exceptions -------- for example, small improvements in the manufacturing process, even if cumulatively large, will usually not require business model innovation. Value can be captured by lowering price and expanding the market and market share. The more radical the innovation, the greater the adjustments that are likely to be required to the business model.
However, as indicated by some of the examples advanced earlier, business model innovation may
well suffice to establish a differentiable competitive advantage. Dell didn't bring any
improvements to the technology of the Personal Computer--------- but it did garner up suppliers' innovations along with its own organizational/distribution system innovation and deliver compelling value to end users (businesses and consumers). Similarly for Virgin, Virgin Blue, and JetBlue in air transport.
Sometimes the creation of new business models lead to the creation of new industries. Consider the payment cards industry. It involves cooperation among several independent businesses. Visa and MasterCard provide network services associate with banks who issue payment cards, and work with acquires who sign up merchants to accept credit cards. Early on in the life of the industry, it required "enormous amounts of capital and ingenuity" to have payment cards accepted. Merchants would not wish to accept a payment card if few consumers carried it. And customers do not want cards that merchants do not take, just as merchants don't want to get set up for cards that consumers don't carry. As Evans and Schmalensee (1999) note, inventing a new business model for credit (the credit card) "required the industry's founders to invest enormous amounts of capital and ingenuity" (p. 3).
New business models, or refinements to existing ones, like new products themselves, usually result in increased value to the consumer. They also provide the opportunity to generate higher returns for the business model pioneer, at least until its features are copied. Business model
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Most payment cards today in America are credit cards. |
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innovation that either (a) helps enhance the value proposition to the consumer, or (b) enhances value capture opportunities (and hopefully both) is as important contribution to society. However, as discussed, innovating with business models will not in and of itself build enterprise-level competitive advantage.
Nevertheless, companies should be searching and considering improvements to business models - particularly difficult to imitate improvements that add value for customers - at all times. However, changing the business model literally involves changing the paradigm by which firms go-to-market; and so inertia is likely to be considerable. It is nevertheless preferable not to have change to the business model dictated by external events - like what several investment banks in the U.S. have recently experienced.
Designing a new business model requires creativity, insight, and a good deal of customer, competitor, and supplier information and intelligence. There is a significant tacit component and learning. It is often the case that the right business model may not be apparent up front; and that learning and adjustments are required. Consider Netflix again. In the U.S., Netflix is today the largest online DVD rental service. In 2007 it had over 6 million subscribers and a collection of 75,000 titles. Netflix offers a flat-fee service for rental of DVD movies'8. Subscribers create and ordered list of movies to receive via mail. Subscribers can locate movies to add to their ordered list by using the browse function to search for movies by genre, and by using an extensive movie recommendation system based on ratings of other users.
However, at its initial launch, the Netflix business model was based on a pay-per-rental service with customers selecting the rentals online and Netflix shipping the movies directly to their homes. The initial pricing model did not succeed, and the company almost failed. It was clear by 1999 that Netflix was failing and that the company would run out of cash unless Netflix could rejigger its business model. It did. It reinvented itself with a subscription model (labeled the Marque Program) in September - October 1999. By 2006 it had reached almost $1 billion in revenues.
http://ir.netflix.com/. Visited April 2007.
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After the success of the subscription models, Netflix ended the pay-per-rental format entirely, and the monthly fee program evolved so as to enable subscribers to rent any number of DVDs per month but with limitations on the number of DVDs that could be out at any one time.
Behind it all was a system of regional distribution centers so that delivery time for almost everyone was short ---- more than 90% of its subscribers could expect next day service.
Clearly, Netflix had invented an entirely new service to enable customers to access movies, and it took a while to be able to distill the right price points and manner of pricing that was most acceptable to the customer base; but Netflix management did figure out over time the "deep truth" with respect to viewer's convenience and wants, and willingness to pay, and adjusted the business model accordingly. This saved the company and allowed Netflix's growth and development.
Clearly, selecting the right 'architecture' and pricing model for a business requires not just understanding the choices available; it also requires assembling the evidence needed to validate conjectures and hunches about costs, customers, competitors, complementers, distributors, and suppliers. Entrepreneurs and executives must make many informed guesses about customer and competitor behavior, as well as the behavior of costs.
Validating a business model and a business plan requires evidence, effort, and insight. This takes detailed fact-specific inquiry including a keen understanding of customer needs and customer willingness to pay, and an understanding of competitor positioning and likely competitive responses.
A helpful analytic approach for management is likely to involve systematic deconstruction/unpacking of existing business models, and an evaluation of each element with an idea toward (1) refinement (2) replacement. Periodic review can increase the chances of avoiding blind spots. Long-lived structural elements - choices made decades ago when the environment may have been different-need to be scrutinized, especially thoroughly.
