Once upon a time, all business models were relatively similar and relatively simple. You bought low and sold high. The more you could repeat this simple recipe, the richer you would grow. But the world has become more complex and more competitive.
New technologies have opened up many different ways of doing business and most companies are no longer competing just with the business down the road, they are competing with entities from across the globe. In this environment of increased complexity and heightened competition, a firm’s business model has become a critical source of competitive advantage.
The entrepreneurs and managers who have taken the time to understand what a business model is and how to innovate around their own business model have found new sources of profit and growth. By contrast, those who have failed to adapt their business model have found themselves languishing and giving way to their more inventive rivals.
What is a business model? What is business model innovation? How can a business model be a source of competitive advantage? How can refining a business model drive growth and profit within an enterprise?
Let’s look at the concept of a business model and see what tools and insights are available to enable entrepreneurs and managers to innovate with new business model designs. In doing so, we’ll be drawing on the concepts captured in the recently released book Business Model Generation by Alex Osterwalder and Yves Pigneur.
What is a business model?
Quite simply a business model is a description of the rationale of how an organisation creates, delivers and captures value. A business model describes how a company creates an offering, gets it to customers and generates profit from the transaction.
The research of Alex Osterwalder and Yves Pigneur suggests that a complete description of a company’s business model can be broken down into nine elements:
- Value proposition: A clear description of the company’s offering and how it solves problems or creates value for customers.
- Customer segments: The specific group of people that the organisation aims to serve.
- Channels: The means that a company uses to reach its customer segments to communicate with them and to deliver products and services to them.
- Customer relationships: The methods used to maintain relationships with customer segments.
- Revenue streams: The income generation and collection mechanisms in the business.
- Key resources: The most important assets that the company needs to make the other elements of the business model work.
- Key activities: The most important things that a company must do to make its business model work.
- Key partnerships: The network of suppliers and partners that make the business model work.
- Cost structure: The major costs that need to be incurred to sustain the business model.
These nine business model building blocks can be captured in a single diagram called the business model canvas. It sets the value proposition at the centre of the business model as the primary focus area. The customer building blocks (customer segments, channels and relationships) can be found to the right of the value proposition and infrastructure building blocks (resources, activities and partners) to the left.
The finance-based building blocks (revenue and cost structure) can be found on the lower portion of the diagram.
Building & refining a business model
The nine building blocks and the business model canvas are excellent tools (1) for understanding your current business; (2) for refining a business to make it more profitable; and (3) for designing a new business model.
The process of applying the business model canvas to define or refine a business model is relatively simple but extremely powerful.
Gather the people you want to participate in the process. In a business it is useful to get the entire management team involved. Different people bring new perspectives and insights and therefore having a broad base of participants is often an advantage.
Once you have all the participants gathered together, you should present a copy of the business model canvas and explain to people what the different components of the canvas mean.
Map out your firm’s existing business model on the business model canvas (note, if you are designing a business model for a brand new business, this step can be skipped). The mapping of the business model will give all participants in the process a common understanding of the company’s current operations.
Brainstorm ideas for different ways of doing things within the business model. If you’re designing a new business model the focus will be on how you build up the different elements of the business model to create a valuable enterprise.
If you are refining a company’s existing business model then you can work though each of the nine building blocks and ask the following questions:
“How could we do things differently?”
“How can we create more value for customers?”
“How could we be more efficient?”
As you go through the process of brainstorming ideas for each of the nine building blocks be sure to:
- Encourage everyone to participate:
- Keep asking questions
- Record all ideas:
- Don’t judge ideas immediately, write them down and judge them later
- Be visual:
Put the business model canvas up where everyone can see it and record the ideas in such a way that all participants can see them. One useful way to do this is to draw the business model canvas on a very large sheet of paper or project board, stick it on the wall and then use post-it notes and markers to record all the participants’ ideas in the respective blocks.
Identify the good ideas. The challenge is to create a way for the group to decide on the best ones. One way to do this is to give the individuals in the group a pack of adhesive stars and get them to vote on the best ideas. Another way is to get the people to vote on paper if you prefer.
Bring the best ideas together in a coherent business model. To do this you can give each participant a clean business model canvas and get them to create a new business model for the company, using the best ideas generated in the session. Each person can then present their new business model back to the group. From this a new business model can be devised.
Plan for the implementation of the new business model. Create a set of action steps and allocate responsibility for the implementation of the steps. The process described above, or some variation of it, will provide an entrepreneur or manager with a practical, meaningful and productive way to design a new business model.
Examples of innovative emerging business models
To understand how business models are evolving and to get inspiration for designing an innovative new business model, it is worth examining some of the new patterns emerging. Over the past 20 years we have seen a proliferation of these.
Many new business models are built around the Internet, yet it’s not an essential ingredient of business model innovation. Below are some examples of emerging business models as identified by Alex Osterwalder and Yves Pigneur.
Long tail business models
In long tail business models a company sells lower quantities of more types of products to very niche groups of customers. Traditionally business looked to create ‘hit’ products – products that would appeal to the largest segment of mainstream customers.
Because the cost of finding customers and producing and distributing products in many industries has decreased, some businesses have emerged to service small, dispersed groups of customers.
