Professional Documents
Culture Documents
A Framework For Business Model Innovation
A Framework For Business Model Innovation
A Framework For Business Model Innovation
net/publication/228466168
CITATIONS READS
37 12,658
1 author:
B. Mahadevan
Indian Institute of Management Bangalore
45 PUBLICATIONS 2,259 CITATIONS
SEE PROFILE
All content following this page was uploaded by B. Mahadevan on 18 February 2014.
Keywords: Innovation, Business Model, Framework, The term business model has been used widely among
Empirical Study the practising community and consultants in a loose
fashion. It is often linked to the revenue model or the
I. INTRODUCTION operating model of the firm and is used to indicate how
robust is the revenue potential of the business idea.
To be successful businesses need to constantly engage in Hamel [7] suggested that the high capitalisation of silicon
value creation for both the shareholders and the valley firms could be due to the business model than the
customers. Innovation has been recognised as one talent of the entrepreneurs. Kim and Mauborgne [8] took
potential lever for value creation. Despite this simple a narrower view of a business model. They defined
truth, business leaders have often grappled with the issue business model with the objective of arriving at a pricing
of value creation over several years. Recently, innovation structure for the product. Amit and Zott [9] noted that the
has been the subject matter of discussion by several perspective of business model is absent in the academic
researchers both in popular press and scholarly journals literature. They define business model as a careful design
[1,2,3]. Alternative forms of innovation have been of content, structure and governance of transactions so
identified in the literature. These include market, product, that it creates value. Venkatraman and Henderson [10]
process innovations [4] and technological innovation [5]. defined business model as a strategy pertaining to
Earlier research on sources of innovation has generally customer interaction, asset configuration and knowledge
classified innovations into Administrative Vs Technical leverage.
or Product Vs Process. However, in our understanding,
recently several firms have seldom deployed radical Mahadevan [11] defined a business model for an Internet
innovations in technology, product or the business based E Commerce using three components: value
processes to create value. This has renewed the interest in stream, revenue stream and logistic stream. Value stream
the subject and raises the fundamental question “what is nothing but a list of tangible value propositions that a
are successful companies leveraging on?” customer is likely to derive from the business. On the
other hand, logistic stream will focus on various elements
We show that these firms deploy business model pertaining to asset control and configuring the supply
innovation (BMI), a framework that creates a strategic chain. All the above definitions point to three important
2
ingredients of a business model: a need to understand the based on the premise that innovation creates dis-
customer requirements, linking it to various operational equilibrium in the market paving the way for new value
choices to be made and activities (transactions) of the creation opportunities. McGrath et al. [19] argued that
business and the need to include supply chain elements in heterogeneity of a firm is likely to delay appropriation of
the definition. rents in competitive markets by the competitors.
Perhaps the closest definition for a business model stems Therefore, degree of differentiation is an important
from Markides [12]. According to Markides, every firm element of innovation. Further, degree of differentiation
needs to position itself appropriately in a three is a good measure of assessing the value creation
dimensional strategic map comprised of who, what and capability of an innovation. By degree of differentiation,
why. The “who” element addresses the target group for we mean distinctiveness in the offering.
the business. By appropriate identification of customers
and their needs, it sets the stage for building the other Firms operating in all sectors of industry go through a
components of the business model. Once the right target cycle of initial value creation (through innovation), value
is identified, firms need to decide the exact nature of the shrinkage (when competitors imitate the innovation) and
value proposition that it needs to provide to the targeted value migration (identifying the next lever for value
segment. It may call for deciding the breadth and the creation). Slywitsky [20] identified value migration paths
depth of the offering, the level of interface required with in several sectors of industry and concluded that in order
the customer and the mode of offering. The “what” to be profitable, firms need to migrate their value
aspect of a business model addresses these issues. Once propositions from time to time. Kim and Mauborgne [3]
these components of the business model are established, observed a similar phenomenon and proposed drawing
the value delivery system could be configured. The value curves to identify when to start the next cycle of
“how” dimension of the business model addresses these innovation.
