Introduction to Business Model
A business model is a sustainable way of doing business. Here sustainability
stresses the ambition to survive over time and create a successful, perhaps
even profitable, entity in the long run. The reason for this apparent ambiguity
around the concept of profitability is, of course, that business models apply to
many different settings than the profit-oriented company. The application of
business models is much broader and is a meaningful concept both in relation
to public-sector administration, NGO’s, schools and universities and us, as
individuals.
Sustainability is here interpreted as the propensity to survive and thus also
the ability to stay competitive. As such, a business model cannot be a static
way of doing business. It must be developed, nursed and optimized
continuously in order for the company to meet changing competitive
demands. Precisely how the company differentiates itself is the competitive
strategy, whilst it is the business model that defines on which basis this is to
be achieved; i.e. how it combines its know-how and resources to deliver the
value proposition (which will secure profits and thus make the company
sustainable).
In the late 1990’s, the e-business revolution changed global competition, and
during the early years of the new millennium the knowledge-based society
along with rising globalization and the developments in the BRIC economies
ensured that momentum continued upwards. As new forms of value
configurations emerge, so do new business models. Therefore, new analysis
models that identify corporate resources such as knowledge and core
processes are needed in order to illustrate the effects of decisions on value
creation. Accordingly, managers as well as analysts must recognize that
business models are made up of portfolios of different resources and assets
and, not merely traditional physical and financial assets, and every company
needs to create their own specific business model that links its unique
combination of assets and activities to value creation.
The difference thus lies in the way activities are performed (strategic and
tactical choices), and therefore a business model is closely connected to a
management control agenda. The business model perspective has also been
found useful for aligning financial and non-financial performance measures
with strategy and goals. In addition, communicative aspects from executive
management to the rest of the organization, and also to external stakeholders
such as bankers, investors, and analysts, are also facilitated by a business
model perspective.
Definition:
A business model describes the coherence in the strategic choices which
facilitates the handling of the processes and relations which create value
on both the operational, tactical and strategic levels in the organization.
The business model is therefore the platform which connects resources,
processes and the supply of a service which results in the fact that the
company is profitable in the long term.
This definition emphasizes the need to focus on understanding the
connections and the interrelations of the business and its operations so that
the core of a business model description is the connections that create value.
This can be thought of e.g. by contemplating the silos by which the
management discussion in the annual report normally is structured. By them-
selves, endless descriptions of customer relations, employee competences,
knowledge sharing, innovation activities and corporate risks do not tell the
story of the business model. However, if we start asking how these different
elements interrelate, which changes among them that are important to keep
an eye on and what is the status on operations, strategy and the activities
initiated in order to conquer a unique value proposition are effectuated, we
will start to get a feeling for how the chosen business model is performing.
Conceptualizing the business model
Conceptualizing the business model is therefore concerned with
identifying this platform, while analyzing it is concerned with gaining an
understanding of precisely which levers of control are apt to deliver the
value proposition of the company. Finally, communicating the business
model is concerned with identifying the most important performance
measures, both absolute and relative measures, and relating them to the
overall value creation story.
A business model is neither just a value chain, nor is it a corporate
strategy. There exist many value configurations that are different to that of a
value chain, like e.g. value networks and hubs. Rather, a business model is
concerned with the unique combination of attributes that deliver a
certain value proposition. Therefore, a business model is the platform,
which enables the strategic choices to become profitable.
In some instances it can be difficult to distinguish between businesses
that succeed because they are the best at executing a generic strategy and
businesses that succeed because they have unique business models. This is an
important distinction to make, and while some cases are clear-cut, others
remain fuzzier.
One of the best examples of a business model that has changed an
existing industry is Ryanair, which has essentially restructured the business
model of the airline industry. As the air transport markets have matured,
incumbent companies that have developed sophisticated and complex
business models now face tremendous pressure to find less costly approaches
that meet broad customer needs with minimal complexity in products and
processes. While the generic strategy of Ryanair can be denoted as a low-price
strategy, this does not render much insight into the business model of the
company.
The low-cost option, or no-frills as it is also dubbed, is per se open to all
existing airlines, and many already compete alongside Ryanair on price.
However, Ryanair was among the first airline companies to mold its business
platform to create a sustainable low-price business. Many unique business
models are easy to communicate because they have a unique quality about
them; i.e. either a unique concept or value proposition. This is also the case for
Ryanair. It is the “no-service business model”. In fact, the business model is so
well thought through that even the arrogance and attitude of the top
management matches the rest of the business. But they can make money in an
industry that has been under pressure for almost a decade, and for this they
deserve recognition. Ryanair’s business model narrative is the story of a novel
flying experience – irrespective of the attitude of the customer after the
ordeal.
A much-applied example in the management literature is Toyota.
