Over the course of my career, I’ve come to see business model innovation not as a static process but as a systemic and reliable capability, one that leaders need to build, strengthen, and eventually turn into a sustainable competitive advantage.

A.G. Lafley, Chairman and CEO of Procter & Gamble

Since its spinoff from Bayer in 2004, the German chemical company Lanxess has experienced several years of upward momentum: rising sales, increasing earnings and the admission to the DAX 30 blue‐chip index in 2012 are only a few examples that indicate its success. In March 2013, Axel Heitmann, then CEO of Lanxess, explained that the company had just experienced “the best in our growth story so far,” and further explicated “our business model proved itself once again” [1]. Only one year later, the situation had dramatically changed. Lanxess’s customers were destocking, prices declining, its balance sheet for 2013 showed a net income loss of €159 million, and Heitmann was replaced. Lanxess’s new CEO, Matthias Zachert, concluded after a corporate‐wide analysis in August 2014, that the “role‐out of a new business model” is necessary, meanwhile asserting that Lanxess needs to become “significantly more competitive” and customer oriented [2].

As the case of Lanxess illustrates, determining the competitiveness of a business model, sustaining a successful business model, and transforming business models that are threatened to become obsolete is an important yet difficult managerial task for executives. In this chapter you will learn what a business model is, why business models matter, what the difference between business models and strategy is, how firms can successfully engage in business model innovation and why chemical and pharmaceutical companies should engage in business model thinking.

7.1 Business Model Design: Essential Management Decisions

In the chemical and particularly in the pharmaceutical industry one can observe increasing attention towards business models in general and business model innovation in particular. However, while a firm’s top management often has (and should have) a thorough understanding of how the firm’s business model works and why the capability to innovate a business model is important to maintain competitive advantage, managers three to four steps down the hierarchy, namely those who actually operate the business model, can often not explain the firm’s business model or articulate how a business model could potentially be changed, such as in response to shifts in competition. Moreover, many managers do confuse business models with strategy or other management concepts. For example, an experienced marketing manager at a major chemical company once explained that the business model of BASF is verbund and the business model of Procter & Gamble is scaling. While BASF’s verbund is part of the answer why BASF’s business model – or more precisely its business models – is successful, verbund is not a business model. Neither is scaling (though being able to scale a business model is without any doubt a capability worth building on). Arguably, a lot of confusion about what a business model is and what it is not exists. So what actually is a business model? In essence, a business model is the story of how a company operates [3]. In so doing, a business model answers questions in two core areas that are essential for any business (see Figure 7.1): (1) Who is our customer, and what does the customer value? and (2) How do we make money in our business? The latter explains the economic logic of businesses, that is, how to make a profit while creating value for the firm’s customer(s) at appropriate costs. Hence, business models enable managers and entrepreneurs alike to think about basic choices firms have to make when it comes to their targeted customer segment, their revenue model, their cost structure and make‐or‐buy decisions [4]. A business model is thus about the managerial choices of how to operate an organization. These choices comprise, but are not limited to, compensation practices, location of facilities, partnerships and so on.

In short, a business model describes how a company creates and captures value. Value creating activities in companies may comprise defining an opportunity or formulating a solution to a given problem, and value capturing activities may involve the collection of fees for rendered services or the collection of rent from the ownership of property rights. In simple terms, the petroleum exploration business, for instance, is to acquire exploration licences, identify the best area for petroleum extraction and then sell the right to exploit a particular area to a client. Thus, the firm creates value in the form of an opportunity for petroleum exploitation and appropriates value by selling the right to exploit the field. Similarly, a biopharmaceutical company might focus on the identification of promising molecular compounds, define an opportunity by testing its safety and efficacy and then sell or licence the property right(s) on that compound to a large pharmaceutical company that develops the drug further.

Value creation and value capture are closely interlinked; this is basically because a business model that doesn’t create value for a firm’s customers doesn’t create value for the firm. Although both value creation and value capture are equally important functions of a business model, we observe that managers often overemphasize the value creation aspect and tend to underemphasize the value capture function. To better grasp both functions of a business model equally and to foster the development of a common language about business models inside companies, scholars have developed frameworks to describe core aspects of a firm’s business model. These frameworks often refer to components or so‐called design elements that constitute a firm’s business model. While these conceptualizations have certain limitations [5], we believe that they are valuable because they allow companies to improve the execution of their business model, enhance resilience by enabling management to think about alternative ways to design their business model, allow executives to communicate management priorities in their business model and, overall allow sense to be made of firms in action. A particularly useful business model conceptualization is offered by Mark Johnson, Clay Christensen and Henning Kagermann [6]. According to their concept, a business model consists of four interlocking elements, namely the customer value proposition, the profit formula, the key resources and the key processes, which taken together explain how companies create and capture value (see Table 7.1).

The customer value proposition, an established concept in the marketing literature, refers to “the combination of end‐result benefits and price to a prospective customer from purchasing a particular product” [7: 533]. Accordingly, a specifically selected bundle of products and/or services that caters to the requirements of the customer is part of a firm’s value proposition. In turn, understanding customers’ preferences and needs is reflected in the customer value proposition. In this context it is important to note that designing a compelling customer value proposition requires that companies “must stop trying to figure out what kinds of products people are trying to buy and instead work out what [job] they are trying to get done” [8: 26]. Hence, customers’ needs should not be defined in relation to a product. Instead, companies need to figure out what type of job their customers want to get done and then construct a “blueprint” of how to fulfil that job profitably. By job we mean a problem the customer wants to solve, such as more efficient stereoselective synthesis of an alkene. Therefore, the outcome or the benefit, for example, cost or time savings, a customer gains from your offering is distinct from the job the customer wants to get done. Companies need to recognize both the job and the outcome. For this reason, companies must entirely understand the customer experience life cycle, namely the discovery, purchase, first use, ongoing use, management (e.g. maintenance, repair and acquisition of add‐on products) and disposal of an offering, and not only the result or the outcome of consumption. Studies, however, show that companies regularly forget about the pre‐ and post‐use phase of products and thus neglect the overall context in which customers use a given product or service [9].

Benefits that contribute to a customer value proposition can be quantitative (e.g. product performance) and/or qualitative (e.g. product design) in nature, depending on the customer’s requirements. Qualitative benefits such as emotional or social aspects should not be underestimated. For example, when a company like Beiersdorf develops a skin‐moisturizing active substance for one of its skincare products, the social job their customer wants to achieve is to look good or younger. Although emotional or social aspects play a more obvious role for companies such as Beiersdorf, Henkel, P&G or Unilever that offer personal care products, cosmetics or consumer goods, chemical manufacturing companies should consider these aspects as well, for example, with respect to the jobs the customers of their customer want to achieve. The better a company understands the customers’ preferences and needs, and the better a company recognizes customers’ benefits, the better it can create a compelling customer value proposition. We can conclude that a compelling customer value proposition consists of one or two points of difference an offering has relative to the next best available alternative on the market (the most profitable situation occurs when no alternative is available). To create a compelling customer value proposition firms have to: (1) understand what elements of the offering are most relevant for the customer, (2) demonstrate the superior performance of the offering compared with its alternatives and (3) communicate the benefits in accordance with the customer’s priorities. The last implies that product characteristics as the firm’s R&D department, for example, defines them can, and most often do, differ with from the customers’ perception of the product or service characteristics and the customers’ priorities. It is crucial to understand that objective product or service characteristics are often inconsistent with subjective perceptions of the customer. Again, it is therefore often advisable not to define customers’ needs in relation to a product or service.