issues. Configuring the operational aspects of the
business would mean deciding on the type of product and Rumelt [21] has shown that intra-industry differences in
process technology to be adopted, decisions on asset profits are greater than inter-industry differences,
configuration, the extent and nature of interactions with strongly suggesting the importance of firm-specific
other supply chain elements and overall operating system factors and the relative unimportance of industry effects.
design. Clearly, one of the important firm-specific factors is the
propensity to innovate. The variability in the propensity
Clearly, the “who”, “what” and “how” form the core to innovate explains why firms experience persistent
elements of a business model. We see this definition of profitability to varying degrees. These studies lead to the
the business model to be broad. Further, it encompasses proposition that in every firm innovation is a persistent
multiple perspectives suggested by other definitions. activity required to remain competitive.
Therefore, in this study, we adopt this definition.
Consequently, we define business model innovation as a However, persistent innovation is a necessary but not a
strategic initiative to configure or reconfigure various sufficient condition for sustaining the profitability. Teece
elements pertaining to the three dimensions of the {5] argued that innovation and value appropriation might
business model to enhance value creation potential of the not go together. While innovation undoubtedly throws up
firm and sustain it over a longer time. opportunities for value creation, there are other factors
that determine who benefits from the innovation.
III. VALUE CREATION AND VALUE Similarly, McGrath et al. [19] argued that firms must
APPROPRIATION FROM AN INNOVATION establish distinctive competitive advantage before they
could appropriate value out of an innovation. If they did
The nature of innovation in firms has been broadly not, rival firms appropriate the value.
classified into three [13]: Administrative Vs Technical
[14], Product Vs Process [15] and Radical Vs According to resource-based view (RBV), there are
Incremental [16]. Technical innovation pertains to several resources in a firm that share properties such as
products, services and production process technology. On scarce, unique, inimitable, durable, idiosyncratic, non-
the other hand, administrative innovation involves tradeable, intangible and non-substitutable making them
organization structure and administrative processes. difficult to imitate [22,23,24]. These difficult-to-imitate
However, the notion of business model innovation has resources may include a firm’s strategic assets such as its
not been explicitly discussed in any of the previous brand name, buyer-seller trust and other unique methods
studies. of marshalling the resources at its disposal. Ghemmawat
[4] identified size and access as important factors in
A set of highly homogenous firms in a sector of an sustaining the competitive advantage. Lieberman and
industry has very little opportunity for value creation. Montgomery [25] identified three mechanisms for
The notion of creating value through innovation has well enhancing first mover advantage.
been articulated in the seminal works of Schumpeter
[17,18]. Schumpeterian innovation-based competition is
3
Clearly, while innovation could trigger the process of sustainable over a period of time? We present some of
value creation, the value that accrues to the innovating our key findings pertaining to these below.
firm is dependant on its ability to sustain the innovation.
Inimitability of resources, preferential access to A. Context for innovation
resources, lock-in and switching costs determine the
degree of sustainability of an innovating firm. The Our analysis shows a pattern in the process that drives a
greater the degree of sustainability, the greater are the business model innovation (Figure 1). First, firms
chances of appropriating value from the innovation. experience value shrinkage due to existing market
conditions. Homogeneity of business models in the sector
We argue that unless firms are able to exploit value of the industry and changing customer needs contributed
creating and value appropriation opportunities fully, the much to the value shrinkage phenomenon. Except AOL
innovation is neither successful nor logically complete. all other firms were experiencing high degree of
Therefore, the elements of a successful business model homogeneity of business models with that of the
innovation would have factors that enable firms to both competition. Similarly, existing business models were not
value creation and value appropriation. The development addressing the changing customer needs. For example,
of a framework for BMI will be on this basis. However, prior to Charles Schwab’s introduction of a “self-service
before we develop the framework, we provide additional multi-channel brokerage” model during early 1990s,
insights on the basis of an empirical analysis of several there was none to address the needs of the investor
business models that we have observed in practice. community that was becoming increasingly diverse.
