Introducing the Magic Triangle of Business Models
Every profit-oriented organization has a business model – its consistency, future ability and basic logic largely influence the overall success of an organization. However, very few managers are able to explain their company’s business model ad-hoc, and even fewer can define what a business model actually is in general. The number of companies, which have established dedicated business model innovation units and processes is even lower. Given the importance of the topic, this lack of corporate institutionalization is surprising – although, considering the complexity and fuzziness of the topic, it is to be expected.
A reason for this might also be the different definitions of various scholars and business thinkers for the concept of a “business model”. In 1994 Peter Drucker defined business models as “stories that explain how enterprises work” and answer the age-old questions of Peter Drucker’s Theory of Business – “Who is the customer? And what does the customer value? How do we make money in this business? What is the underlying economic logic that explains how we can deliver value to customers at an appropriate cost?” (Magretta, 2002). Alex Osterwalder defines a business model as “a set of assumptions or hypotheses” and Michael Lewis claims that “all it really meant was how you planned to make money” (Ovans, 2015).
At heart a business model explains the basic logic of a company – consisting of value creation and value capture. The value creation describes what benefit is created by the company and the value capture explains how the company can generate revenue from the offered benefit. A more comprehensive yet simple way to describe business models is the “Magic Triangle” which consists of four essential dimensions – WHO, WHAT, HOW and VALUE.
WHO – Every business model serves a certain customer group (Chesbrough and Rosenbloom 2002; Hamel 2000). Thus, it should answer the question ´Who is the customer?´ (Magretta 2002). Drawing on the argument from Morris et al. (2005) that the ´failure to adequately define the market is a key factor associated with venture failure´, we identify the definition of the target customer as one central dimension in designing a new business model.
WHAT – The second dimension describes what is offered to the target customer, or, put differently, what the customer values. This notion is commonly referred to as the customer value proposition (Johnson et al. 2008), or, more simply, the value proposition (Teece 2010). It can be defined as a holistic view of a company's bundle of products and services that are of value to the customer (Osterwalder 2004).
HOW – To build and distribute the value proposition, a firm has to master several processes and activities. These processes and activities, along with the involved resources (Hedman and Kalling 2003) and capabilities (Morris et al. 2005), plus their orchestration in the focal firm’s internal value chain form the third dimension within the design of a new business model.
VALUE – The fourth dimension explains why the business model is financially viable, thus it relates to the revenue model. In essence, it unifies aspects such as, for example, the cost structure and the applied revenue mechanisms, and points to the elementary question of any firm, namely how to make money in the business.
Business Models in the context of Innovation
A common way to differentiate innovations is the categorization according to two generic characteristics:
1. The object of innovation
2. The degree of innovation
When differentiating by innovation object, a basic distinction is made between product-, process-, service-, technological-and business model innovation (Edwards-Schachter, 2018). A business model innovation is defined as the conscious change of at least two dimensions of the introduced “Magic Triangle”. Thus, business model innovations can be differentiated from other types of innovations.
There are various triggers for a business model innovation - companies may find themselves in limited growth areas due to market saturation and are thus forced to exit the core business with a new business model. Moreover, emerging technologies or trends may change the market environment - a company may be forced to act reactively or may want to act proactively by adapting the existing business model.
According to the degree of innovation, innovations can be divided into evolutionary and disruptive innovations. Evolutionary innovations are incremental improvements in the performance of existing products along the mainstream customer requirements in existing markets with existing competencies and the current business model (Christensen et al., 2015). Radical innovations are similar to evolutionary innovations - but the leap of innovation is more comprehensive. In radical innovations, the main challenge is often the acquisition of new competencies within an existing business model.
Disruptive innovations are innovations that radically change existing structures and markets (Pisano, 2015). They start in market niches - usually in the low-end market or with non-consumers. Due to this different customer focus, disruptive innovations are initially inferior in the mainstream market but superior in the targeted market niche. Typically, disruptive innovations are cheaper, easier, or more convenient (Christensen et al., 2018). Disruptive innovations are mostly business model innovations that copy successful patterns or technologies from other industries and combine them into a new business model concept. Accordingly, fundamental new competencies are not necessarily required for a disruption - but changes in the business model and a break with existing industry logic are required (Pisano, 2015; Gassmann, 2020).
References:
Chesbrough, H., & Rosenbloom, R.S. (2002). The role of the business model in capturing value from innovation: evidence from Xerox Corporation's technology spin-off companies. Industrial & Corporate Change, 11(3), 529-555.
Christensen C. M, Raynor, M. E., McDonald, R. (2015). What Is Disruptive Innovation? Havard Business Review.
Christensen, C. M., & Raynor, M. E. (2018). The Innovator’s Solution: Warum manche Unternehmen erfolgreicher wachsen als andere (M. Reiss, Übers.; 1. Aufl.). Vahlen, Franz.
Edwards-Schachter, M. (2018). The nature and variety of innovation. International Journal of Innovation Studies, 2(2), 65–79. https://doi.org/10.1016/j.ijis.2018. 08.004
Gassmann, O., Frankenberger, K., & Choudury, M. (2020). Geschäftsmodelle entwickeln: 55 Innovative Konzepte mit dem St. Galler Business Model Navigator. Carl Hanser Veralag GmbH & Co. KG.
Hedman J., & Kalling, T. (2003). The business model concept: theoretical underpinnings and empirical illustrations. European Journal of Information Systems, 12(1), 49-59.
Johnson, M.W., Christensen, C.M., Kagermann, H. (2008). Reinventing Your Business Model. Harvard Business Review, 86(12), 50-59.
Magretta, J. (2002). Why business models matter. Harvard Business Review, 80(5), 86–92, 133. https://hbr.org/2002/05/why-business-models-matter
Morris, M., Schindehutte, M., Allen, J. (2005). The entrepreneur's business model: toward a unified perspective. Journal of Business Research, 58(6), 726-735
Ovans, A. (2015). What is a business model? Harvard Business Review. https://hbr.org/2015/01/what-is-a-business-model
Pisano, G. P. (2015). You need an innovation strategy. Harvard business review. https://hbr.org/2015/06/you-need-an-innovation-strategy
Teece, D.J. (2010). Business models, business strategy and innovation. Long Range Planning, 43(2-3), 172-194.
Want to read more about business model innovation? Download the Business Model Navigator whitepaper.
Buy your copy of the Business Model Navigator book to get a step-by-step guide for building new business models.
Interested to discuss your innovation challenge with Georg von der Ropp, our CEO? Grab a timeslot in his calendar.