business-model-innovation-felix-hofmann

Discussing Business Model Innovation With Felix Hofmann [Lecture]

In this episode, I took the chance to ask, Felix Hofmann, CEO of the Business Model Innovation Lab, a spin-off from the University of St. Gallen, a few questions about business model innovation and more!

To give a bit of context the Business Model Innovation Lab is a spin-off from the University of St. Gallen, from which research, the book “Business Model Navigator,” came up. The Business Model Navigator is one of my favorite books when it comes to understanding business model innovation.

What brought you to study and research business model innovation?

Felix Hofmann: I got involved about 10 years ago when I started my first company, a startup in the field of education. It was like a textbooks platform and we developed a business model. The company was called PaperC GmbH. Basically, you paid only for what you saw. So the idea was to create a freemium business model for digital textbooks, and this was at the time when I was studying in Berlin and writing my diploma thesis. Thus, I got involved from the practical side and then, of course, we changed the business model several times. We pivoted and I learned that business model innovation is not just developing an idea and then going with it, but there is a lot of testing and iteration.

Then four and a half years later, I went back to university. I left the company, I left the startup, and then I met Professor Oliver Gassmann and Professor Karolin Frankenberger, the two professors that wrote the book, “Business Model Navigator,” where they basically described all the possible business models patterns that you can ever think of when you develop a business model. I found this very interesting, intriguing to have this total overview because quite often that you think just about one business model but you don’t think about all the options. So I think that was the motivation for me to join their model.

Gennaro Cuofano: I had a pleasant conversation with Ash Maurya, author of Running Lean. And it was interesting because we discussed how business model innovation is also a lot about tweaking your business model to find the right fit. So business model innovation is not just you coming up with this brilliant idea, you have this business model and everything works out.

Instead, you have to actually change a lot of things, you have to experiment with a lot of things until all the pieces come together. And it’s interesting because you started with the freemium model back in 2008.

Did you find the freemium model to be an effective model in your first start-up?

Felix Hofmann: In general, I think the freemium model is a good model, also for publishing, and for books. It can work. What we basically did wrong was we had some kind of wrong incentives, like what later become famous as “vanity metrics.” We had some investors that were just looking at users, active users, and not so much about the conversion rates, so basically, our motivation was just to get more and more users. So we grew the free part, but then later, the investors said, “Okay, now we want to see the revenues.” And then we had to quickly convert them into paying users.

So it was more like the wrong kind of KPIs incentives, I think. Not so much the business model itself that didn’t work. And another mistake actually that we did, but you never know before, is we had like a freemium paper use business model. So as the company was called PaperC, it was really on a pay per page base, and this was a little bit cumbersome. When you really wanted to purchase something, you need to upload credits. It was not very convenient, and later we wanted to shift the business model to a freemium model, but more like a Spotify, like a premium subscription or a free version.

But at the time, we already had like hundreds of contracts with the old business model, so it wasn’t easy to change that. That was for me an insight. We bet on the wrong horse and basically fixed the business model too early. We should have been much more flexible at the time. This was really 2008, 2009, and it was before the book, “The Lean Startup” was published and then, of course, most people got much smarter at developing business models. But this was a bit too early.

Gennaro Cuofano: And the freemium model, I believe is controversial because we know for a fact that the freemium model can scale the marketing of a company because you can get many users quickly. For me though, as I’m in business development, I know that not all the leads and all the users will ever actually convert in paid customers. Many startups running a freemium model are also still running at net losses. Those two things don’t have to be connected. Yet the freemium model is a harder model than many believe.

Do you think can we call a business model viable when we’re missing the profit formula?

Felix Hofmann: Yes. I think that’s a pretty old discussion, so a lot of big startups had huge valuations before becoming profitable, and sometimes not even having revenues. But of course, it’s very difficult because when you don’t see the conversions, it’s really hard to imagine if people would convert and how many would convert to calculate or extrapolate if this becomes a profitable business model sooner or later. It’s still a high risk at the time. On the one hand, you might have millions or billions of users. But on the other hand, you just have a kind of assumption about whether one percent can be converted in paid customers. And it can be totally different than if it was three or five percent of your users converting to paying customers.

You can make a lot of scenarios and it’s still very, very uncertain if your business model becomes profitable. You definitely have to take this into the calculation of your evaluation.

So there’s no guarantee at this time.

Gennaro Cuofano: I was looking at the Slack business model and it was interesting to me how from over half a million free users, the customers which were making up about 40% of the company’s revenues in 2019 were actually 575 customers. Those were more or less enterprise customers that Slack had to convert through a direct sales force. So it was interesting to me how on one end, of course, you can use the freemium to enhance your brand, especially for people to know you so that you can become a sort of a standard. But then, on the other hand, you still need sort of that sales force to actually manage to understand what is the “good side” of those users from the commercial standpoint. So I think that one is a very important aspect.

And just to go back to a very basic definition, which is important because everyone is talking about business modeling, but then it seems that someone means something, someone else means something else.

What is for you a good definition of business model?