Starbucks, on the other hand, responded to the growing
IV. BUSINESS MODEL INNOVATION: AN demand for “café community”, a relatively unmet
EMPIRICAL ANALYSIS lifestyle need for high-quality yet affordable luxuries
(such as gourmet ice cream, tennis shoes etc.).
We present our overall analysis of 18 business models of
15 companies operating in the US. While 10 business Figure 1
models were those pertaining to start-ups (including An analysis of the context for Business Model Innovation
Amazon, Cisco, Dell, Wal-Mart, Southwest Airlines,
Charles Schwab and AOL), the remaining were those of
incumbent firms (including GE, Corning, and Harley Competition Value Changing
issues Shrinkage customer needs
Davidson). The term start-up has a slightly different
connotation in the paper. In this paper, we have made an
attempt to analyse multiple business models of the same
company. For instance, we analyse two versions of Wal-
Mart and two versions of Charles Schwab. In such cases,
while analyzing the first version, we treat the company as Regulatory/
a start-up and while we anlayse the subsequent versions, Economy issues
New Value
the same company is treated as an incumbent. We have Technology Creation
issues
clarified this in the revised version. Strategies Firm level
issues
The results used in this paper consist of the findings from
a partial list of business models taken up for the study. Firms in our sample have gainfully exploited
For more details on the study, readers are referred to opportunities that enabled them to create dis-equilibrium
Deloitte research [26]. The business models were in the market. Southwest Airlines and Charles Schwab
selected on the basis of an initial short-listing of responded to the changes in the regulatory framework
companies using financial analysis data. From a shortlist and came with new business models in the respective
of top performers in each segment, 16 companies were sectors. Firms such as Amazon, Dell and Cisco could
selected for detailed analysis. Using a structured exploit new technology options for value creation.
approach for data collection each of these cases were Similarly, Owens Corning made significant advances in
classified on the basis of over 60 factors for preliminary optical fibre technology to grow into a diversified high-
analysis. Further analysis involved use of BMI tech manufacturer from a mere specialty glass
conceptual framework to fit these cases, pattern synthesis manufacturer. In several of the incumbent firms, firm
and empirical generalisation. level competencies enabled new value creation strategies.
One prominent example in our sample was GE.
The study was aimed at understanding three main
questions: (a) What are the internal and external drivers B. Business Model components
that cause or enable companies to innovate their business
model? (b) How do companies configure various The business models were analysed using the three
elements in the business model? Are there any dimensional framework (who-what-how). The firms in
discernable patterns in the strategies adopted? (c) How our sample exhibit several features that may enable firms
could companies ensure that their business models are not only to create value but also sustain them for a longer
4
time. They have achieved this by gainfully exploiting operating in a unique mode arising out of business
several factors identified in the literature for sustaining model innovation. This forms the core of the tacit
competitive advantage. While the “who” segment of the knowledge assets of the firm.
business model has provided sufficient scope to create
dis-equilibrium in the market through innovative As we can see, the extent of imitability of these strategies
practices, the “what” and the “how” components have decreases as we go down the list. While replicating large
enabled the firms to deploy strategies to sustain the scale assets are possible (although not worthwhile in
competitive advantage. several cases), tacit knowledge assets can neither be
sourced in the market nor developed overnight.
Earlier research emphasized that inimitability of the
business model plays a fundamental role in sustaining the We make several observations based on the analysis.
competitive advantage for a longer time. The empirical First, very few have made use of tacit knowledge assets
study confirms these as we see several features that based strategies for sustaining innovation. On the other
provide inimitability. Prominent among them is the hand, the strategies are size oriented and in some cases
variety of customer engaging alternatives deployed in the relationship oriented. Second, incumbent firms have been
“what” component of the business model. The able to exploit several advantages arising out of size,
sustainability of Paychex’s BMI was anchored on the learning experience, asset control, supply chain
advantageous customer access that it achieved through reconfiguration and other resource-based strengths. In
greater opportunities of engaging the customer with their contrast, start-up firms have been able to create business
business. models that are highly distinctive. These firms have
developed new modes of developing deep linkages with
Similarly, asset control strategies and branding strategies the customer and operate in areas that are hitherto
are likely to play a significant role in inducing switching unknown or untested by the competition. Starbucks,
costs and provide benefits of lock-in. Harley Davidson Amazon, and Southwest airlines are some of the
could leverage on its brand equity among its loyal examples in our sample that demonstrate this method of
customers to promote Harley Lifestyle. On the other innovation and value appropriation.