Global example of a long tail business model:
Publishing industry: Lulu.com
Previously the goal of a book publishing company was to find the next best-seller – Harry Potter and the like. Lulu.com, an emerging book publishing business, turned this model on its head. Instead of focusing on best-sellers, they created a platform that enables any amateur author – you, me or the person next door – to publish a book.
They make their money by providing authors with the tools to self-publish and they also provide a platform for people to buy and sell self-published books.
Other examples of companies that employ a long tail business model include CD Baby (music), Springleap (T-shirts) and Netflix (movies).
Additional reading on long tail business models:
The Long Tail: Why the Future of Business is Selling Less of More, by Chris Anderson, 2006.
Multi-sided platforms bring together buyers and sellers. They create a space where people can transact. The platform creates value by facilitating interactions between different groups. A multi-sided platform becomes more and more valuable as more and more people use it.
Local example of multi-sided platform business model:
Real estate sector: Private Property
Private Property has established a platform that brings together buyers and sellers of real estate on the Internet.
By making it easy for sellers (including traditional real estate agents) to load property descriptions, pictures and videos onto their site and by making it easy for sellers to search and save properties, they have created a business model that has transformed the way many people find property to buy or rent.
There are many industries, local and global, that are being transformed by businesses with multi-sided platform business models. Examples include eBay (auctions), Craigslist (classifieds), Apple App Store (software applications), and Google (advertising).
Additional reading on multi-sided platform business models: Strategies for Two-Sided Markets, Harvard Business Review, by Thomas Eisenmann, Geoffrey Parker and Marshall W van Alstyne, 2006.
‘Free’ as a business model
Many businesses are finding it possible to deliver a product or service to a substantial customer segment at no cost; non-paying customers are financed by some other portion of the business.
Because people are naturally attracted to offerings that are free, many businesses find benefit in providing their offering at no cost to generate demand and create interest in what they are doing. They then find ways to get certain customer segments to access additional services and to pay for those services.
Global example of a free business model:
Anyone with friends, family and acquaintances living abroad has probably discovered the magic of Skype. If you and your friend both have an Internet connection you can call each other at absolutely no cost (except for the Internet bandwidth that you might be paying for).
Skype does this to get people to start using the network. The more people that are on Skype the more valuable it becomes for users. As people depend more and more on Skype for their daily communication needs so they discover that there are a whole lot of additional services that are worth paying for.
You can pay to call people directly on their phone or to set up premium services with all sorts of additional features. I started using Skype as a pure free user and I now spend about $10 a month to access additional services. As more and more people follow this trend it will become an incredibly profitable business.
Other examples of businesses that incorporate free into their business model include Dropbox (online storage), Google (search), Youtube (online video), and Facebook (social networking).
Additional reading on free as a business model:
Free: The Future of a Radical Price, Chris Anderson, 2008
Bait & Hook
The bait and hook business model is the practice of luring a customer in with a relatively cheap upfront purchase but then making money off them with more lucrative ongoing servicing. The most famous example of the bait and hook business model is in the razor blade industry.
Gillette will sell you the actual razor for next to nothing but then make huge margins every time you replace the disposable blade.
Local example of the bait and hook business model:
Motor Industry: BMW Financial Services
BMW retailers in South Africa give their customers very good deals on cars but then get them to utilise the BMW Financial Services package as a means to finance the car. They make the real money on the purchase through the ongoing interest payments that you make in paying off your vehicle.
Other examples of the bait and hook business model include: HP (printers and printer cartridges), cellphones (cheap handset but expensive ongoing contracts), Multichoice (pay TV – give away the decoder but charge high monthly fees for customers to get value from the decoder).
These are just a few of the interesting new business models that are emerging to create value for companies. One of the real challenges is that successful business models are often replicated and after being copied too many times, they are no longer valuable.
Gary Hamel said, “…all too often, a successful new business model becomes the business model for companies not creative enough to invent their own.” Most times the first mover – the firm that comes up with the business model that transforms an industry – benefits immensely from their innovation.
A new business model can be a source of competitive advantage for many years – Southwest has maintained its advantage with the low-cost airline model for over three decades and Gillette has done the same with its bait and hook razor blade model for just as long.
The challenge for today’s entrepreneurs and business managers is to be creative enough to invent a business model that is radical so you can attain advantage in your industry for decades to come. Don’t just copy what others have done. Use the tools provided in this article to help you create something that is new, different and transformative. Good luck!
Business model generation source book
Business Model Generation, by Alex Osterwalder and Yves Pigneur, is available from Kalahari.net
Disruptive new business models are emblematic of our generation. Yet they remain poorly understood, even as they transform competitive landscapes across industries. Business Model Generation offers you powerful, simple, tested tools for understanding, designing, reworking, and implementing business models. It’s a practical, inspiring handbook for anyone striving to improve a business model – or craft a new one.
The book will teach you powerful and practical innovation techniques used by leading companies worldwide. You will learn how to systematically understand, design and implement a new business model – or analyse and renovate an old one. Business Model Generation also has a tightly-integrated, visual, lie-flat design that enables immediate hands-on use.
- Seizing the White Space: Business Model Innovation for Growth and Renewal; By Mark W Johnson; Harvard Business Press; 2010
- Open Business Models: How to Thrive in the New Innovation Landscape; By Henry W Chesbrough; Harvard Business Press; 2006