To better understand specific customer needs and subsequently create a more compelling customer value proposition, firms can group customers into different customer segments. For example, some business models are tailored to serve one single customer segment in a niche market with a specific value proposition, while other business models target two or more interdependent customer segments (e.g. the business model of credit card companies, which depends on credit card holders and merchants that accept the credit cards). The market for specialty chemicals for example consists of hundreds of customer segments, such as advanced ceramics materials, cosmetic chemicals and water‐soluble polymers. Some chemical companies serve a customer segment that consists of hundreds or more customers, while others may only have two or three customers in a respective segment. Defining customer segments helps managers and entrepreneurs alike in developing a clear target within a market. A targeted customer (segment) should therefore be an element of every business model. Targeting involves analysing the size and the growth of the identified customer segments (e.g. segment sales, growth rates and expected profitability) and the segments’ structural attractiveness (e.g. using the tools you have learned about in the first four chapters of the book, such as Porter’s Five Forces), evaluated against the company’s objectives and resources. The latter concerns questions like: “Do we have the skills and resources to succeed in this segment?”; “Are we allowed to operate in this segment with a given technology? Do we have the necessary intellectual property right(s)?”; or “If we operate in this business, do we have the capability to offer superior value compared with our competitors?” Based upon this evaluation, a firm selects one or more target customer segments. The selection itself is, however, not part of the business model. The business model is tailored towards the target customer segment but the business model does not answer the question of which segment to target. We will come back to that point later when we discuss the difference between strategy and business model. For now we can conclude that designing a business model begins with the identification of an opportunity to satisfy a real customer need and selecting a target customer segment.

The second element in the presented business model definition – the profit formula – is a “blueprint” of how the firm captures a part of the value that it creates for its customers, namely how the company can fulfil the customers’ needs profitably. In Johnson, Christensen and Kagermann’s view [6], the profit formula consists of the revenue model, the cost structure, the margin model and the resource velocity. The revenue model explains how much revenue the firm generates with its offering (i.e. volume × price). Usage fees for analytical equipment, leasing of manufacturing facilities, or licencing of intellectual property rights are examples of revenue streams in the revenue model of many chemical companies. Accordingly, different revenue streams require different pricing mechanisms, for example, fixed or dynamic pricing. The way to think about “volume” largely depends on the way companies generate their revenue. If a producer of batches for example sells these batches, the company certainly defines “volume” in its revenue model differently from a producer of batches that offers a leasing model to its customers. While the revenue model explains how much revenue the firm generates with its offering, the cost structure reflects the allocation of costs, for example, direct costs or economies of scale. The cost structure hence answers what it costs to operate a business model. One way to develop a successful business model is to base cost targets on strategic prices and consequently force the company to “question virtually every assumption about materials, design, and manufacturing” [10: 135]. Companies can therefore set a total profit target and work back from there to determine what the profit formula should look like. Another important element of a firm’s profit formula is the margin model. The margin model refers to the contribution needed from each transaction to achieve the desired profits. Far too often companies do not see the difference between their margin model and their profit formula. Hence, although the margin model is technically reflected in the cost structure, it makes good sense to analyse it as an additional building block of the firm’s profit formula. Moreover, analysing revenue model, cost structure and margin model step by step allows to see why low margin opportunities might be worth pursuing. For example, if a pharmaceutical company only focused on high margin opportunities, it would most likely not make any sense to capture the pharma market in emerging economies or business opportunities at the bottom‐of‐the‐pyramid (i.e. the largest, but poorest group of people). However, we observe that markets in emerging economies can be highly profitable for companies willing to design new business models around lower margins instead of simply importing their domestic business model. The last part of the profit formula, resource velocity (sometimes also termed asset productivity), refers to the utilization of resources, namely how fast a company needs to turn over inventory and assets given the expected volume and profits. In other words, resource velocity tells you how many components or products you can develop, manufacture, store, deliver, sell and service for a given amount of time and money. Mark Johnson hence describes resource velocity as the “measure of not how much money flows through your company but how quickly it flows through it” [11].

In summary, the profit formula answers questions about costs, pricing mechanisms, expected margins, overheads, throughput, lead times and so on. In terms of the profit formula, some business models are more cost‐driven than others. The US chemical company Dow Corning for instance serves customer segments with very different value propositions, and as a result it operates two business models simultaneously: a cost‐driven business model under the Xiameter brand and a value‐driven business model under the Dow Corning brand. With its traditional value‐driven business model the company sells high‐end silicones to customers who expect customized, high‐quality products and sophisticated technical support. Xiameter, on the other hand, serves customers that are looking for competitive prices and “no‐frills” standardized products sold over the internet. Accordingly, the profit formulas of both business models differ substantially from each other. While the value‐driven profit formula is characterized by high‐margin, high‐overhead retail prices and revenue streams from value‐added services, the Xiameter profit formula is based on lower margins, spot‐market pricing and high throughput. These differences are also reflected in the other two business model elements, namely the key resources and key processes (see Table 7.2 for a comparison of both business models).

Key resources refer to a firm’s assets, such as technologies, distribution channels, equipment, production facilities, the brand and people, required to deliver the customer value proposition to the customer. These examples show that key resources can be physical, financial, intangible (e.g. intellectual property) or human resources. Of course not all resources are equally important among firms. Therefore, the emphasis here is on those resources that in combination are required to create and capture value, that is, resources that create competitive differentiation. Generic resources that do not create competitive differentiation are thus not an element of a business model. It is important to understand that key resources can also be provided by external partners. Partnerships are indeed a core aspect of many business models. For example, consider a distribution channel partner. Distribution channel partners very often play an important role in creating the ultimate customer experience [9]. In such a case it is crucial not only to consider the customer’s role during value creation and value appropriation but also the distribution partner’s role. Companies should for instance ask themselves what incentives a distribution partner has to market, or appropriately support, the delivery of the product. Firms must hence align channel actions in their business model by understanding and emphasizing their channel partners’ experience cycle. To develop fit with the distribution partner, firms can for example analyse how their offering affects profitability and operations at each link in the supply chain. In so doing, they can help distribution partners to integrate the offering.

Leveraging partner capabilities and resources can also result in an open business model, a term developed by Henry Chesbrough to explain how partners can help firms to create and capture value more effectively. On the one side, external partners allow firms to create value more effectively because firms can not only define a series of activities that will result in new products or services based on internal capabilities, but also leverage external capabilities. Companies thus have a broader set of options available. On the other side, they allow firms to capture value more effectively because firms can utilize not only their own resources, assets or position but also those of their partners. Open business models typically have an outside‐in and an inside‐out pattern [7]. Typical outside‐in patterns are resources and capabilities that are required to build gateways to external organizations (key resources), activities that connect a firm’s internal business processes and R&D groups to the network of external partners (key processes) and increased R&D productivity, as well as reduced time‐to‐market, which result in lower costs (cost structure). Typical inside‐out patterns are established distribution channels, originally designed to deliver outcomes from internal sources of innovation but now used to deliver outcomes from external sources of innovation to customers (key resources), R&D outputs that cannot be commercialized in the focal industry but are valuable in other industries (customer value proposition) and additional revenue streams from the exploitation of internal ideas outside the firm (profit formula).

