HESSELBEIN & COMPANY
THE TIME HAS COME FOR BUSINESS MODEL INNOVATION
Could you describe your company’s business model in 25 words or less? I would be surprised if you could. If you did, your response would more likely be a strategic vision statement, a P&L description of the company (say, “we’re a high-margin business”), or perhaps an analogy (like, “we have a razors-and-blades model”). But that’s not what I mean by your business model.
To be fair, there’s really no consensus about what the term business model means. Suggestions range from the all-encompassing, everything-in-your-value-chain approach to the simpler “a business model is nothing else than a representation of how an organization makes (or intends to make) money.” But a business model has to specify more than just how a company intends to make money. It also needs to include some information about why customers would ever want to give a company their money.
That is, a business model needs to identify those elements, and only those elements, that allow a company to deliver value to its customers while also delivering value for itself. To that end, in Seizing the White Space: Business Model Innovation for Growth and Renewal I’ve proposed a framework I call the Four Box model to describe the core DNA of a company, focusing on the customer value proposition (CVP), the profit formula, key processes, and key resources.
A company delivers value to its customers through its CVP (the first box). That is, it offers its customers some goods, services, or a combination of the two that fulfill an important job a customer needs to get done better than any current alternative does.
And in doing so, the company delivers value for itself through its profit formula (the second box), which on one level might be thought of as merely revenue (how much you expect to sell at a certain price) minus your costs. However, to make this more useful as a strategic tool, I’ve broken out profit formula into four buckets: revenue model, simply quantity times price; cost structure, including direct costs, indirect costs, and overhead; margin model, which I break out so companies will understand how a lower-margin opportunity could ever be profitable; and resource velocity, often overlooked as a profit generator, which measures how many widgets a company can invent, design, produce, warehouse, ship, service, sell, and pay for throughout the value chain for a given amount of investment, for the given amount of time a company actually executes the profit formula to deliver the customer value proposition.
The company delivers the CVP through certain key processes (the third box) which require certain key resources (the fourth box). These are not all the elements of the value chain—only those vital to operating the profit formula in the delivery of the CVP. I take the time to lay out all these parts of the profit model because people often equate the profit formula with the entire business model. That’s often all that’s captured in many business model analogies, as well. Worse, many people focus just on the margin or overhead requirements of their current model.
But every successful company is operating according to a business model that incorporates all four parts of this framework—a value proposition customers want, delivered through a coherent profit formula, which not only covers overhead and margins but generates revenue at a certain volume and velocity, by employing certain key resources effectively through certain key processes. That’s the model I asked you about at the beginning.
Identify all the components of this model and you will understand why your company is successful in what it’s doing. Perhaps even more important, you’ll have a starting point for working out what you’d need to change to capitalize on a new opportunity or respond to a competitive shift that can only be addressed with a different business model. That’s easy to say but clearly not easy to do. Few companies do it well, or even want to do it at all.
Making Business Model Innovation Systematic and Manageable
Smart companies don’t wait until they’re forced to transform their business models. They view business model innovation in much the same way they view product innovation, as something of an experimental capability, which, if pursued through a portfolio of small-scale experiments, will greatly expand their strategic options in response both to home-grown opportunities and to potential disruptors or market shifts that require new business models.
To develop this kind of capability, business model innovation needs to become a systematic, manageable process rather than one reliant (as it so often has been in the past) on luck, serendipity, and inspiration. I see it as a three-step process—and one that doesn’t in fact begin with business models at all. It begins, as most start-ups do, with identifying a real job that a real customer needs to do. Once you’ve identified a real need, you fashion a CVP that meets that need. The next step is to conceive of possible business models—independent of any constraints of your current one—that can fulfill that value proposition in a profitable way.
This means constructing from the ground up all four boxes of the business model framework I described earlier. If that model is very different from your current one—in particular if it requires lower margins or overhead, substantively different processes or resources, or different incentives and measures of success—then it’s best executed separately from your current operations. Comparing that model to your current one will tell you if you need to set up a separate unit to capitalize on your opportunity or could successfully grasp it through your current operations.
If a new model is needed, step three is to implement it—not all at once, as you would with an improvement to your current model, but as a carefully thought-out series of low-risk experiments in which you test hypotheses about the model and apply lessons learned. In this way, you considerably lower your risk. And the lower you make your risk of venturing into the unknown, the more you expand your strategic growth opportunities beyond your core.
So what are the circumstances that would require a new business model? What I suggest is that strategists need to think first about the external circumstances and then about what the company may or may not need to change. This thought process will help you decide if what you’re talking about is a fundamental business model change.
At a very basic level, circumstances that call for business model innovation can be grouped into threats and opportunities. What kind of threat would require all this effort? Or what kind of opportunity would be worth all this effort?
Responding to Threats
Let’s start with the two basic threats, or those times, as Peter Drucker would say, when “the theory of the business is no longer working.” The first is the process of commoditization. Generally speaking, industries as they mature go through a fairly predictable progression, in which the basis of competition—that is, what customers are willing to pay premium prices for—changes. When an industry is young, companies compete on the basis of performance. Customers will pay more for the widget that does more, and companies respond through product innovation. Eventually, companies figure out how to make the widget do pretty much everything a customer could want it to do, and the basis of competition shifts to reliability. Customers pay a premium for the widget that lasts the longest or breaks down least often.
