Mark Johnson on Business Model Innovation and his new book Seizing the White Space

Mark Johnson, chairman of Innosight and author of Seizing the White Space: Business Model Innovation for Growth and Renewal (see review & summary here), explains his version of the business model concept "The Four-Box Business Model" comprising the Customer Value Proposition, the Profit Formula, and the Key Resources and Processes. This model was also the topic of yesterday's discussion at Innochat, see transcript here.

"Where are there opportunities to deliver new value propositions, where are there important unmet jobs that this company has the potential to make a successful product or service to address."

"Think about where these opportunities are and then allow the organization the flexibility to start devising ways at which it could deliver on that value proposition, that may not be the traditional way it does business"

Related videos:

Clayton Christensen on jobs needing to get done
Scott Anthony on Disruptive Innovation

Scott Anthony on Disruptive Innovation

An interesting interview with Scott Anthony, president of Innosight, on disruptive innovation.

"Disruptive innovation is a particular type of innovation that occurs when an innovator brings to a market an innovation that is simple, convenient, accessible, and affordable; changing the game"

"Disruptive innovation will result in major changes but they don't often rely on technical innovation, in fact many times the technology is quite trivial, it's the business model, the way a company organizes and acts that drives disruption"

Questions to identify opportunities for disruptive innovation:

1. "Look for markets where there is some kind of constrains that inhibits consumptions, where is there something that makes it difficult for people to solve problems in their life. Sometimes they don't have skills, money, access to the solution and sometimes it just takes too long."
2. "Try to identify where people have important unsatisfied jobs to be done, where there is a problem that the customer can’t adequately solve today. If you can find that frustrated customer and ease their pain, you often times have the ticket to disruptive innovation."

"After you have looked for constraints consumptions and you have targeted that job to be done, think about how you can play the innovation game differently. Remember is not about doing it better, it’s about making it simpler, cheaper, more accessible, and more affordable, that's what disruption is all about"

"Think about the markets that you are going to analyze, looking not necessarily at the most demanding customer today, but thinking about people who are relatively undemanding, or people who are not consuming anything at all"

"Focus groups can be a simple way to begin a conversation with customers. Customer observation can be really powerful, because sometimes the customer simple can't tell you what you want. Sometimes you got to give customers something, a very early prototype and let them co-develop the product or service with you. Sometimes you got to do more detailed quantitative research to really pinpoint what are the points of frustration in the market and where are opportunities to do things differently"

"Take a simple first step. Invest a little, learn a lot. Don't spend huge money upfront because the only thing you can be sure of is that your first strategy is wrong, so if you invest too much too soon, you are looking into a path that is fatally flawed"

More videos on disruptive innovation:

Clayton Christensen on jobs needing to get done

Value network analysis and positioning

There is an increasing need for companies to gain insights into what is actually happening around them and where value can be created and captured. Linear value chains have in many cases been replaced by complex, interdependent and dynamic relationships between multiple sets of actors in different industries, different parts of the world, using different business and revenue models.

The increased turbulence creates threats and opportunities for organizations to respond to and quickly reconfigure its business models and with that its different roles in relation to external actors. To capture opportunities more quickly than rivals do, organizations must have agile business models and constantly analyze where value can be created and captured.

An intricate network of roles and relationships

The value network surrounding an organization comprises of different stakeholders and organizations (nodes) that have an effect on the outcome of the organization's activities. Between the nodes are different forms of formal and in-formal relationships connecting the nodes, forming the network. In contrast to linear value chains and One-Sided Business Models, such as buying ingredients to sell lemonade on the driveway, the number of different actors having multiple roles creates an intricate network of roles and relationships.

Nodes with multiple roles

One actor in the value network can simultaneously be a value provider (e.g. out-licensing important technology, co-educating customers, partner in working towards establishing a standard, co-developing new technology, supplier of services, providing user data), a value recipient (e.g. in-licensing technology, buying products and services, having access to process knowledge and technical know-how, benefiting from complementary products and services), a value neutral (e.g. competing with similar products and services, providing substitute technology, products or services, non-connected experts, authorities and regulators, standardization bodies). Additional to the complexity of nodes having multiple roles is that roles, relationships and business models are constantly changing.

Different business and revenue models

Each of the actors in the value network has its own business and revenue models and actors outside the industry may at any time enter with business models disrupting the whole industry, such as Apple entering the music industry or Google entering the navigation technology industry. Organizations need to constantly monitor actors in the value network, at the edges of the industry and potential outside actors that could for example provide something at a much lower cost or even for free. A good question to ask is what an industry outsider would do to take advantage of the weaknesses in existing value network and business models? Some examples of potentially disruptive business models:

• Give away or subsidize hardware to sell software or services
• Give away or subsidize software to sell hardware or services
• Give away or subsidize services to sell hardware or software
• Give away one version of the hardware, software and/or service to sell another
• Give away or subsidize hardware, software and/or services, supported by advertising
• Give away or subsidize hardware, software and/or services, sell access to 3rd party

For more examples: 50 Business Models built on Free

Mapping the value network

To understand the value network, an organization should for every value proposition map out each and every actor that could have an effect on the outcome. This should initially be done as broadly as possible generating a very long list of actors. Different approaches can be used to identify actors such as:

• Roles in relation to one’s own organization "all suppliers, partners, competitors, customers, substitutes…"
• Type of organizations "all incumbents, SMEs, start-ups, research institutes, university research groups, governmental organizations…"
• Different forms of activities or expertise "content idea, content creation, publishing, distribution, content aggregation…"

The next step is to categorize each actor in the list to make it more manageable. This can be done in the style of a mind-map or in Excel lists that are perhaps more easy to sort and filter. The way to categorize and group actors is very situational specific and the approaches above can be used as a starting point.