Accordingly, firms may generate new revenue streams and achieve cost and time savings with an open business model. The concept of open business models is related to Chesbrough’s concept of Open Innovation (see Chapter 5 on Open Innovation). Chesbrough argues that firms aiming to exploit the full potential of Open Innovation should also consider opening‐up their business models. He reasons that “companies must open their business models by actively searching for and exploiting outside ideas and by allowing unused internal technologies to flow to the outside, where other firms can unlock their latent economic potential” [12: 22]. The rationale to open the business model is to address the economic pressure on innovation, that is, the rising costs of innovation and shorter product life in the market. The first refers to increasing internal development costs due to increasing scientific complexity, such as multi‐disciplinary and cross‐functional R&D efforts, limitations to breakthrough discoveries and the rising costs of capital. Rising costs of technology development would imply that only large companies would be able to undertake technology development and commercialization, and as a result become even larger. However, the second force at play – shortening product life cycles – “makes these economics challenging even for the largest firms” [13: 11]. For example, the shipping life of a new drug (while it enjoys patent protection) is today shorter due to longer approval processes by regulation agencies such as the Food and Drug Administration (FDA) agency in the United States. Accordingly, the time to earn a profit with a new drug in the market is shortened. At the same time, successful products are imitated quickly and/or compete with rival products after a short time. As a result of this effect, revenues in the closed model decrease. Together with the rising costs of innovation, “R&D investments under the closed model of innovation [are] increasingly difficult to sustain” [13: 11]. Chesbrough concludes that the economic pressure on innovation reduces the ability of firms to earn a satisfactory return on their investment in innovation. Companies that open their business model can address the described challenges. On the cost side, open business models enable companies to achieve cost and time savings by leveraging external resources, and on the revenue side they allow companies to generate new revenues, for example from licencing fees. Since this notion is similar to the one of Open Innovation, one may come to the conclusion that the concept of open business models is “Open Innovation wrapped into the business model concept.”

However, though similarities between Open Innovation and open business models exist, the concept of open business models is much broader and strategically distinct from the concept of Open Innovation. Firms with open business models co‐create value with their external partners, which may result in product or service innovations (e.g. open business model in combination with Open Innovation), but the concept is not limited to the innovation process. Companies that make use of open business models can co‐create value with their upstream (e.g. supplier) and downstream partners (e.g. distribution channel partner) as a key resource of their business model or they can co‐create value with their customers or other stakeholders, such as NGOs.

The final element of a business model is the key processes. Key processes are operational and managerial processes, for example, product development, production and distribution, which enable a firm to deliver value in a way that can successfully be repeated and increased in scale. In the case of Dow Corning, key processes of the value‐driven business model are R&D, sales and services, whereas key processes of the cost‐driven business model are low‐cost processes characterized by a high degree of automation, such as online ordering of silicones. Key processes also comprise a firm’s rules, metrics and norms. Examples include financial measures such as gross margins, unit margins, net present value calculations and time to breakeven, operational measures such as quality of supply, lead times, or throughput, and other measures such as product development life cycles, brand parameters or incentive systems. These rules, metrics and norms are often the last aspect that emerges during the development of a business model. Moreover, they protect the status quo and are hence a typical obstacle against business model innovation. For example, if a pharmaceutical company demands that the “opportunity size to invest into a new business must be €100 million or more,” this rule might prevent the discovery of new business opportunities that initially do not meet this criterion.

In summary, the customer value proposition and the profit formula define value creation for both the customer and the company, and key processes and key resources describe how that value is delivered. Johnson, Christensen and Kagermann conclude that “as simple as this framework may seem, its power lies in the complex interdependencies of its parts” [6: 53]. Thus, the four elements cannot be viewed as being independent of each other. Scholars for example argue that “an appropriate business model involves choosing the right mix of alternatives” [14: 66] and observe that when an interlocking element of a business model is missing or if one or more elements do not fit with the product offering, market failure is likely to occur. How well different elements of a business model complement each other, that is, the internal consistency of choices, therefore determines the effectiveness of a business model.

Now that we know what a business model is, we can take a look at the way companies in the chemical industry define and manage their business models. To illustrate how companies manage their business models we will take a look at the plastics business of BASF and the consumer goods business of Procter & Gamble (P&G).

7.1.1 Business Models at BASF

In 2001, BASF announced a new business strategy for one of its core businesses, its plastics segment (e.g. elastomers and epoxy resins), in response to a difficult economic climate characterized by weak margins, plant closures and divestitures – a situation similar to the current economic environment and therefore particularly suitable for an analysis. Back then, the company declared three goals to achieve profitable growth in its plastics segment: sharing success with customers, optimization of regional portfolios and development of new business models (see Figure 7.2). To share success with customers, on the one hand, BASF expanded in areas in which it could offer customers “clear advantages” while growing its own business profitably. On the other hand, BASF closed or divested businesses that were (due to capacity, technology or location) no longer competitive, that is, they could as a consequence no longer provide customers with any advantages. The optimization of regional portfolios was estimated to be achieved by improving processes and cost structures (and hence efficiency) in Europe and North America, while continuing expansion in Asia. As a third pillar, BASF planned to re‐align standard polymers as well as specialties businesses due to changing market conditions by building new business models. In the following paragraph several examples will be used to demonstrate the interdependence between these goals and the development of competitive business models in particular.

Plastics can be characterized by means of main price determinants and differentiation potential in the market (see Figure 7.3). The market price of high‐volume mass‐produced plastics such as polyethylene (PE), polypropylene (PP) and poly(vinyl chloride) (PVC) is largely determined by production costs (which are primarily determined by costs of the raw materials), and these commodities offer no or only limited room for product differentiation. On the other side of the spectrum are plastics tailored to customer requirements. The level of product and service customization in this market segment is high – which offers high possibilities for differentiation – and market prices are largely determined by product properties rather than production costs. Polyurethanes and the thermoplastic polymer polybutylene terephthalate (PBT) are examples of products in this segment.

According to BASF, “business models describe the form of cooperation with […] customers and what products and services [are] offer[ed]” [16]. Based on this definition, BASF developed a classification of business models for its plastics business in which the level of product and service customization and the range of products and services determine the business model type. As a result, four types of business model, namely (i) raw materials producer, (ii) lean/reliable basic supplier, (iii) product/process innovator and (iv) customized solution provider, have been identified by the company. “Raw materials producer” business models are characterized by a low level of customization and a limited range of products (see quadrant (i) in Figure 7.3). Such business models focus on low production costs and are typically employed for commodities such as PE and PP. BASF left the PE and PP markets in the early 2000s and thus does not operate a “raw materials producer” business model any longer. “Lean/reliable basic supplier” business models are designed to enable a higher level of customization compared with standard products and product price is determined more by product properties than in the case of typical commodities (see quadrant (ii) in Figure 7.3). Standard products with an appropriate availability and quality constancy are typically delivered with this business model. Furthermore, this business model type is characterized by reliability of supply with lowest costs, while short‐term pricing takes regional and global supply demand into account. BASF employs this type of business model for spin polyamides, polyamide intermediates, styrene, polystyrene (PS), acrylonitrile butadiene styrene (ABS), styrene foam and polyurethane (PUR) basic products.