However, Toyota did not really change the value proposition of the car
industry. They were able to achieve superior quality through JIT and Lean
management technologies, and they may have made slightly smaller cars than
the American car producers, but their value proposition and operating
platform were otherwise unchanged. The same can be said for Ford in the
early 20th century. Ford’s business setup was not really a new business
model. It sold one car model in one color, but so did most other car
manufacturers at the time. Ford was able to reduce costs through a unique
organization of the production setup, but the value proposition was not
unique.
In the 1990’s, Dell changed the personal computer industry by applying
the Internet as a novel distribution channel. This platform as a foundation of
the pricing strategy took out several parts of the sales channel, leaving a larger
cut to Dell and cheaper personal computers to the customers. Nowadays this
distribution strategy is not a unique business model anymore as many other
laptop producers apply it. Therefore, it is also a good example of the fact that
what is unique today is not necessarily unique tomorrow.
This mirrors Christensen’s quote that “today’s competitive advantage
becomes tomorrow’s albatross” (Christensen 2001, 105). Having the right
business model at the present does not necessarily guarantee success for
years on end as new technology or changes in the business environment and
customer base can influence profitability. The point to be made here is that if
the value proposition is not affected in some manner, then it is most likely not
a new business model. However, it could be the case that the value
proposition is not affected, but the business’ value generating attributes are
radically different from those of the competitors. Three examples of this are:
1. The value proposition of two companies producing kitchen appliances. One
may be more high-end than the other, but this is a part of the competitive
strategy, not the actual business model.
2. The value proposition of two companies producing laptops. One may be
priced lower because the range is smaller and the design kept to one color
etc. This is not equivalent to different business models, but also a question
of competitive strategy and customer selection. However, if one of the
producers decides to alter the traditional distribution model, cutting out
store placement and setting up technical support as local franchisees only,
that could be a new business model.
3. Two hair salons will both be performing haircuts, but their value
propositions may be vastly different according to the physical setup
around the core attribute.
Which parameters do we need to understand?
Remembering that the business model is the platform which
enables the strategic choices to become profitable, then it is clear that a
business model is neither a pricing strategy, a new distribution channel,
an information technology, nor is it a quality control scheme in the
production setup. By themselves that is. A business model is concerned
with the value proposition of the company, but it is not the value
proposition alone as it in itself is supported by a number of parameters
and characteristics, e.g. some of the parameters mentioned above like
applied distribution channels, customer relationships, pricing models
and sourcing from strategic partnerships. The key question here is
therefore: how is the strategy and value proposition of the company
leveraged?
The problem with trying to visualize the “business model” of the
company is that it can very quickly become a generic and static
organization diagram illustrating the process of transforming inputs to
outputs in a chain-like fashion. The reader is thus more often than not left
wondering how the organization actually functions. Hence, the core of the
business model description should be the connections between the
different elements that the management review is traditionally divided
into, i.e. the actual activities being performed in the company.
Companies often report a lot of information about activities such as
customer relations, distribution channels, employee competencies,
knowledge sharing, innovation and risks; but this information may seem
unimportant if the company fails to show how the various elements of
the value creation collaborate, and which changes we should keep an eye
on. One such idea on how to visualize the business model is the popular
Business Model Canvas by Osterwalder & Pigneur (2010).
When we perceive relationships and linkages, they often reflect some
kind of tangible transactions, i.e. the flow of products, services or money.
When perceiving and analyzing the value transactions going on inside an
organization, or between an organization and its partners, there is a marked
tendency to neglect or forget the often parallel intangible transactions and
interrelations that are also involved.
At the Business Model Design Center (www.bmdc.aau. dk) we have
recently analyzed how existing “models” or “tools” perceive transactions and
relationships, and we have found that they generally lack a conception of
intangible transactions, which in many cases are the very key to
understanding the value logic of a business model. These ideas are discussed
in depth in chapter 2 in Business Model Design: Networking, Innovation and
Globalizing on value creation maps (http://bookboon. com/en/business-
models-ebook).
While value creation from an accounting perspective merely constitutes
the realization of value at the time of sale of the product, i.e. registration of
turnover, from a process perspective, value creation may be characterized as
the steps leading towards value realization. Thereby we are in this genre more
concerned with value creation potential, value creation processes and value
creation extraction, which all can be said to precede the value realization
phase.
In 2002 Chesbrough & Rosenbloom tried to corner the important
aspects to be considered in order to comprehensively describe the business
model of the company. They defined the business model as “[a] construct that
integrates these earlier perspectives into a coherent framework that takes
technological characteristics and potentials as inputs, and converts them
through customers and markets into economic outputs. The business model is
thus conceived as a focusing device that mediates between technology
development and economic value creation. We argue that firms need to
understand the cognitive role of the business model, in order to
commercialize technology in ways that will allow firms to capture value from
their technology investments” (Chesbrough & Rosenbloom 2002, 5). This
definition is worth noticing because it was among the first one to set value
creation as a central notion of understanding the points of concern in the
business model of a company.