Analyzing the value network

It is important to understand how value is converted from one form to another across the value network. Ideally each actor and relationship should be analyzed and a starting point is to analyze each group of actors and each identified key actor:

• How do value move through the network?
• Where are the bottlenecks?
• Who are benefiting from whom?
• What values are provided from each actor?
• Who are the main value creators?
• What are their objectives and strategies?
• Where are the unique assets and capabilities?
• How well are assets being used?
• How well are the values being realized?
• Who are the main value recipients?
• What do the value recipients need to compromise?
• What social value or cost is generated by each actor?
• Where are the main costs and risks of each actor?

With an understanding of the value network the next step for an organization is to analyze its own position in the value network.

Analyzing one’s own position

Based on the value network analysis the organization can start evaluating its own situation and different alternatives for adjusting its position in the value network:

• What roles and relationships is it dependent upon?
• What are the value propositions (including benefits) it provides to other actors?
• How are different external offerings affecting own value propositions?
• What are the financial and non-financial transactions in these relationships?
• How will success increase other actors' success and vice-versa?
• How will the organization enable other actors to win versus their competition?
• How can it change the game to its own and others advantage?
• How will its position evolve over time?

Positioning through strategic moves

Based on the existing and sought for position, the organization can then use strategic moves to affect identified actors, formulate alliances and partnerships and change its business models, to manage the value network:

• Who to collaborate with, for what purpose, in what form?
• Who to form strategic alliances with?
• What to bring to the table and what to expect from the collaboration?
• What actions to take to affect other organizations or relationships?
• How to adjust value propositions and business models?

Turning turbulence into an advantage

To understand the current and future capability for value creation, it is essential for every organization to understand the surrounding value network and how value is converted from one form to another across the network, and adjust its business models accordingly.

Opportunities arise from strategic moves and from pure luck. The challenge is for organizations to have agile business models to be able to act on these opportunities. I believe that organizations that really understand their different roles and surrounding value networks can turn the turbulence into an advantage.

Business Model Examples

There are many examples of inspiring business models and business model innovators described and referenced on this blog and elsewhere. To provide a quick read with popular examples, a list of business model innovators is presented below. Please feel free to comment or contact me on great business model examples that you find missing.

Amazon - Leveraging assets

Launched in 1994 as an online book seller, Amazon has constantly altered its business model leveraging its assets and capabilities to generate new business… Read more

Apple - Providing convenient solutions

Apple has revolutionized the computer industry, the music industry and now the mobile phone industry, and the classic example is iPod and iTunes… Read more

Better Place - Using per-distance fees

Better Place aims to use the margin between electricity and gas to subsidize the cost of new electric cars, even providing electric cars for free... Read more

Etsy - Mass customization of arts

Aggregating the long tail in an online marketplace for handmade goods with the goal to enable people around the world to make a living making things… Read more

Gillette - Razor and blades

Gillette's success with its razors and blades is a story about superior technology, design and the use of control mechanisms, foremost patents… Read more

Lego - Turning users into developers

Lego has turned its most loyal users into designers and co-creators of their own products. More than 30000 kits have been shared so far… Read more

Tata Motors - Modular distribution

Tata Nano is not only cheap to buy it is constructed of modules that can be built and shipped separately to be assembled in a variety of locations.… Read more

Threadless - Dressing the long tail

Threadless was one of the first firms to systematically mine a community for designs, a trend that today can be seen in various industries… Read more

Xerox - Business Innovation in 1959

The company decided to lease the equipment, instead of selling it, at a relatively low cost and then charge a per copy fee for copies in excess of 2000 copies per month… Read more

Zara - a devastating business model

Zara has managed to substantially shorten the time to develop a new product and get it to stores, and in doing so it can react quickly to changing market trends… Read more

More inspiring examples will come, send me your suggestions!

Further reading:

Using the crowd as a part of the business model

10 Initiatives using the crowd to generate new ideas

Business model example: Zara - A devastating business model

Zara, owned by Inditex, has been described by Daniel Piette, fashion director LVMH, as "possibly the most innovative and devastating retailer in the world" and is a vertically integrated retailer controlling the design, manufacturing and distribution of clothing itself. This is very different from most clothing retailers that outsource much of their manufacturing to developing countries. Zara has managed to substantially shorten the time to develop a new product and get it to stores, and in doing so it can react quickly to changing market trends. From design to finished goods can be made in four to five weeks, and modification of existing items can be made in as little as two weeks. It produces about 11,000 distinct items annually compared with 2,000 to 4,000 items for its key competitors, constantly updating its range of clothes. Zara shop managers report back every day to designers on what has and has not sold, information that is used to decide which product lines and colors to keep or alter, and whether new lines should be created. Reducing the time to get the clothes into the shelves and the batches of clothing in small quantities also keeps the costs down by keeping stocks low, and if a design doesn't sell well within a week, it is withdrawn from shops, and further orders are canceled. Where most retailers have different "seasons" Zara keeps no design on the shop floor for more than four weeks, encouraging customers to make repeat visits. Popular items appear and disappear within a week creating an image of scarcity. Some customers know exactly when new deliveries arrive at their local shop and turn up before opening time to pick up the latest fashion. Zara uses no advertising or promotion, and 50% of the products are manufactured in Spain, 26% in the rest of Europe, and 24% in Asian and African countries and the rest of the world.