ABS is an example of how BASF re‐aligned one of its business models in the early 2000s in accordance with its strategic goal to create competitive business models. ABS is a resistant, common thermoplastic widely used in products such as toys, for example LEGO® bricks are made of ABS, and consumer goods. BASF traditionally produced ABS exclusively at its location in Ludwigshafen and offered customers more than 1500 ABS products, ranging from full standard products to specialties. This model worked for several years. However, in the early 2000s BASF’s ABS business model was under pressure. Firstly, production solely in Ludwigshafen resulted in complex global logistics and packaging requirements. Secondly, more and more applications were no longer dependent on specialties since the quality of standard products, produced at lower costs, had increased over time. In other words, standard ABS products became “good enough” to meet customers’ quality requirements. According to John Feldmann, then member of BASF’s Board of Executive Directors, “[t]his development was a direct assault on our business model, whose costs were […] rising continually […] It was obvious to us that a new business model was needed” [16]. BASF re‐aligned its traditional business model in the following years to a “lean/reliable basic supplier” business model by dramatically decreasing the number of ABS products offered through its business model, enabling online ordering, opening new world‐wide production facilities to enable supply from local production plants, developing a new production technology for the low‐cost production of ABS and introducing a new colouring concept together with supply chain partners. Accordingly, several supply chain practices enabled the implementation of the new business model. On the one hand, the new business model was less complex due to the reduced number of product offerings, convenient online ordering and opening of new production plants. Focused production and efficient logistics thus became key aspects of BASF’s business model. On the other hand, BASF began to offer its customers a colouring concept that allowed customers to colour their resin at their own facilities by using batches offered by selected partners. In this model, BASF supplies uncoloured ABS and partner companies, such as ALBIS Plastic and Clariant, supply the colour batch. Integration of partners hence became another key aspect of BASF’s ABS business model.

At the next level of customization and product/service range are “product/process innovators” business models (see quadrant (iii) in Figure 7.3). These business models are characterized by joint development/collaboration with customers or clients, such as original equipment manufacturers (OEMs) in the automotive and electronics sectors. BASF for instance integrates its customers into its business model in the case of engineering plastics. At the highest level of customization are “customized solution provider” business models (see quadrant (iv) in Figure 7.3). These models are designed to deliver products that have a high potential for differentiation, and require an ever‐closer interaction with customers. In this context, John Feldmann notes that “[f]or many business models, geographic proximity to the customer is […] of great importance” [16]. “Product/process innovator” and “customized solution provider” business models cannot always be exactly distinguished from each other since they share certain characteristics. For example, both business models are characterized by a strong orientation towards customers, enabling for example the joint development of solutions with customers, the need for sales personnel with technical expertise and a high product/application range. BASF employs these types of business models for polyurethane systems and specialties, engineering plastics and styrenic specialties.

BASF’s polyurethane (PUR) specialties business is an example of a “customized solution provider” business model. This model works in a fundamentally different way compared with the business model employed for ABS. A key aspect of its PUR business model is the so‐called system houses, which are responsible for formulating tailor‐made PUR systems for their customers. BASF offers about 8000 tailored systems to customers as well as services that correspond with the product life cycles of these PUR systems. As John Feldmann explains, “[t]he business model draws on two decisive BASF strengths: firstly, our integrated production facilities with all its economies of scale, and secondly, our network of system houses and development centres that enable us to respond flexibly to develop products that meet the exact requirements of the customer” [16].

In 2006, the majority (~70%) of BASF’s plastics business portfolio was based on “lean/reliable basic supplier” business models, followed by “product/process innovator” and “customized solution provider” business models. However, BASF’s target for 2010 was to significantly increase the share of “product/process innovator” and “customized solution provider” business models in its portfolio to 40% (whether this target was met cannot be determined from publicly available data since BASF’s plastic business was regrouped and today it is an integrated part of its Performance Materials division). Accordingly, the company aimed to strategically shift its portfolio towards specialties.

To further illustrate the relevance of business model management, consider the case of BASF Coatings. BASF Coatings is a division of BASF that operates a “customized solution provider” business model, in which BASF Coatings manages customers’ chemical processes. Instead of employing a business model that is entirely based on selling paint to an automotive OEM, BASF Coatings is today engaged to run the OEM’s paint line. As the company explains, “combining modern paint processes with special‐effect pigments and technologies” allows BASF Coatings to offer a “broad array of colour solutions and development capabilities that enable [customers] to enhance productivity and environmental performance” [17]. In such a business model it is in the interest of BASF Coatings to use and waste (and hence to produce) as little paint as possible – a fundamental reconceptualization of the firm’s traditional business logic. Instead of selling as much paint as possible, the firm reversed its logic of value creation. Today BASF Coatings is no longer paid per supplied litre but per painted car, or as Alexander Haunschild, Senior Vice President at BASF Automotive OEM Coatings, explains “we don’t simply supply a kilo of paint […] especially when it comes to automotive OEM coating, processes, paint application and services for all aspects of the finish are indispensable” [18]. This new element of the firm’s profit formula not only shifts the emphasis to fixed costs but also turns out to be quite valuable in changing competitive environments. For example, BASF Coatings recently reported that the US car industry has begun to restructure due to changing demand in terms of vehicle size “as consumer purchases were shifting to smaller, more fuel‐efficient models” [19]. Logically, smaller cars also have smaller surfaces to be painted. Now while this might have been a problem for BASF’s Coatings traditional business model, its new model is much more resilient to this shift in demand. Furthermore, the company expects that North America will strive for more colourful coatings and colour individuality. As Mark Gutjahr, Head of Design Europe at BASF Coatings, notes “[i]t’s about time for us to have more colour” [19]. The new business model allows the unit to create and capture more value from this shift in customer demand due to closer customer proximity and customer familiarity.

BASF’s coating business is also an example of how the different business models of BASF deliver value to the same customer. The electric car manufacturer Tesla is a customer of various BASF business divisions that employ different business models. Tesla approached BASF in 2010 and was at that time only interested in BASF’s coatings capability, but BASF managed to seize “the opportunity and presented not only the benefits offered by a partnership with BASF for coatings but also the opportunities of a cross‐business unit approach” [19], including engineering plastics, heat management and other electric vehicle‐related offerings. Hence business models operated in different business units simultaneously target the same customer, and potentially reinforce each other.

7.2 Strategy, Business Model and Tactics

The relationship between business model and strategy, and subsequently between business model and tactics, has drawn a lot of attention from managers, but has also led to a great deal of confusion. To start with the most important aspect, strategy, business model and tactics are related but are different from each other. Whereas the business model, as a system of interdependent design elements, describes how the single parts of a business fit together to create and capture value in a competitive marketplace, the business model does not explain how a firm plans to compete in such a marketplace nor does it explain which customer segment to target. Although a business model facilitates the analysis, testing and validation of strategic choices, it is not itself a strategy.

