Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
Business Models Bibliography |
Organization Structure Main Page
Business model innovations are needed to address the shifts in an organization's competitive landscape. However, new model innovations are difficult for two reasons: a lack of definition, and the fact that few companies understand their current business model well enough to know when success requires a new model. The purpose of the article is to provide a roadmap for business model innovations that includes three steps. The main idea is to start by thinking about the opportunity to satisfy a customer need. Construct a blueprint or model for satisfying that need, and then compare that model with your existing model to see if a new business model is needed.
A Business Model Definition
The authors define a business model as consisting of four parts: A customer value proposition, a profit formula, key resources, and key processes.
1. Start by developing a customer value proposition, i.e., how to satisfy a real customer who needs to get a real job done.
2. Construct a profit formula that defines how the company creates value for itself while creating value for the customer. This includes a revenue model, cost structure, margin model, and resource velocity. Start with the price needed to deliver the desired profit and work backwards to determine what the variable cost and margins must be.1
3. Key resources required to deliver the value proposition to the target customer, e.g., people, technology, channels, etc.
4. Key processes that allow the company to deliver value that can be successfully repeated and increased in scale, e.g., training, manufacturing, planning, budgeting, sales, service, rules, etc.
How Great Models are Built
The most important part of a customer value proposition is how precise it is in satisfying the customer's need. A lack of focus dilutes the effectiveness of the model. A value proposition that attempts to do many things, tends to do nothing really well. To be precise, a company needs to start by thinking about the most common barriers that keep people from getting a job done: Lack of wealth, lack of access, lack of skills, and lack of time. For example, Intuit broke the skills barrier by developing QuickBooks, a program that provided small-business owners with access to simplified accounting software. Apple solved the access barrier when it introduced the iPod with the iTunes store to make downloading digital music easy and convenient. Tata Motors, broke the wealth barrier when it developed a safer, all-weather alternative (the Tata Nano) for the scooter families in Mumbai. Hilti, a Liechtenstein-based manufacturer of high-end power tools broke the time barrier when it shifted to a lease/subscription model that made a full complement of tools available to contractors on a timely basis.
Designing a Profit Formula and Identifying Key Resources and Processes
Tata Motors profit formula required a significant decrease in gross margins and a radical decrease in cost structure. It did this by dramatically minimizing the number of parts in the vehicle, and outsourcing 85% of the Nano's components to nearly 60% fewer vendors than normal to reduce cost and build economies of scale. It also developed a new business model for assembling and distributing its cars, i.e., ship the modular components to a network of company-owned and independent assembly plants that build their cars to order.
Hilti's tool fleet management service's value proposition is based on leasing a comprehensive fleet of tools to increase contractors' on site productivity. Their profit formula is based on higher margins, monthly payments for tool maintenance and replacement, supported by a direct sales approach, contract management, robust IT systems for inventory management and repair, and warehousing. They also developed a website that allowed construction managers to view all the tools in their fleet and their usage rates.
When Will the Old Model Work?
The old business model will work when it can fulfill the new customer value proposition with the current profit formula, key resources and processes, and core metrics, rules, and norms. For example, Procter & Gamble introduced the Swiffer using its existing business model because the profit formula and key resources were not radically different from their other household products.
When is a New Business Model Needed?
There are five circumstances that frequently require a business model change:
1. When large groups of potential customers are shut out of the market because of one or more of the barriers mentioned above, i.e., lack of wealth, access, skills, or time, e.g., the target customers for Tata's Nano.
2. When there is an opportunity to capitalize on a new technology by combining it with a new business model (e.g. Apple and MP3 players), or by leveraging a tested technology by bringing it to a new market.
3. When there is an opportunity to focus on doing a job that is not being done, e.g., FedEx's faster, more reliable package delivery service.
4. The need to fend off low-end competitors.
5. The need to respond to a change in the basis of competition.
Creating a new business model does not mean the current model should be changed. A new model may reinforce the existing model. Questions that help a company decide whether a new business model will produce acceptable results include:
1. Can a focused, compelling customer value proposition be developed?
2. Can a model be developed where all the elements (value proposition, profit formula, key resources and processes) work together to get the job done in the most efficient way possible?
3. Can a new business development process be developed without being influenced negatively by the company's core business?
4. Will the new business model disrupt competitors?
How Dow Corning Got Out of its Own Way
Dow Corning's development of a new model for Xiameter is provided as an example. The company's established value proposition was based on customized solutions, and negotiated contracts. It's profit formula included high-margin, high-overhead retail prices, and pay for value-added services. It's key resources were R&D, sales, and a service orientation. However, customers in the company's low-end product segment needed basic products at low prices and little if any service. The company needed a new value proposition for these price-driven customers and a new business unit to fulfill the need and avoid "the corporate antibodies that would kill the initiative" before it had a chance to succeed. There were just too many rules, norms and metrics standing in the way, e.g. requirements related to gross margins, product quality, pricing, channels, net present value calculations, etc. To satisfy this need, the new unit's value proposition was based on no frills, bulk prices, and products sold through the internet. The profit formula involved spot-market pricing, low overhead, lower margins, and high throughput. It's key resources were its IT system, lowest-cost processes, and maximum automation.
The Secret Sauce
When developing a new business model, companies have to focus on learning and adjusting, as well as executing. They also must be patient for growth, but impatient for profit, since profit is the best indication that the model is viable. Transformative business innovations are never exclusively about a new technology, but instead come from combining a new technology with a powerful new business model.
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Note:
1 The authors don't mention the term 'target costing', but that is essentially how target costing works. See MAAW's target costing section at Target Costing Main
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