Further reading:

• List of business model examples
• Threadless - Dressing the long tail in user design

Business model example: Xerox - Business Model Innovation in 1959

The business model around Xerox Model 914, introduced to the public in 1959, has become a classical example of how a new technology sometimes needs a new business model to become successful. The Xerography technology, to produce images using electricity that avoids the use of wet chemicals, was superior to other available methods, but also very expensive. When Haloid (later renamed Haloid Xerox and then Xerox Corporation) tried to find marketing partners for its Model 914 the company was constantly turned down by the likes of GE, IBM and Kodak. Haloid decided to lease the equipment, instead of selling it, at a relatively low cost and then charge a per copy fee for copies in excess of 2000 copies per day. The company provided all the required supplies, service and support and the customer could cancel the lease on only fifteen day's notice. This was a bold move given that the average business copier at that time produced an average of 15-20 copies per day. Haloid took a large risk as customers were only committed to the monthly lease payment and paid no more unless the performance of the Model 914 led them to make more than 2000 copies. The Model 914 became a huge success, with customers averaging two thousand copies per day (instead of month) and the company sustained a compound annual growth rate of 41% over a 12 year period. Also, the company became highly incentivized to develop faster machines that could handle high volumes with maximum machine uptime and availability.

Further reading:

• List of business model examples

Business model example: Apple - Providing convenient solutions

Apple has a history of design-driven product innovation and has introduced a number of high-end products such as personal computers, media devices, accessories, peripherals as well as media and software to support their products including operating systems, applications for areas such as music and video. Apple has revolutionized the computer industry, the music industry and now the mobile phone industry. The classical example of business model innovation is related to Apple's iPod and later the iPhone. Launched in 2001, the iPod was a standalone product, but when Apple launched the iTunes Music Store in 2003, it provided cheap music for buyers of their physical products, turning Apple into the world's largest online music retailer. The same strategy was applied to provide a convenient solution for applications to its iPhone when the App Store for iPhone was launched in 2008, establishing Apple as a broker of application, collecting a 30% royalty on each application sold.

Further reading:

• List of business model examples

Business model example: Amazon - Leveraging assets

Amazon was launched in 1994 and established itself as an online book seller providing books but also an online community for customers to share information and opinions about books with one another. The company soon realized the potential in leveraging the platform and infrastructure to offer new categories of products, turning into an online department store. Amazon also supplies e-commerce services and features to power other companies' web sites. Another way of leveraging its software is the supply of e-commerce services to syndicated stores that sell Amazons products on other companies' web sites resulting in distributed distribution channels. To provide the largest catalog possible on its platform, other companies including competitors are allowed to utilize the platform establishing Amazon as a broker of transactions and leaser of web space to other retailers. By bringing buyer and seller together, collecting the buyer's funds when the order is placed, and maintaining advantageous payment terms with suppliers, Amazon has done with online retailing what Dell did with computers. Further leveraging its assets and capabilities Amazon started to offer a number of services such as storage services, the lease of computing power, together with an end-to-end product sales and logistics platform, handling orders, payments and shipments.

Further reading:

• List of business model examples

P&G - Procter & Gamble - Innovating & Growing with Business Model

Did you know that Procter and Gamble - P&G makes all these cool products below that you use everyday in your house?

You betcha... from Duracell and Gillette to Crest, Charmin to Tide, Bounty to Iams - P&G is the world's largest consumer goods company. As a matter of fact, "three billion times a day, P&G brands touch the lives of people around the world." P&G has a bigger mission that they are trying to fulfill: "Provide branded products and services of superior quality and value that improve the lives of the world's consumers, now and for generations to come."

P&G is one of the Top 20 innovators of the Innovation Index.

P&G stock is doing relatively well compared to the major indexes. Here is a snapshot of how well P&G is holding up since 2007, beating both S&P 500 and Dow Jones indices:

Why is P&G doing so well?

One answer: Innovation. Innovation driving new business, innovation driving growth, innovative leadership by past CEO of P&G A.G. Lafley, & current CEO Bob McDonald. Another fact that most investors may not know about: Barclays Global Investors and Berkshire Hathaway (Warren Buffett's company) are the top two institutional holders of P&G.

P&G has been making or handily beating the earnings estimates for the past 4 quarters (despite the Great Recession):

Earnings History	Dec-08	Mar-09	Jun-09	Sep-09
EPS Est	1.58	0.80	0.79	0.99
EPS Actual	1.58	0.84	0.80	1.06
Difference	0.00	0.04	0.01	0.07
Surprise %	0.0%	5.0%	1.3%	7.1%

(Courtesy - Yahoo Finance)

P&G Revenue & Gross Profit are beginning to climb back (check earnings results below), after divesting major businesses such as the prescription business in 2009 (courtesy - Yahoo Finance). Sales fell in 2008-2009 (yearly sales for June 2009) owing to the recession, divesting of businesses, and P&G's ill-timed strategy of raising prices for its products in the midst of the Great Recession that backfired. The price increases initially helped buoy sales, but eventually sales suffered. P&G is correcting the price increase strategy of 2008 beginning in Q3 of 2009.