Strategy is, by its definition, “the plan to create a unique and valuable position involving a distinctive set of activities” [5: 107] (see also the first four chapters of this book). Accordingly, based on their strategy, firms have made a choice about how to compete in the marketplace. This choice has consequences for a firm’s way of value creation and value capture. The business model, as a system of choices and consequences, is therefore a reflection of a firm’s strategy but it is not the strategy. Rather, strategy is about which business model a company should choose. This definition implies that competitive strategy contains actions for different contingencies, such as moves from competitors or market change, whether they become a reality or not [5]. Executives can thus either translate strategic choices directly into a single business model or they can consider several business models simultaneously based upon different strategic choices. Arguably, not every firm has such a plan of action for contingencies, but every firm operates according to its system of choices and consequences. Hence, every firm has a business model, whether expressed and understood by its management or not, but not every firm has a (competitive) strategy. This situation has been dramatically in evidence during the early 2000s when the dot‐com‐bubble burst. Many internet start‐ups at that time had basically the same business model but no competitive strategy [3]. One can hence conclude that a well‐designed business model is not enough for a company to survive in the long run. This observation allows us to realize that business models are not a silver bullet. True, they are a valuable way to understand how firms act and operate but executives should never forget about the competitive strategy of their firm.

While strategy influences the business model, the business model in turn influences the tactics available to the firm. Tactics refer to the “residual choices open to a company by virtue of the business model that it employs” [5: 107]. Therefore, the business models determine the tactics that are available to a firm. For example, a newspaper company with an ad‐sponsored business model (sometimes also termed a freemium business model) cannot use price as a tactic, because the business model dictates that the newspaper must be for free. Accordingly, the business model “connects” strategy and tactics. Ideally, companies start by developing a (competitive) strategy, choose a business model determined by the strategic choice(s) and then have a set of tactics available by virtue of the business model. Figure 7.4 illustrates the relationship between strategy, business model and tactics in a simplified way. While strategic choices made by firm’s management during the creation of a business model cannot easily be changed, tactical choices, such as prices or minor product modifications, can be changed relatively easily. Strategic choices are accordingly more rigid than tactical choices. As an example, the German chemical company Altana describes its strategy as a “value‐added specialty strategy” that is characterized by high spending for R&D. High R&D spending is hence a strategic choice with consequences for Altana’s business model that cannot easily be reversed. However, this R&D policy does not prescribe a specific R&D spending, just that R&D spending should be high. Hence, the precise R&D spending can be changed and is thus not a strategic but a tactical choice. What constrains the set of tactics available to Altana is its business model. Elements of the business model set a boundary on how high Altana’s R&D spending can go.

As straightforward as this relationship seems, we acknowledge that the business model does not necessarily emerge as a linear process out of the chosen strategy. Some companies, especially entrepreneurial ventures, may start with the development of a business model and later on develop their competitive strategy by virtue of their business model. Hence the business model can also be a blueprint for a strategy. In any case, executives need to understand the relationship between business model and strategy to sustain a successful business.

7.3 Business Model Innovation

Before engaging in business model innovation, incumbent firms first need to define a starting point. This starting point is the existing business model, its way of value creation and value capture, and specifically its links to different external stakeholders. A good exercise is therefore to describe your firm’s present business model by using tools such as the business model framework presented (customer value proposition, profit formula, key resources and key processes). In so doing, companies can develop a common and acceptable understanding of what constitutes their current business model, what makes it competitive or unique, but also what factors limit and constrain it. Such an understanding further enables the firm to analyse threats and opportunities for its current business model. Understanding and managing existing business models can hence be classified as a first‐order capability to business model thinking and business model innovation.

Acquisitions, strategic partnerships and the formation of new ventures can lead to new business models. Chemical and pharmaceutical companies that have the capability to design new business models, to seize business opportunities, such as those that emerge with the development of new technologies, can increase the total value creation potential by identifying new ways to create and capture value. This can, for example, be achieved by analysing business models in other industries and adapting these models to the industry in which the focal firm operates. Developing and designing new business models can therefore be classified as a second‐order capability to business model thinking.

Finally, companies may face a situation in which their established business model is under threat of becoming obsolete. Chemical and pharmaceutical companies that have the capability to anticipate the need to transform their established business model, re‐think their traditional business model, namely question the current way of value creation and value appropriation, and the capability to manage the transformation process, will be able to survive in dynamic and competitive environments. Re‐thinking and transforming existing business models can thus be classified as a third‐order capability to business model thinking.

To illustrate the role of these three capabilities we have associated each of them with a quote from a CEO in Figure 7.5. Later you will find a more detailed description of how to develop these capabilities and you will be provided with some basic questions to test whether your firm is ready for business model innovation. But beforehand you need to understand why business model innovation is important and why business model innovation is often challenging for incumbents.

Companies often invest substantially in the development of product and process innovations to achieve future revenue growth, profits and market advantages. However, creating, developing and then commercializing those innovations is more and more complex and expensive. Firstly, this is because technologies and business contexts change more rapidly. Secondly, existing business rules (e.g. assumptions about scale or profit mechanisms) that are built to increase efficiency and revenue are more often in conflict with innovations. Thirdly, innovation takes place more frequently in new, uncharted areas, that is, areas where no precedent products and services exist, overlooked market segments emerge, or the nature of competition is changed by new operational capabilities. In turn, this also implies that companies today may face competition from players that were traditionally not considered a threat at all – not only in terms of competition from the low‐end of the market, but also in terms of competition from other industries. As an example of unexpected competition from a different industry, consider the case of Google’s self‐driving car from the viewpoint of, for instance, Volkswagen. Over recent years, Google has acquired several robotic companies, such as Boston Dynamics and Schaft, and is actively developing capabilities in the field of robotics and in particular in the field of self‐driving cars. These activities are not only a hotbed for future technological development, they are Google’s way of strategically positioning itself in the markets of the future. In the case of cars, Google is adding robotics and auto‐driving to its capabilities and competencies in maps and route planning. Taken together, Google is thus building core strengths for the production of autonomous cars. While established automotive companies such as Volkswagen certainly did not view Google as a potential competitor ten years ago, they should do so today (or at least seriously observe Google’s robotic initiatives that, moon‐shots aside, are not cute science projects but rather intended to sell products sooner rather than later).

While future returns from investments in innovation are always uncertain, it is today even more difficult (1) to evaluate the potential of new ideas due to increasing complexity and (2) to justify investments in innovation when the expected net revenue is smaller due to rising costs of innovation and shorter product life cycles. Meanwhile, this situation is far from news to companies. Many firms accept that the environment for innovation is today more complex and expensive than it used to be. Though they accept this, it is surprising that companies still struggle to manage innovation (e.g. Blackberry) or even survive in this environment (e.g. Kodak). We find that firms struggle because they view innovation entirely through a product‐, service‐ or process‐lens (or worse through a market‐capital‐lens). Instead, successful firms realize that value creation in this environment goes beyond traditional types of innovation and encompasses new ways of achieving competitive advantage. Research shows that many firms innovate in operations and/or products and services in response to fundamental changes in their industries, but financial outperformers put twice as much emphasis on other forms of value creation and on new ways of achieving competitive advantage as underperformers do [26]. One can conclude that successful firms recognize that:

1. innovation is more than R&D and technology
2. innovation can be a fundamental reconceptualization of what the business is all about.