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While designing good business models is in part 'art', the chances of good design are greater if entrepreneurs
and managers (1) have a deep understanding of user needs, (2) analyze multiple alternatives, (3) analyze the
value chain thoroughly so as to understand just how to deliver what the customer wants in a cost-effective
and timely fashion, and (4) adopt a neutrality or relative efficiency perspective to outsourcing decisions.
Useful tools include market research and the PFI framework.
X.Business Models as an Element of Dynamic Capabilities
Technical fitness references how well the enterprise performs particular functions and operations. Evolutionary fitness determines whether the enterprise is in synch with its environment. Dynamic
capabilities are the sensing, seizing, and reconfiguring skills that the business enterprise has to stay in synch
with changing markets (Teece, Pisano, and Shuen, 1997; Teece, 2007). They enable the enterprise to not just
stay alive but to adapt to and shape the (changing) business environment. Dynamic capabilities govern
evolutionary fitness.
The selection/design of business models is a key microfoundation of dynamic capabilities. Get the model
wrong and there is almost no chance of business success . Get the model right and customize it for a market
segment and it is likely to have considerable non-imitable dimensions, which afford the possibility that the
business model will contribute to the firm's competitive advantage.
Recognized above, but not developed here, is the notion that a business model cannot be assessed in the
abstract; its suitability can only be determined against a particular business environment or context. Neither
business strategies, business structures nor business models can be properly determined absent assessment
of the business environment; and of course the business environment is in part a choice variable; i.e. firms
can both select a business environment, and be selected by the environment. They can also shape the
environment.
19 Magretta (2002) claims that business models are "variations on the generic value chain underlying all businesses". This statement would seem to overlook that the business model is only partially about how to organize the value chain. It's also about where to position within it i.e. what are the key bottleneck assets to own/control in order to capture value (Teece, 1986). Clearly, the industry must perform the various activities in the value chain, but which one(s) the firm chooses to do is very much a business model choice.
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Choice of business model configurations undoubtedly impact performance. Zott and Amit (2008) bravely endeavor to hypothesize as to the appropriate mapping of business models to two product market choices: cost leadership and differentiation. However, our state of understanding as to the precise relationship between choices of business model and enterprise performance is highly content dependent and is rather primitive. In certain contexts (e.g. market entry strategies for innovators) testable propositions have been advanced (Teece 1986, 2006) but strategic studies will have to advance further as a field before mapping can be anything other than suggestive.
XI. Conclusion
The notion that businesses need to be designed, that good business model design is contingent on many factors, and that from a strategic management perspective acceptable designs not only help deliver value to customers, but also are hard to imitate, is not original to this author. However, the amount of literature that endeavor to explore the issues raised here is pathetically small.
Profiting from innovation requires the invention or at a minimum the selection of a business model, and its distinctive refinement and rollout. Only then can value be captured, and the enterprise sustained. Clearly, getting the business model right is not just a shareholder return issue; it is likely to go to the fundamental viability of the business. For science and technology enthusiasts, the importance of designing business models correctly is a sober reminder that technological innovation, even when it does meet a user need, does not guarantee a commercial success. Deepening our understanding of business models and how their architecture impacts value generation and value capture is one of the most critical topics in strategic management, entrepreneurship, and planning.
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References
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Chesbrough, H. and Rosenbloom R.S. (2002), "The Role of the Business Model in Capturing Value from Innovation: Evidence from Xerox Corporation's Technology", Industrial and Corporate Change, 11:3, 529-555.
de Figueiredo, J. M. and Teece, D. J. (1996), "Mitigating Procurement Hazards in the Context of Innovation", Industrial and Corporate Change, 5:2 (1996).
Dell, M. (2008), The Early Entrepreneurial Years" in Starting a Business (Harvard Business School Press).
Evans, D. and Schmalensee, R. (1999), Paving with Plastic, Cambridge: MIT Press.
Lippman, S. and Rumelt, R. (1982). "Uncertain Imitability: An Analysis of Interfirm Differences in Efficiency Under Competition", Bell Journal of Economics 13:413-438.
Magretta, J. (2002), "Why Business Models Matter", Harvard Business Review.
Shirky, C. (2008), Here Comes Everybody: The Power of Organizing Without Organizations (New York: Penguin).
Shuen, A. (2008), Web 2.0: A Strategy Guide (Sebastopol: O'Reilly).
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Somaya, D. and Teece, D. J. (2007), "Patents, Licensing and Entrepreneurship: Effectuating Innovation in Multi-Invention Contexts" in Sheshinki, Strom and Baumol (eds.), Entrepreneurship, Innovation, and the Growth of Free-Market Economies (Princeton University Press).
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