Felix Hofmann: many still use just a revenue model and name that a business model. I see that still basically every day. When you look at slides and presentations of startups you see, “this is our away proposition, this is the customer, this is the problem, blah, blah, blah…” “And this is the business model,” and then they actually just talk about how they want to earn money.

But the definition of a business model is like the one we drafted in the Business Model Navigation, with a whole set of dimensions. We have the definition of four main dimensions, starting from the four Ws questions: the who, the what, the how, and the why.

  • So we say who is the customer? We need to first understand the customer, we need to be able to describe the customer because also a business model innovation can be a new customer or at least a new customer problem that we target. So that’s one element of the business model.
  • Then the what, basically the products and service that we offer, but also the benefits that you create, the problems that we solve. So describing the what.

And of course the what and the who needs to fit together. So I need to solve the problem that a customer has.

  • the third dimension is the how dimension. So basically what the key partners are, the key activities and the key resources in the business model.
  • And then the why dimension, which we say is not just the revenue, but also the purpose. And then, of course, the profit formula. So why do we earn more money than we have costs? And a big part of that is the revenue model. But the revenue model is just one element of the why.

And all these four questions together, for us, describe the business model.

what-is-a-business-model

Gennaro Cuofano: This is so important, because often the people think of a business model, as a revenue model. Rather, it is something way more holistic and it needs to take into account all other pieces that we need to put together in order to have a viable business model.

What’s the difference between a business model pattern and the business model?

Felix Hofmann: The Business Model Navigator framework is basically just the questions, the “empty canvas.” But then, of course, you can fill this with life, you can fill this with ideas and you describe an existing business model or you can describe a vision for a future business model. But then you have a concrete case, and the business model pattern is basically on a different level. So we say it’s a recurring logic that you see in very different business models and in very different products and industries, but it’s always the same kind of logic why it works.

And it’s best explained with an example, so we use the razor and blade business model pattern as an example. So razor and blade got its name from Gillette. Since Gillette is selling razors and razor blades for more than 100 years with the kind of same logic, selling cheap razors and then very expensive razor blades. And basically, of course, you have the lock-in, first with the razor, so there are a lot of patterns used, et cetera. So there are only the official Gillette razor blades that work with the razor. And then you have the high margins on the blades.

This kind of logic, you can use it to describe the Gillette business model, but it’s very similar also when you talk about printers and printer cartridges from HP for example, that have been developed since the 1980s, where you always have the same kind of cartridges for the printers, or so other products like Nespresso coffee capsules or some medical devices, like in diabetes care. So it’s very different industries, it’s a medical industry, it’s coffee, it’s Gillette razors. Very different industries but it’s always the same kind of logic. It’s a recurring logic, and so we have identified 55+ business model patterns that basically describe these logics and that have been applied not just for one product category or one industry but can be transferred to different industries.

And that’s why we say, okay, when it’s transferrable, then we call it a business model pattern, and you can use it as a blueprint, as a recipe for your own business model.

Gennaro Cuofano: There is also one argument that I believe that is in the book, in the business model navigator, which is often times, a business model innovation is a matter of actually mixing up those patterns.

So it’s not necessary to come up with a whole new idea, but just combining those patterns so you sort of create a new recipe for your business model.

Is business model innovation about mixing up those patterns and blueprints?

Felix Hofmann: That’s another element of it. So yeah, a business model itself typically is a combination of several of those patterns. We did a lot of case studies. Also, some are public on Slide Share. When we analyze business models, let’s say for example for Tesla or for Uber, or the other big, famous examples for business model innovation. When you look at them, you find at least three, four, five, six business model patterns that they have combined in a very smart way.

And of course It’s a long process, sometimes takes several years, but it’s typically that good mix of business model patterns that makes them really strong.

Gennaro Cuofano: there is another topic, which you covered recently on your blog, which is about business model scalability.

How does business model scalability work?

Felix Hofmann: business model scalability comes from the very old question also. Every venture capital basically is asking, “Okay, how scalable is your business model?” Right, so of course when they invest one, two, three million, they want to have a high return so they want to see high exit IPO. And for that, a business model needs to scale.

That means that it can be in very different ways. So it means that it’s geographically can scale into different countries, having more users and this is a very profitable way. And we looked into the concept of scalability because we figured out that sometimes it’s not clear what actually means. First of all, we kind of just figured out that it’s basically at least two dimensions, and it’s good to think of those two dimensions.

The one thing is the external scalability. That means can I scale my business model to normal users? Globally, are there limitations, for example in terms of regulation? And then there is the other dimension, the internal scalability that means: how efficient can I grow my customer base? Do I have a lot of investments to take? Like a lot of capital is bound or is it more very light business model, let’s say, software, where I basically have just initial investment and then no other investments to basically grow.

And this is the internal dimension, so the internal dimension is basically a lot about digitization. So how digital is my business model? Do I have, let’s say, physical assets or just digital assets? And the external scalability is really about is this a global need for this business model? Are there regulations restricting it?

