Business model innovation

Business Model Innovation (BMI) refers to the creation, or reinvention, of a business itself. Whereas innovation is more typically seen in the form of a new product or service offering, a business model innovation results in an entirely different type of company that competes not only on the value proposition of its offerings, but aligns its profit formula, resources and processes to enhance that value proposition, capture new market segments and alienate competitors.

Evolution and key principles of the theory

Adrian Slywotzky, a consultant and author of several books on economic theory and management has highlighted the importance of adjusting the Business-Design in order to adjust to value migration or drive value value migration within an industry.

Clayton Christensen, a Professor at the Harvard Business School, cites the need for business model innovation as one of the core elements of a successful market disruption. In his book The Innovator’s Prescription (McGraw Hill 2008) he and his co-authors define the role of BMI by stating that first, a simplifying technology is needed to spark the disruption, a new business model is then needed to maximize the reach of the technology and a comprehensive value network must finally evolve to support it.

The BMI concept itself was explored in detail by Mark Johnson of Innosight, Clayton Christensen, and Henning Kagermann of SAP in their McKinsey Award winning feature article “Reinventing Your Business Model” published in the December 2008 Harvard Business Review. Mark Johnson built on this framework in his book Seizing the White Space: Business Model Innovation for Growth and Renewal (Harvard Business Press 2010) when establishing the 4-box model. According to this model, a business model consists of four interlocking elements that, taken together, create and deliver value. Innovation can occur in one or more of these areas simultaneously:

Customer Value Proposition First and most important, a successful company is one that has found a way to create value for customers — that is, a way to help customers get an important job done. By job we mean a fundamental problem, in a given situation, that needs a solution. The best customer value proposition is an offering that gets that job–and only that job–done perfectly. The lower the price of the offering and the better the match between the offering and the job, the greater the overall value generated for the customer. The more important the job is to the customer, the lower the level of customer satisfaction with current options, and the better your solution is than your competitors’ at getting the job done, the greater the value for your company.

Profit Formula The profit formula is the blueprint that defines how the company creates value for itself. People often think that profit formulas and business models are interchangeable, but how you make a profit is only one piece of the model. It consists of the following:

Revenue model (price × volume)
Cost structure (assets; direct and indirect costs; and a model of how, and whether, scale affects costs)
Margin model (How much does each transaction need to net to cover the cost structure and deliver target profits?)
Resource velocity (How much revenue do we need to generate per dollar of assets and per dollar of fixed costs, and how quickly?)

Key Resources The key resources (or assets) are the people, technology, products, facilities, equipment and brand required to deliver the value proposition to the targeted customer. The focus here is on the key elements that create value for the customer and company, and the way those elements interact. Every company also has generic resources that do not create competitive differentiation.

Key Processes Successful companies have operational and managerial processes that allow them to deliver value in a way they can successfully repeat and increase in scale. These may include such recurrent tasks as training, development, manufacturing, budgeting, planning, sales and service. Key processes also include a company’s rules, metrics and norms.

Market context and circumstances fueling BMI

Bob Higgins, founder and managing general partner of Highland Capital Partners, is quoted in Johnson, Christensen and Kagermann’s Harvard Business Review article as saying, “I think historically where we [venture capitalists] fail is when we back technology. Where we succeed is when we back new business models.”

Business model innovations have reshaped entire industries and redistributed billions of dollars of value. Retail discounters such as Walmart and Target, which entered the market with innovative business models, now account for 75% of the total valuation of the retail sector. Low-cost U.S. airlines grew from a blip on the radar screen to 55% of the market value of all carriers. Over the past decade (1997-2007), 14 of the 19 entrants into the Fortune 500 owed their success to business model innovations that either transformed existing industries or created new ones.

A 2005 survey by the Economist Intelligence Unit reported more than 50% of executives believe that between now and 2010, business model innovation will be even more important for success than product or service innovation. A 2008 IBM survey of corporate CEOs echoed these results. Nearly all of the CEOs polled reported the need to adapt their business models; more than two-thirds said that extensive changes were needed.