Together, successful firms engage in business model innovation in response to a fundamental change in their environment.

Many companies realize that shifts in the economy open up opportunities to create breakthrough growth and allocate a lot of energy and resources to the generation of business ideas in such an environment. Meanwhile, the same companies often struggle to convert breakthrough ideas into sustainable businesses. By breakthrough ideas we mean the highest risk, highest return type of innovation. The challenge for incumbents with breakthrough ideas is to realize that generating breakthrough ideas is not enough because the capabilities of the company that “surround” this category of ideas and new technologies “will make or break them” [27: 66]. Accordingly, breakthrough ideas can often not be converted into breakthrough growth because they go beyond idea generation and leadership excellence. In a study by Vijay Govindarajan and Chris Trimble, one executive described this phenomenon as follows: “I came to the conclusion […] that limits to innovation have less to do with technology or creativity than organizational agility” [27: 58]. Thus, the problem with breakthrough ideas is that they very often cannot coexist with the established business. As a consequence of this unnatural coexistence, breakthrough ideas often fail, when firms do not have the organizational agility to “cultivate” them. In this context, organizational agility means that firms have to build and successfully launch a new business model around the breakthrough idea when the existing business model is not suitable for commercializing the idea. Business model innovation therefore refers to the introduction of a new business model in an existing market. In summary, truly transformative companies never focus exclusively on R&D and the commercialization of new technologies. Truly transformative companies recognize that innovation includes business models, rather than just products or processes.

A changing environment is not only an opportunity to create and commercialize breakthrough ideas to achieve long‐term growth with new businesses, but it can also be a serious threat to the established business of a company. Instead of having an existing business in strategic health and developing a new business (model) to commercialize a breakthrough idea or technology in addition to the established business model, the situation here is that the strategic health of the existing business model is in danger. When the existing business model of the firm is threatened with becoming obsolete, a fundamental reconceptualization of what the business is all about may become necessary. Accordingly, rather than introducing technological innovations (in combination with a new business model), the affected firm has to find a way to “break the rules of the game”¹ in its industry. Business model innovation therefore not only refers to the introduction of a new business model in an existing market but also to a fundamental change in at least one design element of an established business model (since the design elements of a business model are interdependent, a fundamental change in one design element, e.g. the profit formula, as a consequence affects the other elements as well). When firms recognize that innovation requires a fundamental reconceptualization of what the business is all about, they engage in business model innovation (sometimes also termed strategic innovation), which “in turn, leads to a dramatically different way of playing the game in an existing business” [28: 32]. As an example, in the 1960s Xerox dominated the photocopier market with a business model designed to serve customers that demand fast‐working copying machines that can handle high volumes, that is, large corporations. Elements of Xerox’s business model, for example, a professional sales forces (key resources) and leasing (profit formula), were tailored to serve these corporate customers as well as possible. In fact, Xerox’s business model was so successful that some entrants, like IBM and Kodak, tried to adopt basically the same model. When Canon entered the market for photocopiers it decided, however, to compete with a fundamentally different business model. Instead of tailoring its business model to serving large corporations, Canon designed a business model to serve small and medium‐sized enterprises that were overlooked by Xerox, because they did not demand high‐speed copy machines. To make photocopiers affordable for these customers, Canon consequently differentiated itself based on price instead of speed. This different customer value proposition had consequences for other elements of its business model. For example, Canon leveraged partner capabilities by selling its machines through a dealer network instead of through its own distribution channel by means of a direct sales force. While entrants like IBM and Kodak were not very successful in imitating Xerox’s business model, Canon was able to become the market leader in terms of unit sales because it entered the market with an innovative business model [28].

Accordingly, business model innovations by entrants and business model innovations by incumbents can be two sides of the same coin. On the one side, business model innovations by entrants threaten the business of established firms, and on the other side, established firms can respond to exactly that kind of threat with business model innovation. Consequently, understanding business model innovation and thus realizing innovation can be a fundamental reconceptualization of what the business is all about is relevant for established firms and newcomers alike.

While it may sound obvious to change the established business model before it becomes obsolete, several barriers exist that prevent an early adoption of an incumbent’s business model. For example, a prerequisite for business model innovation from established companies is to fundamentally question the firm’s present way of doing business. However, as Constantinos Markides notes very well in one of his studies, “advising companies to question their way of playing the game and think of alternative ways, especially when they are successful, is fruitless […] they simply do not do it, even though they know and agree with the principle” [28: 34]. To understand the reason for this disturbing observation, let us consider a company that has experienced a history of increasing profits, then, after profits have reached a maximum, a profit decline, and finally a financial crisis (net income loss, etc.). More often than one might expect, companies do not begin to question their business model in times of declining profits but only when they are already in a financial crisis. It is not difficult to understand that innovating a business model in the middle of a financial crisis is the worst time to do so. Most obviously, the ideal scenario would be to question a firm’s current way of playing the game not when the numbers are red but when profits have reached a maximum. The problem with this intuitive scenario is that financial metrics that are typically applied by companies to monitor the health of a business model will at the point of maximum profits not indicate an upcoming crisis [28]. Accordingly, when firms are successful, many managers will argue against a change, simply because metrics indicate good financial health. This inertia of success is often the reason why firms recognize a necessary change in their business model too late.

Before exploring how to overcome the inertia of success, let us address another common pitfall in the context of business model innovation: business model innovation is “not about what the business will be doing in 20 years; [it is] about the preparations it must make today” [27: 110]. This statement should be framed and placed somewhere in a company’s executive meeting room because we frequently observe the opposite understanding of business model innovation in the chemical and pharmaceutical industry. Business model innovation is not about the choice of business model design elements in 20 years, it is about the changes a firm has to make today to still exist in 20 years. Too often we notice that managers confuse business model innovation as a kind of forecasting tool; business model innovation has more to do with the present than most managers realize. This in turn is one reason why business model innovation often fails – at the point when an (unprepared) company recognizes the need to change, it is already too late to alter the course, because the time to make the preparations for a fundamental change in the business model is over. True, examples exist where companies had their backs against the wall and managed to rejuvenate themselves out of a financial crisis by means of business model innovation, for example, Dow Corning with Xiameter, but for one company that manages this transition there are hundreds of firms that did not. The business graveyard is littered with failed business model innovators. This is not only a disaster for the focal firm but for the whole economy. For instance, at its peak Kodak² had 160 000 employees and a market capitalization of $28 billion, and Blockbuster (a company that offered video rental services in the United States) had 30 000 employees and a market capitalization of $5 billion at its peak. Both companies missed adapting their business to the digital revolution and went bankrupt (when Blockbuster had to close its last stores in 2013, CNN titled the story “digital killed the video store”).

So how can your company become a successful business model innovator? To answer this question, we will break down the three core capabilities (understanding and managing existing business models, developing and designing new business models and re‐thinking and transforming existing business models), which we introduced earlier, into six steps:

1. Analyse your current business model. The fundamental starting point to business model thinking and business model innovation is to understand your present business model. Particularly in the chemical industry one can observe a lack of communication from top management about the elements of the firm’s business model. Business models need to be explained. It is the job of every executive to communicate the business model internally. The better you communicate what your business model is, the better it can be executed, and the more likely it is that people in your company can identify a need to change the business model. These questions will help you to develop a thorough understanding of your present business model: What are the key elements of your business model? What value proposition(s) do you offer? How do you deliver value to your company? What key resources and key processes do you need to deliver your value proposition? What makes your business model unique? What are the strengths and weaknesses of your current business model?
2. Develop the capability to manage your business model. Companies need to understand how to manage their present business model before engaging in business model innovation. A firm’s business model connects the strategy level of the company with its operational level, for example, the firm’s supply chain practices. Successful companies align these interdependent levels by creating strategic fit. These questions will help you to identify core management tasks: Do you have product groups with similar business models in your portfolio? How do the business models in your portfolio benefit from each other? How do strategic orientation and the design of your present business model reinforce each other? What contingency factors, such as shifts in competition, changing regulation, disruptive innovation, are a threat to your current business model? Would any of these contingencies require a fundamental change in your business model? If your chemical or pharmaceutical company was Apple (Amazon, Dell, GE, Google, McDonald’s, Skype, UPS, Wal‐Mart, or any company that operates differently to other companies in your industry), what would your business model look like and how is this different from your current way of doing business?
3. Develop the capability to sense the need to adapt your business model. In order to recognize a necessary change, firms need to develop a strategic sensing capability. A first step to developing this capability is to “forget” about the existing business model of the firm. This means that a firm has to “leave behind notions about what skills and competencies are valuable” [27] and subsequently find a new answer to the fundamental questions that define a business. “Throwing assumptions overboard” is something that is easy to say but difficult to achieve because companies have strong sources of organizational memory. Sources of organizational memory may cause companies to assume that what has successfully worked for the established business model will also work in the future. Because firms’ existing rules, metrics and norms can interfere substantially with those needed in the future, it is important that firms develop a questioning attitude and systematically begin to sense alternative ways of operating. In this context, a questioning attitude refers to mentally experimenting with a few “what ifs” and “whys.” Developing this kind of attitude is especially difficult when your company has well‐established performance standards, a history of promoting from the inside and a strong culture of holding people accountable to plans. Moreover, as you have already learned, financial metrics cannot tell you early enough that something is wrong with your business model (don’t get it wrong: you absolutely need financial measures such as ROI or gross profits but they do not monitor the strategic health of a business). Accordingly, you need measures for strategic health and not just for financial health. These strategic measures are company‐specific but could be things like customer dissatisfaction, structural changes in the industry, deregulation, distributor and supplier feedback, or even employee morale. In a second step, successful business model innovators challenge the established planning process of the firm. Under stable conditions, the typical annual planning cycle of an established business works, but if business realities begin to change you need a more frequent planning cycle, such as quarterly or even monthly. Moreover, in a typical planning meeting companies spend more time on questions about efficiency, that is, how to improve operations, than on asking who their customers are and what kind of job they really want to get done. Sensing requires focusing more on the who‐ and what‐type of questions. Therefore, a forward‐looking executive not only focuses on performance excellence and continuous improvement of the existing business, that is, the execution of the existing business model, but promotes the long‐term potential by questioning the status quo [27]. Overall, it requires strong leadership to “see a different future and having the courage to abandon the status quo for something uncertain” [28].

   These questions will help you to develop this capability: Who is our customer? What if our customers begin to value different attributes of our offering and what if their priorities among these attributes change? Why do our customers pay the way they do? What if our customers can no longer be reached through our traditional distribution channels? What if we have to operate our business abroad, why would our domestic business model still work in a foreign country? Do we have measures for customer/employee satisfaction/dissatisfaction? In our planning meeting, how much time do we spend on how‐type questions and how much time on who‐ and what‐type questions?

4. Integrate customers and suppliers during business model development. Business models need to be explained and communicated – not only internally but also externally. Discussing your business model design with your most important customers and key suppliers will help you to transform your present business model. From our point of view, most chemical and pharmaceutical companies already integrate their customers into their new product development efforts on a regular basis. This integration, however, needs to be shifted from a product to a business model level. In the case of supplier integration, there is still a lot of untapped potential in the chemical and pharmaceutical industry. In contrast to, for example, the automotive industry, suppliers are more seldom integrated into innovation efforts in the chemical and pharmaceutical industry. In terms of business model innovation, companies should, however, consider customer and supplier integration equally.

   These questions will help you to integrate customers and suppliers into the business model development process: What is the business model of your customer (supplier)? On a scale from 1 to 7, how different is your current business model from those of your key customers (suppliers)? Which three key suppliers are needed to operate your present business model?

5. Use strategic and operational flexibility to successfully implement a new business model. Because organizational memory is an obstacle to forgetting how your business currently operates, one might come to the conclusion that the easiest way to ensure that the established organization does not interfere with the implementation of a new business model would be to strictly separate the new from the established business model. Though a separation strategy has advantages, a complete separation does not come without disadvantages and is in fact often impractical. The biggest disadvantage of a complete separation is that it prevents exploitation of synergies between the two business models [29]. Accordingly, firms face a trade‐off. On the one side, a new business model has a lot to borrow from the established business, for example, supplier network or people, but on the other side if the new business borrows too much, breaking free of organizational memory becomes more difficult. Thus, companies have to keep a balance between separation and integration of the two business models. This requires strategic and operational flexibility. A rule of thumb is that the new business should only borrow those resources that are crucial to gain competitive advantage. Therefore, a small and carefully selected number of links between the established and the new business has to be established and managed. This requires significant attention from senior management because points of interaction often create tension between the two businesses and their business models. Those tensions might even disintegrate the collaboration between the two businesses and consequently destroy the new business. Firms should hence promote collaboration through individual incentives that reward managers’ willingness to collaborate, compensate the established business when it releases resources to the new business and reinforce common values to build trust between the two businesses. Overall, a firm’s top management needs to convince unit heads, or those managers in the established business who have to share resources with the new business, of the relevance and usefulness of resource sharing. Because these conflicts tend to be serious, it is advisable to let a senior executive with a proven track record supervise this process. As a general rule, the more intense the anticipated conflicts are, the more separated should the new business model be. We can conclude that companies that have the flexibility to re‐allocate resources and reconfigure processes will more likely be able to succeed in business model innovation.

   These questions will help you to identify core management tasks for the development of strategic and operational flexibility: How painless is resource sharing, for example, between business units, in your company? Are the new business model and the established business model strategically related (same market, same profit formula, etc.)? What key processes are an inherent part of the new business model and which can better be performed in the established business? What level of autonomy does the new business model require with respect to rules, norms and metrics? Is a new culture required to successfully operate the new business model?