PERIOD ENDING		30-Jun-09	30-Jun-08	30-Jun-07
Total Revenue		79,029,000	83,503,000	76,476,000
Cost of Revenue		38,898,000	40,695,000	36,686,000
Gross Profit		40,131,000	42,808,000	39,790,000

P&G Global Business Unit Organization

Courtesy: P&G Quarterly News. PG.com

24 of P&G's brands have more than a billion dollars in net annual sales,^[15] and another 18 have sales between $500 million and $1 billion. (Courtesy - Wikipedia). These P&G brands are run as business units, with brand heads managing the operations, products & profits.

Billion dollar brands

• Ariel is a brand of laundry detergent/liquid available in numerous forms and scents.
• Actonel is a brand of the osteoporosis drug risedronate co-marketed by Sanofi-Aventis.
• Bounty is a brand of paper towel sold in the United States, Canada, and the United Kingdom (rebranded to "Plenty" in the UK after being sold to SCA Svenska Cellulosa Aktiebolaget).
• Braun is a small-appliances manufacturer specializing in electric razors, coffeemakers, toasters, and blenders.
• Crest is a brand of toothpaste.
• Dawn is a brand of dishwashing detergent.
• Downy/Lenor is a brand of fabric softener.
• Duracell is a brand of batteries and flashlights.
• Fusion is a brand of men's wet shave razors and is the quickest P&G brand to have reached $1 billion in annual sales.
• Gain is a brand of laundry detergent and fabric softeners.
• Gillette is a safety razor manufacturer.
• Head & Shoulders is a brand of shampoo body wash, and deodorant.
• Old Spice is a brand of aftershave and shaving cream.
• Ivory is a soap.
• Nice 'n Easy is a hair coloring product.
• Olay is a brand of women's skin care products.
• Oral-B is a brand of toothbrush.
• Pampers is a brand of disposable diaper.
• Pantene is a brand of hair care products (conditioners/styling aids).
• Prilosec OTC is a brand of heartburn medicine co-marketed by AstraZeneca.
• Pringles is a brand of potato chips.
• Puffs is a brand of facial tissue.
• Secret is a brand of antiperspirant and deodorant.
• TAG is a deodorant and body spray.
• Tide is a brand of laundry detergent.
• Vicks is a brand name of over-the-counter medicines (Formula 44, Sinex, NyQuil/DayQuil)
• Wella is a brand name of hair care products (shampoo, conditioner, styling, and hair color).
• Whisper is a brand of pantyliners sold primarily in Asian markets.

Global Products A to Z

Most of these brands, including Bounty, Crest, Pringles, Puffs, and Tide, are global products available in several continents. Procter & Gamble products are available in North America, Latin America, Europe, the Middle East, Africa, and Asia.

How did P&G do in the latest quarter?

"The Procter & Gamble Company (NYSE:PG) reported net sales of $19.8 billion for the July - September quarter which exceeded the Company's guidance. Organic sales growth was up two percent versus a guidance range of flat to minus three percent on better than expected results across most business segments. Diluted net earnings per share increased three percent to $1.06, above the Company's guidance range of $0.95 to $1.00. The Company raised its outlook for the October - December quarter and fiscal 2010 organic sales growth citing modestly higher expectation for market growth. The Company also increased the low end of its fiscal year guidance range by $0.03 per share to reflect the higher top-line growth projection." - Courtesy PG.com Quarterly Press Release.

"Our September quarter results give us encouragement we are making the right choices to grow market share profitably," said President and Chief Executive Officer Bob McDonald. "We are investing in innovation, expanding our portfolio and improving consumer value to serve more consumers, in more parts of the world, more completely. We are driving simplification and improving execution while leveraging scale to create cost efficiencies that help fund these investments and accelerate growth."

What is sexy, new and exciting that P&G is innovating?

P&G recently introduced Cascade Complete All-in-1 ActionPacs.

Cascade Complete All-in-1 ActionPacs "give you the confidence of a job done right. It breaks down, dissolves, and rinses away tough food particles without the need to pre-wash."

Here is what one highly satisfied P&G customer had to say about All-in-1 ActionPacs:

OMG this is the most amazing product

"I have an older dishwasher that came with the apartment I live in. You had to completely wash the dishes before putting them in the dishwasher. I was basically using it to drain the dishes. I saw this on T.V. and went to walmart and got it. All I can say is it is almost magical the way it cleans. I tested it on several hard to wash dishes, dried oatmeal, dried rice krispy cereal and my stainless steel pots and everything came out clean, no stuck on food, no hard water residue. thank you! thank you! thank you! what a time saver. I am disabled and one of the hardest things to do is standing over the sink washing dishes."
By beadjeannie. Reviewer from Fresno, CA August 14, 2008

Marketing Machine

According to the Nielsen Company, in 2007 P&G spent more on U.S. advertising than any other company; the $2.62 billion spent by P&G is almost twice as much as that spent by General Motors, the next company on the Nielsen list.^[5] P&G was named 2008 Advertiser of the Year by Cannes International Advertising Festival.^[6]