hand, BMI in Corning involved leveraging the existing
strengths in product development and technology D. A framework for business model innovation
research as well as developing new supply chain linkages
to outsource execution. Asset control strategies such as A successful business model innovation requires three
achieving a dominant position on critical assets required important ingredients; recognizing the need to migrate
for the innovation and acquiring/licensing IP with the the business model to the next cycle as value shrinkage
partners were important elements of Corning’s strategy. occurs, exploiting new value creation opportunities for
crafting the next business model and sustaining the
C. Sustainability of the innovation innovation sufficiently long to appropriate value ahead of
the competition through careful choices of the business
Past research seem to converge on a set of factors for model components. The basic structure of business model
sustaining competitive advantage. The business model innovation that we propose is ground on this premise
component of each firm in our sample exhibits a (Figure 2). The process is repetitive as diffusion of
combination of several of these. Wal-Mart, for example, innovation happens over time.
took advantage of its valuable inventory management and
distribution capabilities while innovating its second The context drives one cycle of business model
business model. Based on the detailed analysis of the innovation. During this stage, firms experience value
factors that provided sustainability, we have identified shrinkage as business models are highly homogeneous.
four generic categories under which these fall: They look for alternative paths that enable them identify
new opportunities for configuring various elements of the
(a) Size based: The strategies deployed in the business business model. Through such an innovation the firm
model components are mainly arising out of size creates dis-equilibrium and customers perceive
advantages. distinctiveness in the offerings. The operational details of
(b) Complimentary physical assets based: The the nature of innovation are evident in various choices
competitive advantages stem in this case from made in the core elements of the business model. Various
physical assets that are essential for benefiting from alternative choices are employed in the “who”, “what”
the innovation. and “how” components of the business model. As we
(c) Relationship based: In this case, the firms move noted in the empirical study, these choices impact the
from a mere transactional interaction to one of a sustainability of the model over time. These choices
relational mode. Over time, deep and lasting enable the firm to develop idiosyncratic insights,
relationships are formed with the customers. resources and routines out of innovation. Diffusion of
(d) Tacit knowledge assets based: In addition to physical innovation is unavoidable. At best, it can be postponed to
resources and deep relationships, firms have a later time. Therefore the context will once again drive
accumulated valuable experiences pertaining to the next cycle of innovation.
5
of competitors’ ideas. They are neither good in [8] Kim, W.C. and Mauborgne, R., 2000, “Knowing a
differentiating nor in sustaining “so-called” innovation. Winning Business Idea When You See One,”
We characterise them as imitators. Finally, there is a Harvard Business Review, 78 (5),
category of followers. Several other firms take time to [9] Amit, R. and Zott, C., 2001, “Value creation in E-
copy the innovation by suitably adjusting the innovation business”, Strategic Management Journal 22, 493 –
to their operating system. These are defined as followers. 520.
Followers play an important role in diffusing the [10] Venkatraman, N. and Henderson, J.C., 1998, “Real
innovation over time and triggering the next cycle of strategies for virtual organizing”, Sloan Management
innovation. Review, 40 (Fall), 33 – 48.
[11] Mahadevan, B., 2000, “Business Models for
VI. CONCLUSIONS Internet-based E-Commerce: An anatomy”,
California Management Review, 42 (4), 55 – 69.
