Business Model: When and how to change it?

Why Do Business Models matter?

During the dot com boom in the 90s, the phrase “Business Model” became a viral buzzword. Many companies succeeded in receiving investment without any actual strategy or competence and just by demonstrating a semi-functional business model for their digital platform. This has caused the failure of many companies leaving behind a big number of disappointed entrepreneurs, investors or executives.

The problem at its core was not introducing a business model for companies nor investing in it but, the misunderstanding and the misuse of the term without having a clear understanding or simultaneously acquiring the other essential requirements to run a successful business.

The main objective of a Business Model is to answer the essential questions of: Who is the customer? What does the customer value? How do we make money in this business? How are we going to deliver value to a customer at a reasonable cost? A successful Business Model clearly presents how we are better than the existing alternatives either in comparison with existing solutions or offering a new solution which did not exist before.

The Story and the Numbers

A quick test to evaluate the solidity and accuracy of a Business Model depends on its two features. The heart of a Business Model is comparable to a good story. It includes well-defined characters, motivations, insights and a plot or narrative which binds all the elements of the story together. It makes you understand who the customer is, where the money comes from, what is the logic behind, how are you going to deliver the value, what are the costs and so on.

There is also a numerical side of a Business Model. Nowadays it is quite easy to spread our assumptions of a Business Model into numbers in a software or a spreadsheet in its simplest form. This will help you to predict the potential outcomes by changing your assumptions as well as make it possible to estimate and analyze the risks of changes in variables which you have built the Business Model on.

Business Model and the Strategy

Even though many people misunderstand this, the Business Model is not defining your company’s strategy. Business Models illustrate how different pieces of your business puzzle fit together. They define systems where specific questions about your business are well answered however, they do not represent the critical factors for performance of a business, most importantly, competition. 

If your Business Model offers a better solution compared to existing ones, it means that you already have competitors in the market. Even if you are introducing a solution which did not exist before, soon there will be competitors in your market trying to offer better choices to the customer. In any case, dealing with this reality is defined by your Strategy. It is your company’s strategy which defines how you are going to do better and be different. 

Sometimes, it is the Business Model which could be used in a company’s strategy to provide competitive advantage. By changing the rules of the existing game, a company may bring the competition to a level where adequate profit making is not possible. Offering more value or less price by using new technologies is a familiar example of such disruptions.

Is one Business Model enough?

To establish more than one functional Business Model at once is usually hard to achieve and has failed many companies. However, on rare occasions, not only is it beneficial but also necessary. For example, businesses who want or have to address multiple customer segments at the same time, or if you want to utilize the existing resources in your business to expand into new markets or disrupt a competition.

The challenges of managing multiple Business Models

Defining complementing Business Models. Technically, different Business Models in the same business are more viable if they complement each other by enforcing each other’s customer segments, line of investment, marketing or more.On the other hand, if multiple Business Models are substitutes of each other, they will drain the resources of the business and drag it towards the failure.

Additional complexity. Planning to run multiple Business Models at the same time, is a sophisticated task to define the borders between your customer segments and business assets for each model. For example, if you are going to assign different Business Models for B2B and B2C segments, there should be transparent definitions in place for when a customer falls into which category.

Broader organizational skills. Obviously, your staff and personnel need the right training, skill set and understanding of the difference between multiple Business Models. Also you may need dedicated resources to fully or partially address a specific model.

Additional investment. Sometimes your investors are interested in one or some of the multiple existing Business Models. This may bring some obstacles, if not confusion, in upcoming rounds of investments at your company. You need to be prepared to address this issue before sitting at the table with the investors making them understand and feel safe how they are going to invest in what part of your business.

Is your Business Model in trouble?

With the emergence of new technologies, the lifecycle of products and designs are getting shorter. Customers are now used to looking forward to finding the next big thing. At the same time, there is a competition between industries disrupting each other’s markets. For example, smartphones made it possible for you to carry multiple tools and features in your pocket like a watch, a calculator, a compass and more which had their own companies, businesses and industry before.

The same way, changes in Business Models could disrupt the existing businesses by offering a better (different) user experience while fulfilling a need or delivering a product or service. Once you have entered a market and have proven that the customers are looking after what you offer, it is so easy for competitors to raise towards the market with a more fine tuned Business Model. That is why the Business Model is usually associated with being “Dynamic” and needs to continuously change, evolve and improve.

Three signs to relook at your Business Model

The first and the biggest indicator that it is time for your company to rethink its Business Model, is when the more you try to further develop the products or services, it results in smaller and smaller improvements. If your team is having a hard time thinking about what could be done better, it is time to think about fundamental changes in the existing Business Model.