This is also basically then either promoting or limiting my business model. And in combination, based off these two dimensions, we have drawn a diagram, driven by by two metrics that we call the BMI scalability metrics. And that metrics, of course, you see in the upper right corners are basically the perfect scalable business models of the digital platforms, let’s say Facebook, Google, et cetera.

business-model-scalability

Source: bmilab.com

And you also see that in the evaluation of those companies which are the most valuable companies in the world right now they are also the most scalable business models. And on the left basically lower corners, so basically the less scalable business models are basically the business models of the past,100 years old, or 200 years old business models. Let’s say the butcher in your village or the bakery; they are fixed for one location, they are physical and you need a lot of people to scale them up. It’s not digitized at all, and before franchise models, they also haven’t been scalable.

Based on these kinds of metrics, you can describe where is your business model, and maybe make it more scalable. For example, Uber is not as scalable as Google. You can see that because there are a lot of physical assets you need to scale Uber. Even they don’t have their own cars, they have much more people involved. And then, of course, the big point is regulation with Uber, which poses obstacles, as every city is different. Thus, Uber is not as scalable in terms of external scalability compared to let’s say Facebook.

Gennaro Cuofano: And of course, this going to hold true until there is not going to be also massive regulation on the digital side, on the media side because right now companies like Google and Facebook have scaled obviously, also because there is not yet much regulation.

Are there business models that you see will be dominating in the future?

Felix Hofmann: What we are looking into, especially with the research that we are doing in St. Gallen, as we are a spin-off from it; we still have our ties to some researchers. We’re looking very much into circular business models, so basically business models for the circular economy. And when talking about circular business models, what matters are ecosystems.

Thus, it’s not just about your business models anymore. It’s really about creating an ecosystem of business models, and then, of course, they ask the question “who is the orchestrator?” So basically who is designing the whole ecosystem model, or basically are there several orchestrators, or what’s your role?

Maybe you are the orchestrator at one ecosystem, and maybe you’re just another smaller supplier in another ecosystem. That ecosystem strategy I think becomes more and more important. And of course it’s sustainability with circular business models, they also need to be sustainable, otherwise, it’s just pure marketing.

Then we look into of course digital ledgers technologies. If they will produce new types of platforms, decentralized platforms that work differently than the big centralized platforms that we see today. That’s also a very interesting field that we look into. So this is really the research that is going on. We see this coming more and more, but of course, they have to prove to be successful. This would probably take also many years.

And we also see it from the larger corporations, that they have more interest in circular business model innovation right now than it was maybe before, some years ago. But of course you have to show that they can really be profitable, but the same was true in the mid-’90s when you have all the e-commerce startups that also haven’t been profitable at the times. Like the Amazons of the time. So it needs some time and also people need to get smarter on how to make those business models successful.

Are there any interesting business model patterns that you notice so far in the blockchain world?

Felix Hofmann: Probably yes, but it’s difficult to identify patterns until you just see the business model in full grown and successful. We had a researcher looking into this, but we stopped the project actually because of lack of commercial viability yet.

Gennaro Cuofano: Of course it takes time because the research is way more rigorous compared to anything else. And it’s very interesting what you said in your research, of course, you have to wait years because you need to isolate the noise and the “marketing effect.”

Is there any person, academics, that you suggest following from the business modeling side?

Of course, the professors that I mentioned, Professor Oliver Gassmann, definitely interesting to follow. And at his institute, there are some researchers that look into ecosystems and that look into digital ledgers technologies, and the works together with Professor Karolin Frankenberger, and Professor Michaela Csik, authors of the Business Model Navigator.

So definitely interesting to follow them and also to see what they publish in terms of papers and also probably some books over the next years. We are writing on a circular business model navigator book right now!

Gennaro Cuofano: It’s going to be a great reading!

Is there a companion book that you suggest reading together of course with the “Business Model Navigator?”

If you know everything about design thinking and lean startup and the business model canvas, and the “Business Model Navigator,” definitely worth reading as an additional resource. If you start, I think there are other books, like “Lean Startup,” and definitely just look into everything from Steve Blank and then Eric Ries. And also Ash Maurya, “Running Lean!”

I think that there’s a big literature. Also “Corporate Startup,” I think is a very good book when more about when you’re more coming from a corporate side. So there’s a lot of literature that is good and that you can recommend.

Gennaro Cuofano: Thank you very much, Felix! It was a pleasure having you here.

Felix Hofmann: Yes, thanks, Gennaro.

Key takeaways from the interview

  • Business model innovation implies a lot of testing and iterations
  • Beware of falling in love with vanity metrics
  • A business model comprises a revenue model, but they are not the same thing
  • A revenue model is part of the “why” dimension of a business model
  • The blueprint of a business model is called a pattern. This needs to be repeatable
  • Often a successful business model implies mixing up several business model patterns
  • Before a business model might become viable it might take up years of experimentation and testing
  • A business model scalability implies two dimensions: internal and external
  • The business models of the future are becoming more about creating ecosystems
  • Thus, circular business models might become dominant in the future

Suggested readings from the interview

the-business-model-navigator-book

A glance at the business model patterns from the Business Model Navigator

60-business-model-patterns

Other resources:

Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which he brought to reach about a million business students, professionals, and entrepreneurs in 2019 alone | Gennaro is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate and become profitable | Gennaro is an International MBA with emphasis on Corporate Finance | