A business model describes how an organization runs its operations. That seems simple enough, but when it comes to innovative business models there are many other questions that arise. What makes up a business model? What type of business model do I have? What do business models have to do with disruption? Do I need a new business model?
This week’s Thursday Theory Tips blog will answer all of these questions so that you can determine if your business model is working for you.
What makes up a business model?
A business model is made up of four interdependent elements that together create and deliver value. These elements consist of the value proposition, resources, processes and profit formula.
The value proposition is the product or service that helps customers do a job. Completing a job, trying to make progress towards a goal through your product or service, is essential because if customers are not trying to complete a job then the value proposition won’t be viable. The value proposition will then determine the resources that need to be put in place. These resources are tangible and can be, but are not limited to: people, technology, products, facilities, or cash.
How companies use their resources to deliver their value proposition becomes the company’s process. Processes can be either formal or informal, but once they are successfully repeated enough and followed by assumption rather than explicit decision they become a company’s culture. Finally, the profit formula defines how big the organization has to be to break even, and how they will continue to grow their profit if they continue to scale. Essentially, the profit formula defines how fast the organization must turn over its assets in order to achieve adequate returns.
When thinking of these four elements as an entire unit, the sequence in which the four elements of the business model are assembled will typically vary by circumstance. However, regardless of sequence, generally the value proposition determines value for the customer and the profit formula determines value for the company and its owners. The resources and processes determine how that value is delivered to both the customers and the company.
What type of business model do I have?
With a better understanding of what a business model is, we can now dive into the three main types of business models: the solution shop model , the value adding process model, and the facilitated network model.
Solution shops are institutions whose resources and processes are structured to diagnose and recommend solutions to complicated problems. These institutions usually follow a fee for service revenue model. Examples can be consulting firms, advertising agencies, or specialist physicians.
The value adding process model adds value to things that are incomplete or broken to repair or complete them. These institutions usually follow a fee for outcome revenue model. Examples can be retail, restaurants, automobile manufacturing or educational institutions.
Facilitated networks are institutions in which people buy and sell, and deliver and receive things from each other. In this business model companies make money by facilitating the effective operation of a network. Examples include mutual insurance companies or telecommunication companies.
What do business models have to do with disruption?
Negligence of innovative business models is often why companies struggle with capturing new growth or even why they might fail when challenged by a disruptive attacker.
Disruptive innovation is a process enabled by three elements: a technological innovation, a disruptive business model, and a new value network. In disruption the simplifying technology must be embedded in a business model whose resources, process and profit formula enable it to deliver the simple and affordable solution in a cost effective way. The business model in turn needs to be embedded in a new ecosystem, or value network, that won’t force the disruptive business to conform. A disruptive business model is essential for a disruptive business.
However, disruption can happen within and across business model types. This means that when an enabling technology makes it more affordable and simple for a new population of people to own and use a product, the disruption occurs within a type of business model. For example Toyota disrupted General Motors with their simple, affordable vehicles, but this all happened within the value adding process model.
When the enabling technology makes it affordable and simple for a new population of people to produce or provide a product or service, then the disruption happens across business models. For example Airbnb gained a significant foothold in the hotel industry and now offers more rooms than even the largest hotel chain. By opening up the lodging industry to anyone who had available property, Airbnb didn’t only impact hotels but also impacted hotel restaurants, hotel cafes, hotel cleaning staff and so on and so forth, transforming value-adding process businesses into facilitated network businesses.
Do I need a new business model?
With a better understanding of business models and their role in disruption, now you can determine if it’s time your company developed a new business model. Note that if your business model is disruptive to competitors but not your own business, then you don’t necessarily need a new business model. But if you decide your company needs a new business model, then you should know there are two types of opportunities for business model innovation: low end disruptions and new market disruptions.
When something new is too expensive and has limited accessibility, there is an opportunity to make simple or accessible options and “decentralize” the industry. During this decentralization process, each step is achieved by making the product simpler and more affordable, and is therefore generally disruptive to the business models of the prior generation of competitors.
Business model innovation can be the determining factor in a company’s success or failure, so understanding the elements of business models and the process of building them will not only let you know if your business model is working for you, but will give you an idea of what to do if it’s not.
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