The second sign is losing customers over alternative solutions. When you realize your customers are more satisfied with other solutions in the market, it indicates your Business Model is not good enough anymore. You may start by not getting as many new customers as before and eventually end up with losing existing customers too.

The last sign shows up when it is almost too late and you will realize that in your financial results or business performance indicators. Since the people at the top of a company have gotten there by the existing Business Model, they will have a hard time accepting the early evidence and signals of the need to reconsider the Business Model until usually it is too late.

The Business Models to avoid

Between the different types of Business Models, you should avoid the most where the customer buys something once and goes away. In other terms, you do not have “Stickiness” in your Business Model or have no plans for “Returning Customers”. The other trap to avoid falling into is forgetting about a revenue model in your business. For example, offering a limited number of free products or services is reasonable if you want to run an experiment at low cost but if you are going to offer a freemium or free trial version, think about how you could monetize those indirectly in order to generate some revenue.

Who can resolve the problems in Business Model

Before deciding about doing any changes, you should do some investigation and run experiments to challenge the existing assumptions in your existing Business Model. Not only reprocess the current data, but also find out what type of new datasets may help you to find out how you can offer a better solution. Try not looking for confirming signals about what you are doing right now. Collect raw information/data directly from customers, simulate customer experience, try to find out what they are going through and what could be done better or differently.

After you have collected enough fresh data, put a diverse experienced team together who know about the technology in your business, have a long term vision from different aspects of your business, and understand the customer needs.  Develop hypotheses and run experiments to find out if and how you are going to implement them in the existing Business Model.

It is very wise to invest in several high priority hypotheses to experiment. Naturally some may fail and some may succeed. This will save you a lot of time instead of experimenting one hypothesis at the time. However, be careful about the experiments which may be interrelated and affect each other’s results or outcome.

When is the right time to start troubleshooting

There is no general recipe for scheduling the changes. First of all, have an estimation about when the cash flow of the new Business Model kicks in. Meanwhile, if you are still generating a reasonable revenue from your existing Business Model, it is wise to put the new model in place gradually. You may also be able to monetize the old Business Plan for example by licensing it to other companies or by outsourcing some operational parts with a lower cost.

Considering the required time for communicating with your stakeholders and investors about the changes is also very important. They need to be informed, aware and patient about the risks and the time which may be necessary for the transition between Business Models to take place. 

Reinventing your Business Model

In 2003 when Apple introduced the iPod to the market, they did not just wrap a good technology in a dashing design. They did something way smarter! They implemented good technology in an amazing Business Model combining hardware, software and service, providing a game-changing convenience for customers and record-breaking profits for the company.

Great Business Models can disrupt or reshape the whole industry while driving spectacular growth and profit for the companies. However, one main reason for companies to find Business Model innovation hard to achieve, is that executives and managers do not understand their existing Business Model enough to know when it is time to change and how. 

Four fundamental elements of Business Model

In order to better understand your current Business Model, you need to identify and analyze its four interlocking and fundamental parts which together they create and deliver value to the customer:

• Customer Value Proposition (CVP)

The core success of every company is in the way that they have found to create (propose) value for their customers. A way for customers to get the “job” done meaning a fundamental problem to address in need of a solution. The better you understand the “job”, the better you realize all its dimensions including the process of how to get it done. That is when you can design a better offering for the solution.

Your Customer Value Proposition (CVP) will be greater when: the more important the “job” is to the customers, the lower the satisfaction they have from existing solutions, the better your offering is compared to the existing ones, the cheaper your solution is compared to the alternatives.

• Profit formula

Business Model is not the formula or instructions for your company to earn money. How your business is generating profit is a part of your Business Model even though sometimes people may misunderstand one with the other. While offering value for your customers, you should provide some value for your business as well to survive. This is called profit formula and consists of the following parts:

• Revenue model: How much money can be made in terms of price multiplied by volume. Volume can be thought of in terms of market size, purchase frequency, sales, etc.
• Cost structure: How costs are allocated including direct costs, indirect costs, cost of key assets, and economy scales. This is mainly driven by the cost of the key resources required by the Business Model.
• Margin model: How much each transaction should net to achieve desired profit levels.
• Resource velocity: How quickly resources need to be used to support target volume. Includes lead time, throughput, inventory turns, asset utilization, and so on.

• Key resources

All the assets including human resources, technology, products, facilities, equipment, channels, etc. which are required to deliver the value to the targeted segment of the customers. At the same time there may be generic resources in every company which are not generating any competitive advantage. Here we put our focus on the term “key” meaning the resources creating value for both customers and the company.

