Bringing your business model up to date

Innovation / 11 January 2012

Organisations need to continuously evolve their business model to keep pace with an ever-changing marketplace. Steve Coomber explores how managers can inspire innovation and ensure their company makes some smart moves

The Darwinian nature of competitive markets is a brutal reality for most businesses, large or small.

The prospects of long-term corporate survival are slim. Only two firms from the original 1935 FT30 index of British companies remain in the list. Whole industries have been wiped out – the buggy whip business, for example, was thrashed out of sight, almost overnight, by the invention of the motor car.
 
But while many firms fail to adjust their business focus to meet the needs of changing consumer expectations, a few evolve with the times, even adapting to periods of disruptive turmoil in their markets. Look at the success of the once niche computer firm Apple, which now sells a whole range of items such as iPods, iPhones and iPads, and is a major competitor in the downloadable music market.

Or Nokia, one-time rubber boots, tyres and paper products manufacturer, now a smartphone giant. One thing sets these companies apart – the ability to innovate and adapt their business model successfully.

“The phrase ‘business model’ emerged during the late 1990s and the dot-com era,” says Julian Birkinshaw, professor of strategy and entrepreneurship at the London Business School. “But the underlying phenomenon has existed for years.

A business model is about the choices a company makes on how to turn a profit. And a successful model is one where those decisions end up netting a decent margin.”

The combination of words may vary, but the broad definition of a business model remains the same. “Most simply, it is a way of turning capabilities into money,” says Katy Mason, senior lecturer at Lancaster University Management School.

“It applies to any company, whether you make and sell things, or deliver services, and whether you do it all yourself or in collaboration with another party.”

Business models exist at all levels of an organisation. Take IBM, for example. “We’re obviously a very large organisation with a lot of complexity and many different products and service offerings,” says Graham Wright, executive head of services for IBM Global Business Services in the UK and Ireland.

“At a global level we have a business model that governs how objectives and authority are distributed throughout the underlying business units. The units then have their own business models depending on their specific technical scope, their scale and where they are in the world.
 
“What is key, in really large organisations where there are lots of different components – whether in one entity such as IBM, or in a consortium or network – is that everyone involved is clear about what service we are providing and how we make money.”

Transforming over time

One way of looking at business models is through the lens of innovation. Models change over time as people find better ways of leveraging the capabilities of the organisation. Typically, innovation is incremental as companies make small improvements along the value chain over long time frames.

The phrase ‘business model’ emerged during the late 1990s and the dot-com era. But the underlying phenomenon has existed for years.

Julian Birkinshaw, professor of strategy and entrepreneurship, London Business School

Less frequently, business model innovation (BMI) will offer a more radical approach, usually when a market entrant uses technology to provide the customer with a similar end experience to that offered by existing competitors, but in a completely new way.

The first few decades of the internet will probably be seen as a mass extinction event for many companies.

The film industry offers a good example of how business models and market players shift over time.

In the early 1900s, films were enjoyed in cinemas. Then the invention of television allowed people to watch movies in their own home. Videotape technology led to the video rental market, then DVDs replaced videos but the business model remained the same and movie rental stores continued to thrive.

Then along came the internet, which led to companies adopting a send-and-return-DVDs-by-post business model. And now firms are piping video on demand (VoD) directly to customers’ homes via the internet.

The movie viewing market has therefore seen periods of business model evolution and revolution. Market players have changed. Some have adapted and some were removed from the credits altogether. The changes continue as, even now, traditional Hollywood studios vie with supermarkets and online retailers for a starring role in the VoD marketplace.
 
A good example of a BMI trend is the ‘servitisation’ of product manufacturers and suppliers. This can occur when manufacturers innovate traditional manufacturing business models. This may simply entail the addition of services but, for some corporations, it means a complete transformation into a provider of complex services.

This latter phenomenon is explored in From Processes to Promise: How Complex Service Providers Use Business Model Innovation to Deliver Sustainable Growth. In this recent white paper, Ivanka Visnjic, assistant professor at ESADE Business School in Spain, and Andy Neely, director of the Cambridge Service Alliance at the University of Cambridge, propose a sophisticated framework for BMI.