Companies rise to this challenge through process innovation. That’s what made Toyota so successful and why the current product recalls are so much more damaging for it than they might be for a company not so clearly identified with reliability. Eventually, though, the basis of competition will shift again—to customization and convenience—that is, customers will pay more for a product they can get more easily or that’s more tailored to their own particular needs. And, eventually when all of that is said and done, markets progress to pure commoditization, when customers don’t seem willing to pay a premium for anything and everyone is competing only on price.
When an industry moves beyond the reliability stage, companies are usually unable to respond with their current business model. Customization and convenience often require radically different processes and distribution systems, which may in fact conflict with a company’s existing model. That was true in the market for personal computers when Dell Computer introduced a direct-to-customer, manufacture-just-what-the-customer-wants business model that was not only fundamentally different from the prevailing high-volume, mass-produced model IBM and Compaq had mastered, but conflicted with their retail distribution systems.
When commoditization looms, business model innovation offers the promise of a path back to profitability. That was true for high-end silicon products manufacturer Dow Corning, when its high-margin, high-touch business model was threatened by decreasing demand for technical support among some segments of its customer base. Rather than cede those customers to a competitor, Dow Corning created a whole new business unit called Xiameter to execute a radically different business model in which it lowered costs, not only by stripping away support (which would just lower its margins) but by sourcing its product on the spot market.
Dow Corning is perhaps a rare case in which an incumbent company faced with customers demanding lower-margin products didn’t just put its head in the sand and say, “Well, we can’t serve those customers profitably, so we won’t, and we hope no other competitor does either.” So often when a company puts its head in the sand, its hopes are dashed and a competitor emerges that’s more than happy to take those customers away.
That’s the classic pattern of disruption—the second threat to which a company would need to respond with business model innovation. Take the case of the old integrated steel mills when they confronted a disruptive threat from small minimills, which had worked out a way to produce lesser-grade steel at far lower cost. The big, integrated mills had two choices. They could either pass along all that low-cost business to the minimills (which is, in fact, what they did), or they could say, “Well, we’re being disrupted, so let’s come up with a whole new business model to address that.” If they had gone with option two, they might have survived when the minimills improved their quality and began eating the entire customer base from the bottom up.
Capitalizing on Opportunities
Responding to threats is clearly responding reactively. But companies can employ business model innovation proactively as well to create or capitalize on new opportunities. In that case there are two particularly fruitful circumstances in which a new business model can enable a business to take advantage of opportunities.
The first opportunity is the chance to democratize a market—that is, open it up to people who have been entirely shut out because all current alternatives are either too expensive, too time-consuming, too complicated, or too inaccessible for them. To use the computing world as an example, we went from mainframe computers to minicomputers to personal computers to laptop computers to netbooks and handhelds. Generally speaking different companies dominated at each stage. That’s because each of those steps required a different business model. There’s a lot more to it than that, but that’s a fairly simple example.
The final circumstance in which business model innovation is needed is when a company comes up with an internal innovation that it doesn’t know what to do with. Xerox PARC is the classic sad example—scientists there famously came up with the graphical user interface and the mouse. But those technologies would have required Xerox to take a different approach than just saying, “How does this apply to copiers and the copier business model?” So those technologies ended up in the Apple computing business model. Later, Ethernet technology went into 3Com, and Adobe used the PostScript technology when it started up.
Really, all those technologies required different business models. If Xerox had been as good at innovating business models as it was at product innovation it would have given itself the opportunity to reap the fruits of its own labors.
Focus on Where the World Is Going
Not all new opportunities or threats require business model innovation. The only way an individual company can determine for sure whether a particular threat or opportunity requires an entirely new business model is to work up an initial estimate of the business model that could capture the new opportunity (or address the threat) and compare it with its current model. The Swiffer, for instance, although it was highly disruptive to the traditional mop makers, fit squarely within Procter & Gamble’s established model for making and distributing household consumables in high volume.
That’s why it’s imperative that companies judge opportunities and threats first according to their own capacity to meet them—that is according to how they fit with their own business models—rather than according to how near or far the opportunity might be to competitors. Going after a seemingly lucrative opportunity with the wrong business model is what has led so many companies to fail in their efforts at transformational growth. And failing to respond to a disruptor in your market because it requires you to develop a new business model can be suicidal, as the big integrated steel companies found out.
Conversely, though, failing to grasp opportunities like P&G did with Swiffer—using your current business model to disrupt other markets—is just throwing money away, something companies can ill afford in the current economy.
Companies that develop a robust business model innovation capability will be able to focus on where the world is going—and where they would like to go—unencumbered by their existing systems and structures. By comparing how different a new business model is from your current one (particularly in terms of margins, overhead, and success metrics), you can get a clear picture of what you’d need to do to grasp the new opportunity. Would it be easy because it dovetails well with your current model, or would it require you to marshal different resources and processes? Once you know that, you can be flexible and respond effectively because you’ve already experimented with and built a business model that will take advantage of that shift.
Mark W. Johnson is the author of “Seizing the White Space: Business Model Innovation for Growth and Renewal” and chairman of Innosight, a strategic innovation consulting and investing company with offices in Massachusetts, Singapore, and India, which he cofounded with Clayton M. Christensen. He has consulted to Global 1000 and start-up companies in a wide range of industries—including health care, aerospace and defense, enterprise IT, energy, automotive, and consumer packaged goods—and has advised Singapore’s government on innovation and entrepreneurship.