An analysis of major innovations within existing corporations in the last decade (1998-2008), though, shows that precious few have been business-model related. And a recent American Management Association study determined that no more than 10% of innovation investment at global companies is focused on developing new business models. The authors therefore highlight five strategic circumstances companies commonly face that often require business model change:

1. The opportunity to address the needs of large groups of potential customers who are shut out of a market entirely because existing solutions are too expensive or complicated for them. This includes the opportunity to democratize products in emerging markets (or reach the bottom of the pyramid).
2. The opportunity to leverage a brand-new technology, wrapping the right business model around it or the opportunity to leverage a tested technology in a whole new market.
3. The opportunity to bring a job-to-be-done focus to a marketing-driven industry. Such industries tend to make offerings into commodities. But a jobs focus allows companies to redefine the industry profit formula.
4. The need to fend off low-end disruptors. If Tata’s 1 Lakh ($2300) Nano is successful, it will threaten other automobile makers.
5. The need to respond to a shifting basis of competition. Inevitably, what defines an acceptable solution in a market will change over time, leading core market segments to commoditize.

Business Model Innovation is an important tool to both capture, design, innovate and transform the business. However in order to transform ones organization and align them to ones business model, business model innovation can and should not be seen separately, but as Prof. Dr. Mark von Rosing has specified, in connection with:

File:Full Approach.png

A step-by-step roadmap that describes the synergy and context between business model innovation and alignment of business innovation into the organization.

• The main business goals of the organization, e.g. strategic business objectives, critical success factors and key performance indicators, which a holistic business model approach should include.
• The main business Issues/pain points and thereby organizational weakness, which a holistic business model approach should include for they represent the threat to the company’s business model.
• A clear cause and effect linkages between the competencies, desired outcomes and performance measurements e.g scorecards.
• An emphasis on business model management and thereby a continuous improvement and governance approach to the business model.
• The business maturity level, in order to develop the organization representation of core differentiated and core competitive competencies [linked to strategy], which is a basis for building a business model as they the represent some of the most important sources of uniqueness. These are the things that a company can do uniquely well, and that no-one else can copy quickly enough to affect competition.
• Linkages among competences and competency development.
• The possible value creation and realization of the organization.
• The information flow, and thereby information need for effective and efficient decision making.

Such a holistic approach would help clarify both intent and sources of synergy and disconnect between business model innovation, strategy innovation, scorecards e.g. performance innovation, information, innovation, processes innovation and at last but not least IT innovation. This includes business architectural alignment as well as business transformation and value and performance views. Such dialogues allow Executives to apply business model innovation with their business alignment.

Examples of BMI where the business model is the core value proposition

Tata–Tata Nano 1 Lakh ($2300) city car
Apple–iTunes Store + iPod
WalMart–Discount retailing
Hilti–Power tools leasing/subscription
FedEx–Guaranteed overnight delivery
Southwest–Low-cost regional air travel

Related concepts

Disruptive Technology/Innovation
Business Model
Business Design/Enterprise Architecture

References

• Johnson, Mark, Christensen, Clayton, Kagermann, Henning Reinventing Your Business Model Harvard Business Review, December 2008
• Christensen, Clayton, Grossman, Jerome, Hwang, Jason. (2008). The Innovator's Prescription: A Disruptive Solution for Health Care. McGraw Hill. ISBN 0071592083. 
• The Economist Intelligence Unit Business 2010: Embracing the Challenge of Change Report commissioned by SAP, 2005
• IBM The Enterprise of the Future Report, 2008
• Innosight LLC (Mark Johnson, founder, Chairman and CEO) Business Model Innovation webpage retrieved November 19, 2008. Text shared here under GFDL.
• Johnson, Mark W. (2010). Seizing the White Space: Business Model Innovation for Growth and Renewal. Harvard Business Review Press. ISBN 1422124819.