• Key processes

Key processes are repeatable operational and managerial activities resulting in delivering value to customers and the company. The scalability of these processes will result in growth of the business. Key processes may also include tasks like training, development, manufacturing, budgeting, planning, sales and services.

These four fundamental blocks define the backbone of every Business Model. The CVP defines value for the customers. The profit formula defines the value for the company. Key resources and key processes define how those values are generated and delivered for both customers and the company.

How great models are built

By understanding the four fundamental parts of an existing Business Model, the possibility of generating a better version or an innovative new Business Model for the company correlates with the possibility of redefining those fundamental parts in a better, improved or innovative way.

Create CVP

The most important attribute of a CVP is its precision. How perfectly and precisely it fulfills the customer job to be done and nothing else. Such a precision is not usually easy to achieve since many companies get distracted by trying to offer a lot of things without doing anything really well.  One way to generate a precise customer value proposition is to think about the four most common obstacles keeping customers from getting the job done: Finances, Access, Skill, or Time. 

When you successfully identify a demand in the market or a “job”, the problem on the way of customers to get it done is usually one or some of those four common factors. A successful CVP should precisely address the obstacle by removing it or minimizing the problem.

Design a profit formula

There are countless identified problems which no company has offered a solution for, yet. One of the main reasons is that there is technically no feasible way for a company to formulate profits by providing the solution. Designing a profit formula needs to provide value for the company while maintaining the CVP as feasible. For example, if your profit formula is in contrast with the above mentioned obstacles (finance, access, skill or time), it will drag down the most important element of your Business Model being CVP. 

Identify the resources & processes

Articulating the value proposition for both customers and the company will define the feasibility of doing business. However, to keep your business viable, you need to consider the key resources and required processes to run your business and deliver those values. Depending on the nature of your business, industry, customers, and etc. your key resource may for example be the people (HR) which makes your key processes people related like training, education, and development. 

Most of the time, there is no single resource or process which is the key in your Business Model but a group of resources and processes. You should pay attention to the relations between the different elements as well where changes in any or some resources or processes will affect the nature and relations of the rest. 

When the new Business Model is needed

Answering the question if your company is in need of a new or innovative Business Model is not easy. For most established and running businesses, developing a new product or service may be the answer to disrupt the competitors instead of changing the whole existing Business Model. However, there are situations where further development of your business and growth of the company depends not only on entering into unknown markets but also using an unknown Business Model. In such cases and if you realize that all four fundamental parts of your existing Business Model needs to change, it could be an indicator that your company needs a new Business Model.

The indicators

It is not reasonable for companies to pursue changes in the Business Model unless there is concrete evidence that the opportunity is large enough to compensate for all changes and efforts. Also, changing to a new Business Model is not reasonable if it is only new to the company without introducing any innovation or disruption to the market. Here are the 5 most common signs that you may need a new Business Model:

1. When there is a large group of customers abandoned from the market and there are opportunities to address them via disruptive innovation. For example, when you realize that innovative and disruptive changes in your Business Model can expand your market towards the bottom of the market pyramid by democratizing your CVP.
2. When you can refine the existing non-focused solutions to offer a precise alternative for getting the job done. This usually happens when there is no existing precise solution for that specific job in the market resulting in introducing new or innovative solutions to the customer segment.
3. When there is a new technology which could be capitalized by putting it into a well defined Business Model. You can leverage the tested existing technologies and bring them to the market via innovative Business Models to get the job done.
4. When you need to disrupt the low-end competition. If there are competitors in your market offering low-end solutions and taking away your customers, redefining the Business Model may make it possible to own a bigger share of the market and fend off or pre-empt those competitors.
5. When you need to address the shifting demand in the market. The definition of an acceptable solution may change during the course of time in the market and you may need a new Business Model to respond to the changes.

The secret

On average, a new company needs to revise their Business Model at least four times before showing signs of acceptable success and profitability. A well composed and innovative Business Model can often dramatically help to reduce this cycle. However, being observant, patient and understanding the need for taking courses of corrections must be recognized by company owners and managers. Collecting data, learning and adjusting the Business model are as important as executing the processes and operations.

Business Model Analogies

Source: Mark W. Johnson, Reinvent Your Business Model (Boston: Harvard Business Review Press, 2018), 145-146. 

References:

• Magretta, Joan. (2002). Why Business Models Matter. Harvard business review. 80. 86-92, 133.
• Casadesus-Masanell, R. & Tarzijan, Jorge. (2012). When one business model isn’t enough. 90.
• Rita Gunther McGrath interview with HBR executive editor Sarah Cliffe.
• Johnson, Mark & Christensen, C.C. & Kagermann, Henning. (2008). Reinventing Your Business Model. Harvard Business Review. 87. 52-60.