Innovative practices enable organisations to discover new [12] Markides, C., 2000, “All the Right Moves: A Guide
value creation opportunities. In the past, several types of to Crafting Breakthrough Strategy”, Harvard
innovation have been found to be useful. BMI is a meta- Business School Press, 169 – 178.
level activity that provides a basis for deploying available [13] Damanpour, F., 1991, “Organisational innovation: A
options in technology, product, markets, supply chain meta analysis of effects of determinants and
alternatives and assets to provide unique advantages to moderators”, Academy of Management Review
the firm. We provide a formal definition and description Journal, 34 (3), 555 – 590.
of the BMI process from an analysis of business models [14] Damanpour, F. and Evan, W.M., 1984,
found in practice. Alternative migration paths proposed “Organizational innovation and performance: The
in this study require considerable research and empirical problem of organizational lag”, Administrative
verification. We suspect that firms are likely to switch Science Quarterly, 29, 392 – 409.
from one migration path to another over time. It is [15] Utterback, J.M and Abernathy, W.J., 1975, “A
important to know what factors drives this phenomenon. dynamic model of process and product innovation”,
Omega, 3, 639 – 656.
ACKNOWLEDGEMENT [16] Nord, W.R. and Tucker, S., 1987, “Implementing
routine and radical innovation”, Lexington Books,
The conceptual foundations of this paper were evolved Lexington, MA.
during a collaborative research work the author did with [17] Schumpeter, J. 1950, “Capitalism, Socialism &
concultants of Deloitte Consulting, L.L.P, USA as a part Democracy”, Harper, NY.
of an assignment during 2001 – 2002. The author wishes [18] Schumpeter, J. 1934, “The theory of economic
to place on record the support provided by Mr. Mumtaz development”, Harvard University Press,
Ahmed and Mr. Douglass Tomlinson of Deloitte Cambridge, MA.
Consulting by way of joint discussions and sharing of [19] McGrath, R.G, Tsai, M-H., Venkatraman, S. and
data for the purpose of developing a framework for MacMillan, I.C., 1996, “Innovation, competitive
Business Model Innovation. advantage and rent: a model and test”, Management
Science, 42 (3), 389 – 403.
REFERENCES [20] Slywitsky, A., 1996, “Value Migration”, Harvard
Business School Press.
[1] Drucker, P., 1998, “The Discipline of Innovation,” [21] Rumelt, R.P. 1991, “How much does industry
Harvard Business Review, 76 (6). matter”, Strategic Management Journal, 12, 167 –
[2] Stringer, R., 2000, “How to Manage Radical 185.
Innovation,” California Management Review, 42 (4), [22] Amit, R. and Shoemaker, P.J.H., 1993, “Strategic
70 – 88. Assets and organizational rent”, Strategic
[3] Kim, W.C. and Mauborgne, R., 1997, “Value Management Journal, 14, (1), 33 – 46.
Innovation: The Strategic Logic of High Growth,” [23] Barney, J.B., 1991, “Firm resources and sustained
Harvard Business Review, 75 (1). competitive advantage”, Journal of Management, 17,
[4] Ghemmawat, P., 1986, “Sustainable advantage”, 99 – 120.
Harvard Business Review, 64 (5), 53 – 58. [24] Peteraf, M.A., 1993, “The corner stones of
[5] Teece, D.J. 1986, “Profiting from technological competitive advantage: A resource based view”,
innovation: Implications for integration, Strategic Management Journal, 14 (3), 179 – 191.
collaboration, licensing and public policy”, Research [25] Lieberman, M.B. & Montgomery, B., 1988, “First
Policy, 15, 285 – 305. Mover Advantages”, Strategic Management Journal,
[6] Brandenburger, A.M. and Stuart, H., 1996, “Value- 9, 41 – 58.
based business strategy”, Journal of Economics and [26] Deloitte Research, 2001, “Business Model
Management Strategy, 5, 5 – 25. Innovation: Deconstructing the formula for
[7] Hamel, G., 1999, “Bringing silicon valley inside”, uncovering value-creating opportunities in familiar
Harvard Business Review, 77 (5), 70 – 84. places”, A competitive strategy study by Deloitte
Consulting and Deloitte & Touche.