Bottomline:

P&G is a great company with great leadership and employees, and highly satisfied customers. P&G will be around for the next 100 years. P&G will continue to grow high single digits even in this economy because of the breadth of its products, creativity and innovation, global market share, and delighted repeat customers who will not buy another brand. When P&G made increases in product prices to bolster revenue & profits - as high as 16 percent because of higher costs for plastic, energy, and paper in 2008 - consumers reacted and bought less of P&G products, and sales fell. P&G changed strategies in Q3 2009 to react to the price-conscious buyers & accommodate frugal shoppers: "Company leaders say they are cutting prices about 10 percent of their global product line, stepping up promotions such as coupons and other discounts, and making more “value” pitches to consumers." P&G also announced a new plan for its laundry business, slashing the price of Cheer detergent by 13 percent and promoting it as a bargain brand. In CEO McDonald's words: "the focus on innovation, expanding our portfolio and improving consumer value" are keys to P&G's continued growth.

Download my Creativity and Innovation eBook. 212-page collection of over 55 best practices, case studies, and insights on the current state of Creativity and Innovation in Business at Top Innovators including Apple, Google, Netflix, 3M, Frito Lay, Johnson & Johnson, Proctor & Gamble, Toyota, GE, BMW, Deloitte, Southwest, Nike, IBM, Dell and more. "Your report from the eBook and definitive guide was the primary reference that we used." Used by over 500 leading organizations including HP, Pepsi, EDS, J&J, Nokia ... Learn more
Download Now

Selected references:
Creativity and Innovation Best Practices
Creativity and Innovation Case Studies
The Innovation Index
Top 50 innovative companies in the world

Innovation Index Reports

Introducing The Innovation Index
Annual Report 2007 - The Innovation Index gains 66%
Measuring Business Innovation Success
Q1 2008 Report - Innovation Index ahead of S&P 500
Q2 2008 Report - Top Innovators Deliver
Top 50 Innovative Companies in the world
Annual Report - Chapter One - Total Innovation Activity
Annual Report - Chapter Two - The Top Innovator
Annual Report - Chapter Three - The Innovation Insights
Innovation and Stock Performance Correlation
Future earnings guidance, A leading indicator
Smart Investing In Tough Economic Times
Creativity and Innovation Best Practices
Creativity and Innovation Case Studies

About the Innovation Index

The Innovation Index introduced in December 2006 is a weighted stock price index of the top 20 Innovators in North America.The Innovation Index returned 66% in 2007 based on performance model, and would have returned 174% over the previous five years (2002-2006) based on historical model*. This assumes equal investment in each stock of The Innovation Index as of December 31, 2001. An average of $100 invested in The Innovation Index on December 31, 2001 returned $454 as of December 31, 2007. By comparison, $100 invested in S&P 500 returned 28% or $129, $100 invested in NASDAQ returned 34% or $136, and $100 invested in the Dow Jones Index returned 30% or $131 through December 31, 2007. The Innovation Index beats the S & P 500, NASDAQ and Dow Jones Index by more than seven times over the past six years.

Alphabetical list of the Top 20 Innovators of The Innovation Index for 2008 and their stock ticker symbols:

3M Company - (NYSE: MMM)
Amazon.com, Inc. - (NASDAQ: AMZN)
America Movil - (NYSE: AMX)
Apple Inc. - (NASDAQ: AAPL)
AT&T Inc. - (NYSE: T)
Best Buy Co., Inc. - (NYSE: BBY)
Cisco Systems, Inc. - (NASDAQ: CSCO)
Costco Wholesale Corporation - (NASDAQ: COST)
eBay Inc. - (NASDAQ: EBAY)
General Electric Co. - (NYSE: GE)
Google Inc. - (NASDAQ: GOOG)
Hewlett-Packard Co. - (NYSE: HPQ)
Intel Corporation - (NASDAQ: INTC)
International Business Machines Corp. - (NYSE: IBM)
Merck & Co., Inc. - (NYSE: MRK)
McDonald's Corporation (NYSE: MCD)
Microsoft Corporation - (NASDAQ: MSFT)
NIKE, Inc. - (NYSE: NKE)
Research In Motion Limited - (NASDAQ: RIMM)
The Proctor & Gamble Company - (NYSE: PG)

The Innovation Index will analyze the positions and standings of the Top 20 Innovators at the end of each year. For 2008, there will be no further changes in The Innovation Index.

Originally published in 2008; republished in with major revisions in 2009.

The Business Model Cost Structure

All components of a business model have related costs and the size and behavior of the costs provide an indication on the flexibility and scalability of the business model. As all managers know, lowering cost with $1 has a greater impact on the bottom line than increasing the revenue with $1 as revenue almost always comes with an associated cost.

Having a low cost structure is a strong competitive advantage which market leaders in industry after industry recognize, when companies with low cost business models enter their markets. In the steel industry the mimimills took on traditional smelters, in automobile manufacturing standardized Japanese cars won out over customized vehicles, "no frills" airlines such as Southwest Airlines or Ryanair took down traditional airlines such as US Airways and Swissair, open source software has taken large market shares within several software areas, and a hot topic right now is the struggle of traditional newspaper companies as a consequence of low cost online substitutes. See separate post here

Online companies with low costs structures are currently disrupting traditional industries and have created some very high operating margin businesses, with Craigslist perhaps the most referenced example, generating an estimated $100mm in annual revenues with an operating margin of 90%.