Visnjic and Neely argue that, for complex service providers at least, BMI comprises a number of essential elements. Managers need to understand these elements and their implications before they can begin to innovate their business models.

A business model comprises two elements: the value proposition, which is the offer to the end customer and what the service provider is accountable for; and value delivery – how that value proposition is delivered.

The environment within which the service is provided is called the ecosystem, which consists of those organisations that impact on the service provider’s ability to create value – whether customers, partners or even market regulators.

Many service providers are increasingly becoming accountable for their value proposition, which creates additional risk. This added facet of the business model is known as the accountability spread – and it must be managed appropriately. 

Promises, promises

This move to accountability reflects the direction that business models of many organisations are heading towards. It involves a shift from transaction (providing a product) to relationship (becoming accountable to a customer for a promise to do something).

So a train operator, for example, rather than just selling a train, may promise to provide a customer with a working train to a certain standard for 20 years. Or take Rolls-Royce’s business model, which shifted from just selling aircraft engines to charging a fee for its engines on an hourly basis, accompanied by a promise to maintain and replace them in the event of breakdown.

Moving towards a model of accountability for a promise enables a company to turn to other members of its ecosystem for help to fulfil it more efficiently and effectively.

“The shift in the business model is that it has got to focus on the business network, so it’s looking at the network from the outset; that’s a key difference,” says Mason. “You’re saying, what can we do with all these amazing capabilities within our network or how might we grow our network to do something amazing?”

It is difficult to stress the importance of this trend and these concepts – they are likely to have an impact on many business models across most sectors in the future.

If failing to respond to changes in the market can lead to competitive stagnation and corporate failure, how do you know when it is time to change your business model?

“There are a number of signals,” says Wright. “The most obvious is your profit and loss statement (P&L), but that’s a bit of an historic indicator. If you haven’t spotted it until the P&L starts to suffer, you’re probably too late,” he says. “You shouldn’t really need a signal to tell you that it’s time, because it’s always time.

“An absolutely vital characteristic of a successful business model is that it is always evolving and transforming. If your proposition is standing still, even if you’re the market leader, someone else will be catching up and you’ll soon be yesterday’s proposition.”

Core contributors

To proactively evolve its business model, a company needs to do a number of things well, which requires the input of individuals at every level of the organisation.
 
A key task is detecting signals and trends in the external world. “One of the roles of senior leaders is to be looking at the way the world and the markets are moving,” says Neely. “What are the implications of these indicators for our organisation? What do we need to do differently?

“It can also be the case that people at many different levels in the organisation possess knowledge and insight into what’s happening. So sales staff or delivery drivers may well be closer to customers on the ground than senior managers.

“You should encourage an environment inside the organisation where employees at all levels can look for the signals – do the strategic intelligence gathering – and gain an insight of what’s happening externally. Then this must feed into a continuous conversation in the organisation, where you’re constantly asking, ‘Is the way we’re trying to do things correct or should we do things differently?’ and ‘If we’re going to do things differently, how should we change?’.”

Finally, says Neely, the company needs to have clear ways of making decisions based on the results of these continuous conversations. These choices should create projects or initiatives that help nudge the firm’s business model, or components of that model, in a particular direction.

Wright says managers should focus on creating innovative concepts. “Really good ideas involve a total transformation that your customer would probably never have thought of. So it’s lazy and very dangerous to simply ask your customers what they want and then just do what they say. You’ve got to have more challenge in your system than that. You need to keep getting feedback from customers but also have a culture that is open to new ideas from everyone, even completely radical suggestions.”

People first

There are personnel issues to consider, too. “Different people require different incentives and management techniques,” says Wright. “So everything in the business is about how you handle your people. If you want your employees to be service providers rather than product manufacturers, there’s quite a big change required in the way in which you source, develop and manage them.”

Mastering BMI will help firms to survive for a certain time. Inevitably though, a major disruption to their market will arrive at some point. Then all bets are off.

“The weight of history is against you,” says Birkinshaw. “Trying to be a business model innovator, doing something different alongside your existing business, is really hard to pull off. There are so many ways in which it can fail. You can get the concept wrong, have too many management systems, be too late, not possess the entrepreneurial skills. But then again, if you’re facing a major threat, sometimes it is worth the risk.”