6. Learn from strategic experiments with business model design elements. Executing business model innovation does not just require strategic and operational flexibility. Companies that successfully transform their business model engage in strategic learning, that is, they conduct experiments among the design elements of a business model, accept failure but fail fast and learn from failure with speed and discipline. During the implementation of a new business model (or the transformation of your established business model), you will naturally face a lot of uncertainties. It is important to solve these critical uncertainties with speed and discipline because unknowns will make or break the new business model. Strategic learning is a process, starting with “wild guesses” and ending with “reliable forecasts.” Because predictions are at the outset imprecise and uninformed, and consequently tend to be wrong, it is quite tempting to forget them or put little effort into their analysis. For example, top managers at the new business may assume that the new business has little time to review discrepancies between planned outcomes and realities because they want to focus on execution (instead of planning) in order to quickly achieve first‐mover advantages. However, “predictions are important not because of their accuracy but because of the learning opportunities they present” [27: 66]. Companies should therefore carefully analyse disparities (including positive disparities) between predicted and actual outcomes, such as sales or profits. This analysis is a crucial learning step during the ongoing development of a new business model because decision‐making based on discarded or overly aggressive predictions can lead to fundamental misjudgements of business conditions, preventing necessary adjustments in the design of the new business model. To improve learning, companies can for example create architectural variety among the design elements of their model by testing different designs, such as at different locations. In so doing, companies can learn which business model designs work and which do not, and act on that knowledge. Joan Magretta once described this process as follows: “Business modelling is, in this sense, the managerial equivalent to the scientific method: You start with a hypothesis, which you then test in action, and revise when necessary” [3: 90]. Inspiration for experiments with the design elements of your business model can come from almost everywhere – but in particular from other industries and markets. These experiments do not have to be complicated. Consider an unusual example for an experiment with a firm’s profit formula: imagine a German zoo in December. It’s cold, it’s grey and it’s raining a lot. The zoo in the city of Münster has on average 11 200 visitors in December – the lowest number throughout the whole year. In December 2012 Münster zoo decided to do a small experiment with its profit formula and offered customers the opportunity to pay whatever they liked to get into the zoo. Instead of selling tickets at a regular price (typically around €12 in winter), this pay‐what‐you‐want‐model enabled customers to pay more or less than the regular price or even nothing. What is easy to guess is that the number of visitors significantly increased in 2012. Indeed, the number of visitors increased by a factor of five. Surprisingly, revenue increased by a factor of 2.5 at the same time. Although the zoo’s basic business model remained the same, this experiment with the profit formula was a huge success. Münster zoo tried the same again in 2013 and it was even more successful. In fact, the zoo had so many visitors that it had to stop the pay‐what‐you‐want‐model in order to protect the animals from too much stress. One can draw two conclusions from this simple example. (1) Experiments with the business model design do not have to be complicated. (2) Take a look outside your own bubble (company/market/industry) to get inspiration for business model innovation. From our experience, developing a learning attitude is the capability most difficult to build.

   These questions will help you to identify core areas in developing a learning capability: On a scale from 1 to 7, how good is your firm in identifying strategies that have not worked? How easy is it to recognize alternative approaches to achieving your firm’s objectives? How accepted is it in your company to fail? How fast can you adjust your business model design?

   In practice, these six steps will help you not only to develop a business model that is new to your company but one that is also appropriate in the market. Overall you need both novelty and appropriateness (Figure 7.6).

7.4 The Role of Business Models in the Chemical and Pharmaceutical Industry

We will close this chapter with a look at why and how chemical and pharmaceutical companies engage in business model thinking and business model innovation. Both the chemical and pharmaceutical industries are facing dynamic change on a global scale. Global megatrends such as growing and aging populations, energy and climate change and inter‐industry innovations (e.g. electric mobility) provide growth opportunities for chemical and pharmaceutical companies but also represent challenges.

On the one side chemical and pharmaceutical products that increase sustainability, quality of life and health represent opportunities for downstream expansion. Companies that can leverage their core competencies to seize these opportunities can create value by increasing supply chain sustainability, integrating core businesses and/or by moving beyond current areas of operation. Accordingly, the changing shape of the chemical industry’s value chain that has forced companies to diversify and reduce value chain coverage, from the 1990s onwards, is estimated to continue. Some companies will continue to integrate forward, for example, to performance chemicals, while others, particularly chemical companies in emerging economies, will focus upstream on feedstock foundations. Future growth in the chemical and pharmaceutical industry will also be enabled by new functional materials, such as in the area of battery materials or functional crop care and the creation of “system solutions.” Companies that have the capability to identify new ways to deliver future technologies to customers and to expand into new application fields, for example, personalized medicine, are estimated to significantly benefit from this development. Furthermore, shifts from developed to emerging economies such as Argentina, Brazil, Malaysia and Thailand, particularly in markets for plastics, agrochemicals, pharmaceuticals and automotive materials, continue to create growth opportunities. Capturing growth in emerging economies requires that firms develop the capability to manage complex global supply chains and operations, balance global and regional strategy execution and create ways to seize business opportunities at the bottom of the pyramid.

On the other hand, the changing industry landscape threatens traditional ways of operation and value capture. Shifts in competition, such as from low‐end disruptors, commoditization, “genericization” and new industry entrants that target emerging customer segments, challenge the traditional ways of how incumbents do business. Established chemical and pharmaceutical companies face the challenge of transforming their businesses by increasing agility and flexibility, reducing complexity and improving resilience to shifts in competition. Companies that seize downstream business opportunities for example become more customer‐focused but meanwhile increase the complexity of their operations. Closing or divesting upstream businesses in a firm’s business portfolio and meanwhile focusing on downstream opportunities in future growth markets, for example, medicines for rare diseases, OLEDs (organic light‐emitting diodes) or lithium‐air batteries, may hence not be the appropriate decision. In fact, responding to the defection of customers to low‐cost suppliers by disrupting the disruptor may create competitive advantage and increase a firm’s performance. Creating the right mix in a firm’s portfolio, understanding interdependencies between business segments and identifying the right collaboration partners that enable fit between a firm’s value creation activities as well as between a firm’s interdependent businesses are challenges that chemical and pharmaceutical companies need to address more than ever. The management consultancy Accenture concludes in a recent chemicals report that “[a] changing, more complex world drives the need to rethink existing business and operating models that are key to delivering high performance” [30].

Based on these observations one can conclude that chemical and pharmaceutical companies need to consider business models to: (1) create value inside and outside their core area of operations, (2) to commercialize new technologies in new application fields, (3) to respond to shifts in competition and (4) to identify new ways of value creation and appropriation (Table 7.4).

7.5 Summary

• A business model describes how companies create and capture value. It consists of four interlocking elements, namely the customer value proposition, the profit formula, the key resources and the key processes. The internal consistency of choices among these elements determines the effectiveness of a business model.
• Successful companies help their customers to get an important job done. Successful business model innovators do not start with a product idea, they start with identifying how to help customers get an important job done and then develop a blueprint of how to fulfil that need profitably.
• Business model, strategy and tactics are related but they are not the same. The business model, as a system of choices and consequences, is a reflection of a firm’s strategy but it is not the strategy. Strategy is about which business model a company should choose. The business model determines the tactics that are available to a firm.
• Business model innovation is not about how a business looks in 20 years; it is about the changes a company needs to make today to still exist in 20 years. Business model innovation is the introduction of a new business model in an existing market and/or a fundamental change in the design elements of an established business model. Business model innovators have an excellent understanding of their established business model, can sense the need to adapt it, integrate customers and suppliers during the development of a new business model, have the necessary strategic and operational flexibility to manage two business models simultaneously and have a strong strategic learning capability.
• Do not overestimate business model innovation and never forget competitive strategy. Companies should only engage in business model innovation if they are confident that the opportunity is great enough to warrant the effort. Moreover, the best business model is worthless if the company has no competitive strategy, namely, a plan to create a unique position in a competitive marketplace.

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