The Business Model Framework

The business model concept is a good framework to identify where costs arise, and how it relates to the creation and capturing of value for customers and other value recipients. Identifying significant costs and assets needed, relating to each component of the business model, provides an overview that can be used to improve the existing model or completely alter it.

Not only a number

When doing the cost analysis in relation to each business model component it is important to identify underlying cost drivers, relationships between different costs and the behavior in terms of size, growth, volatility, and whether it is linear, degressive or progressive in relation to increasing activities. This will answer an important question on how the business model will correspond to change, and how predictable that is, and can be used to find ways to balance the need for growth while managing costs and risks.

Knowing how much things costs and how it will change over time is the only way of maintaining a rational cost structure. Also knowing how choices in the different business model components affects costs in other components is a great starting point for business model innovation.

General questions once the full picture is known

Few if any managers and executives have visibility of the costs associated with the different parts of the business model. Especially in times of cost reduction it often ends up cutting too deeply in areas that are critical to the business while leaving money on the table in areas that are less critical. Once the different major costs are identified you can start question each of the business model components:

• How can this be performed differently at lower cost, or even be eliminted?
• What companies are focusing on low-cost alternatives in this particular business model component but perhaps in another industry?
• How could collaboration with another actor lower or eliminate costs?

Below are some examples on more specific questions:

Customers and Value propositions

Do we need to serve all existing customers or market segments? Are some of the segments more costly? What if we configure our value proposition differently? What if we reduced performance, eliminated features, changed the mix of value propositions, adjusted the level of service, and eliminated expensive value propositions exposed to price competition? Would it be possible to create synergies between different value propositions? What if we changed the way or time of delivery? What if we employed or changed to other channels of delivery?

Resources and activities

What if we used other raw materials? Shifted location? Changed specifications for purchased components? Lowered wages paid, amenities provided to employees or training? What if we replaced owning of IT systems and software, and replace it with software as services? What if we abandoned unused patents, or sell and license them back? What if we outsourced development, marketing or installation? What if we invested in new processes? Automation? Simplification? Elimination? Centralization? Standardization? Shared Services? Can we create synergies between different activities or use resources in a more efficient ways?

Partners and relationships:

What if we change specifications? Quality? The number of partners? The type of partnerships? What if we partner with upstream, downstream or horizontal actors? Configure the value network in a different way? Etc.

Even though the cost side of a business model to a large extent determines flexibility and scalability, it is seldom discussed in relation to business model innovation. Growth in revenues is of course important but it’s only half of the value creation equation.

Further reading:

10 Tips on Business Model Innovation

Scalable Business Models

External links:

When Talking About Business Models, Remember That Profits Equal Revenues Minus Costs

10 Tips on Business Model Innovation

How can we start innovating on our business model?

Business Model Innovations have redesigned entire industries and there are many stories on how companies by providing something different, in a different way or to a different customer segment completely change the rules of the game.

There are many ways to explore and analyze markets and the different components of the business model to identify opportunities for innovation. Here are 10 tips on how you can approach business model innovation:

1. Create a common understanding of the existing business model

This might seem obvious but in many organizations the knowledge about how the company operates is widely distributed in the organization. A good idea is to bring together key people from different parts of the organization who understands different parts of the existing business model and the underlying reasons for why things are the way they are. Is it because it always has been in that way? Is it because it was the easiest way to do it at the time the decision was made? A great way to create a common understanding is to visualize the business model by drawing boxes on a whiteboard, using the business model canvas, or as I sometimes do; list business model components in Excel using a projector to facilitate collaboration.

2. Create a common understanding of what is core in the business model

Focusing on what a business does best is often argued the easiest and most efficient way for companies to grow and be profitable. Understanding customers' perspectives and their perception of value is fundamental to identify what is core. Perhaps it’s not what you deliver but how you deliver it, that makes people buy? - Perhaps you should deliver something else as well given your good way of delivering things? - Perhaps it’s not the gadget you sell as such, but the software interface that people like? - Could other gadget manufacturers need your better software interfaces? - Perhaps the reason someone wants to collaborate with you is because your customer relationship and contracts with a certain organization? - Could other companies be interested to get access to the same organization? Read more about identifying the core in a business model here.

3. Identify interrelationship between the different business model components

Discovering real and perceived relationships and interdependencies between different components is important to understand underlying reasons for why things are the way they are. Identifying perceived relationships is also a good way to find underlying assumptions that might be wrong. What are the underlying assets enabling key activities? For what parts of the value proposition are partners and external actors necessary? How do the customer segments affect the choice of customer relationships and delivery methods?

4. Identify drivers of change and trends affecting existing business model

Why do you need to reinvent your business model? Is it because of low cost competition? Niche actors? New actors? New technology? Changing customer behavior? Changing partner behavior? Identifying the drivers of change and trends affecting the existing business model will turn your focus to the most crucial components of your business model.