In the wake of this definition, they define six elements which make up
the business model:
1. Articulate the value proposition, that is, the value created for users by
the offering based on the technology
2. Identify a market segment, that is, the users to whom the technology
is useful and for what purpose
3. Define the structure of the value chain within the firm required to
create and distribute the offering
4. Estimate the cost structure and profit potential of producing the
offering, given the value proposition and value chain structure chosen
5. Describe the position of the firm within the value network linking
suppliers and customers, including identification of potential
complementors and competitors
6. Formulate the competitive strategy by which the innovating firm will
gain and hold advantage over rivals
It is interesting to note that Chesbrough & Rosenbloom in the above take in
strategy as an element of the business model. The relationship between
business models and strategy is, if not fuzzy, then at least undecided. In her
book from 2002, Joan Magretta defines business models as “stories that
explain how enterprises work”, and notes that strategy, understood as how to
outmaneuver your competitors, is something different from a business model.
Seddon et al. 2004 take part in this discussion by schematizing the
possibilities in figure 3 below.
If we briefly recap the business model definition given above: “A
business model describes the coherence in the strategic choices which
facilitates the handling of the processes and relations which create value on
both the operational, tactical and strategic levels in the organization. The
business model is therefore the platform which connects resources, processes
and the supply of a service which results in the fact that the company is
profitable in the long term”, it is evident that it takes the stance of Seddon et
al.’s (2004) option E, because it sees the business model as the platform that
enables strategy-execution.
DRIVING OUT THE BUSINESS MODEL
In order to start working with clarifying the business model of a
company or an organization, one can start off by asking the following
questions (regardless of which business model framework one chooses
for structuring and visualizing the business model during the process):
Which value creation proposition are we trying to sell to our
customers and the users of our products?
Which connections are we trying to optimize through the value
creation of the company?
In which way is the product/service of the company unique in
comparison to those of major competitors?
Are there any critical connections between the different phases of
value creation undertaken?
Can we describe the activities that we set in motion in order to
become better at what we do?
…and can we enlighten these through relevant performance
measures?
Which resources, systems and competences must we attain in
order to be able to mobilize our strategy?
What do we do in relation to ensuring access to and developing the
necessary competences?
Can we measure the effects of our striving to become better, more
innovative or more efficient, apart from the bottom line?
Which risks can undermine the success of the chosen Business
Model?
What can we do to control and minimize these?
ARCHETYPES OF BUSINESS MODELS: LOOKING FOR PATTERNS
Other authors have attempted to define business models by discussing
and identifying overall business model generics and archetypes. Business
model archetypes was one of the primary discussions in the field in relation to
e-business models.
Already in 1998, Timmers classified 10 generic types of Internet
business models:
e-shop
e-procurement
e-auction
3rd party marketplace
e-mall
Virtual communities
Value chain integrator
Information brokers
Value chain service provider
Collaboration platforms
Two years later, Rappa (2000) identified 41 types of Internet business
models and classified them into 9 categories, which were fairly similar to
Weill & Vitale’s eight (e-)business models from 2001:
Content Provider
Direct to Consumer
Full Service Provider
Intermediary
Shared Infrastructure
Value net integrator
Virtual Community
Whole of Enterprise/Government
In recent years it is to a rising degree being realized that archetypes of
e-business in reality merely are translations of already existing business
models. And thus business model archetypes seen through today’s lenses
could be something along the lines of:
Buyer-seller models
Advanced buyer-seller models
Network-based business models
Multisided business models
Business models based on ecology
Bottom of the pyramid business models
Business Models based on social communities
Co-creation and consumer-collaboration models
Freemium models
Over the past decade, multiple attempts have been made at developing
business model definitions and frameworks and tools for conceptualizing and
analyzing business models. There are several contributions towards
comprehending various levels of abstraction in modeling the value creation of
businesses. For example, Osterwalder et al. (2004) distinguish between meta-
models of business models, taxonomies of business model types, modeled
instances of business models and real-life companies. Lambert (2015) also
surveys the usefulness of taking ones point of departure in specific levels of
abstraction. In a recent contribution, Massa and Tucci (2013), distinguish
between six levels of abstraction (Figure 4).
Massa and Tucci (2013) suggest that BM narratives and archetypes are
situated at higher levels of abstraction to other applications and frameworks
such as ontologies in the form of conceptual, graphical frameworks (e.g.
Osterwalder and Pigneur, 2010; Johnson et al., 2008). Further down we find
the level of various taxonomic/typological specified graphical frameworks (e.g.
Lambert, 2015), as well as various meta-models (e.g. Casadesus-Masanell and
Ricart, 2010; Gordijn and Akermans, 2001), which are equivalent to the term
BM configurations. Table 1 below depicts the classification dimensions in a
selection of the most cited studies in the field.