5. Analyze strengths, weaknesses, opportunities and threats

The SWOT analysis is simple yet a powerful tool to create a common understanding of the current situation and to summarize the findings from the steps above. It is often illuminating to point out what needs to be done and to put weaknesses and threats into perspective. Use precise and verifiable statements rather than lose assumptions or opinions, and prioritize to spend your time on the most significant factors. The SWOT analysis can also be used on the business models of competitors or other external actors to find new ways to compete or collaborate.

6. Analyze theoretical ideal situation and contradictions for each business model component

By exploring what would be the theoretical ideal situation for each business model component you can create out-of-the-box-ideas without being locked into existing solutions. In doing so you can also find the constraints of a business model: why can't we provide this for free? Why not instantly? Why not exactly the way the customer wants it? With the ideal situation identified, the next step is to work backwards to something that is achievable by decreasing benefits and/or increasing costs and harms.

7. Analyze external alternatives that could take each business model component closer to the ideal situation

With a rigorous SWOT analysis and Ideality analysis you are well equipped to analyze how external actors could fill in the gaps you have identified. What if X delivered this instead? What if we replaced some of our existing assets or activities with external ones at lower cost or better performance? What if we created a low cost version? A digital version?

8. Analyze what would happen if applying principles for innovation

You can use the 40 principles for innovation, based on TRIZ adjusted for business problems, to explore "what if" questions for each business component (see example in the business model innovation matrix). What if we took away something? (principle 2), turned something the other way around? (13), did something slightly less or slightly more? (16) etc. Exploring 40 principles on several different business model components is an extensive work and I find two approaches helpful; either have a session on one business model component and apply the different principles, or take a few principles and apply them on all business model components.

9. Decide on ways to explore alternative business models with limited risk

The development of a successful business model is often the result of lots of learning from lots of failures, so it is important to find ways to fail fast and cheap without destroying existing business models. To avoid failing in front of your existing customers and partners, common methods are to set up separate working groups within or outside the company and use closed focus groups, advisory boards, release limited beta versions or try out new business models in limited geographic areas.

10. Track progress and unexpected customer or partner behavior

When tracking the progress of a new business model it is important to not focus blindly on parameters such as costs and revenues, but to identify existing, expected or unexpected customer or partner behavior and iterate the business model.

In retrospect most business models seem obvious but at the time it's not always that clear. To quote an article in Business Week from 2000 "But how will Google ever make money? There's the rub. The company's adamant refusal to use banner or other graphical ads eliminates what is the most lucrative income stream for rival search engines."

Further reading:

Table of contents

Tools for Business Model Innovation:

Business Model Innovation Matrix

The Business Model Canvas

What elements are core?

The Value Proposition Explorer

Ideality as an innovation tool

Visualizing value propositions and revenue models

On the website Boardofinnovation 10 generic building blocks are presented to "build any business model". Each building block is presented graphically and the idea is to visualize different business models to enable mapping and comparison of different businesses and "a new way of designing and innovating business models." I find visualizing business models very powerful, see for example the business model canvas, and the way of drawing blocks and arrows is of course a commonly used method to describe business models.


The visualized building blocks are:
Company - the company whose business model is described
Product - from commodities to finished goods
Services - services around a product or stand alone
Experience - not only offering a product or service but an experience
Reputation - a brand experience shaping client identity
Client- receives the product and gives something in return
Money - the normal value of a good
Less Money - less money than the normal value of a good
Attention - a currency of paying attention to advertising
Exposure - a currency of spreading the word

Building blocks to describe value propositions and revenue models
The term business model can be understood in a broad or narrow sense and can be expressed, visualized and explained in many different ways. Common elements in a business model, not described by the 10 building blocks presented above are what internal and external assets and capabilities that are used, what activities that are performed, how the value propositions are delivered, what forms of relationships the company has with its clients and external partners, control mechanisms used and the business model cost structure.

According to me what the 10 building blocks describe is not the business model but the different involved actors, value propositions and different types of revenues and benefits. It gives a first understanding of what a business model is about but it doesn't explain how value is created or delivered and only using the 10 building blocks will make fundamentally different business models look similar if they share some similar principles.

The main contributions with the 10 building blocks are according to me the blocks "experience" and "reputation" broadening the concept of value propositions from products and services, and "exposure" and "attention" broadening the concept of revenue model.

Broadening the concept of value propositions
A value proposition is often defined as "what the customer gets for what the customer pays" or "a bundle of products and services that are of value to the customer". I argue in my post about value propositions that a value proposition is how value is bundled and offered to potential value recipients where the term "value" is not limited to products and services and the term "value recipient" is not limited to customers.

Providing something new, something unique, something more convenient or accessible, customized, with higher performance or to a lower price are all common value propositions towards traditional customers. But value can also be to enable risk- or cost reduction for a supplier, provide access to databases or research tools for early-stage university research, provide user data to "upstream" application developers, out-license manufacturing or quality assurance processes to other companies, cross-license technology & IP, bring passengers to remote airports, provide jobs and environmental responsibility for a region, pay tax to a government, or take active involvement in a community.

The building blocks "experience" and "reputation" adds, according to me, important dimensions to the common perception of the value proposition. "Belonging" is another interesting dimension when the value proposition includes being part of a community, that shares common interests or values. I find conceptualization of products and services and the use of brands highly interesting and I plan to write separate posts exploring the subject in relation to business models.

Broadening the concept of revenue model
As with the term value proposition, the common perception of the term revenue model when used in relation to business models, is according to me rather narrow. I often talk about the "revenue and benefit model" and the main thing I want to understand is "What do I get in return for providing value to each value recipient?" The term revenue model implies revenues, money, but as the website Boardofinnovation shows in its building blocks, benefits can also be other things such as attention or exposure.

I would argue that what a business can get in return for providing value to a value recipient can be much more than attention and exposure, with examples such as cross-licensing of technology and IP to get access to new assets and capabilities, user data to improve services or improve the value for advertisers, adoption of a technology platform or service to create momentum and obtain network externalities, co-development efforts to lower cost and reduce risks etc.


To read more about the 10 building blocks and see some examples please visit Boardofinnovation

Further reading:
What is a business model?
What is a value proposition?
The Business Model Canvas

Videos on Business Models

Below is a list of videos relating to business models. If you know any good videos on business models that are missing, please let me know.

• Alan Bell on the business of motion pictures
• Alexander Osterwalder on Business Models
• Alexander Osterwalder on The Net's Next Business Models
• Amazon's platform business model
• BMDesigner - An interesting software tool based on the business model canvas
• Chris Anderson on Freemium: The First Business Model of the 21st Century
• Chris Anderson & Guy Kawasaki debate The Freemium Business Model
• David Heinemeier Hansson on Charging for Online Services
• David Rowe on Open Hardware business models
• Eric Schmidt on news, newspapers and real time content
• Fred Wilson on disruption talks@google
• IMVU, Tripit, Photobucket, Commission Junction, and ShoeMoney Media in a very interesting panel about online Revenue Models
• Interview with Craig Beers, project manager for Ether Saga Online
• Interview with Eric Schmidt on Charlie Rose
• Interview with Evan Williams, CEO Twitter
• Interview with Marc Andreessen on Internet business models
• Interview with Marissa Mayer on The future of Google, on Charlie Rose
• Interview with Steve Rubel on business models for newspapers and online communities
• Interview with Trent Reznor on business models in the music industry
• Is the Advertising Model Dead?
• Journalism and business models discussed by panel at the International Center for Journalists' annual Board Dinner
• Mad Avenue Blues - The year the media died
• Making $1.6 Million in a week for music given away for free
• Martin Geddes on telco Business Models
• Music 2.0 Business Models from Future of Music Coalition
• Nick Bilton on new technology that will enable interesting business models for news
• Ning, Pandora, YouSendit, Pinger & Ngcomo in an extensive panel discussion about different Business Models
• Reshma Sohoni, CEO Seedcamp, on finding Business Models
• Rory Sutherland on revenues from mobile advertising and accidental business model innovation
• Shai Agassi on the business model of Better Place
• Simon Torrance on Two-Sided Business Models
• The Future of Content & Telecoms: Flat Rate Content Bundles and Social Media (Gerd Leonhard @ eComm 2009)
• Tim O'Reilly on Open Publishing
• TimesOpen: Tim O'Reilly Keynote Video
• Umair Haque on the music industry
• USC Marshall Webinars on Business Models
• Videos from New Business Models For News Summit 2008
• Zong, Super Rewards, PayPal and GMG Entertainment in an interesting panel on Monetization Infrastructure for Social Games

Aravind uses Freemium Business Model to enable FREE eye surgery for the poor

There are an estimated 12 million blind people in India with most cases arising from treatable or preventable causes such as cataracts. In a developing country with limited resources government alone cannot meet health needs of all the poor and the challenges are to make the service accessible, affordable and with high quality.

Aravind is the world’s biggest eye-hospital chain, based in India founded in 1976. Its core principle is that the hospital must provide services to the rich and poor alike, yet be financially self-supporting. It treats over 1.7 million patients each year, two-thirds of them for free.

Aravind's Freemium Business Model:

• Fee for service: 35% of patient care
• Free or subsidized service: 65% of patient care

There are separate facilities for paying and non-paying patients and it is up to the patient to choose where to get the care. The fee based service can include fancy meals or air-conditioned rooms and the paying customers pay well above costs to cover the costs for subsidized and free services. The free or subsidized services are made very cost efficient by proving only the basic facilities that enact a process of social self-selection and create a hurdle for those who can afford to pay to demand free treatment.

To maintain the quality of the care, the same doctors rotate to deal with both paying and non-paying patients.

High volumes

Aravind uses community partners and eye camps to access the poor, something that creates a huge demand for its services. Aravind’s business model is based on the high volumes generated and a surgeon in Aravind performs more than 2000 cataract surgeries a year which is 5 times the number performed by an average Indian ophthalmologist. The large number of performed surgeries creates an expertise and reputation which has lead to Aravind becoming a training center for ophthalmic professionals and trainees.

Aravind is not only a eye-hospital but also

• a social organization committed to the goal of elimination of needless blindness

• an international training centre for ophthalmic professionals and trainees

• an institute for research that contributes to the development of eye care

• an institute to train health-related and managerial personnel in the development and implementation of efficient and sustainable eye care programs

• a manufacturer of ophthalmic products available at low costs

"Aravind’s model does not just depend on pricing, scale, technology or process, but on a clever combination of all of them" The Economist, April 16th 2009

Further reading:

The Freemium Business Model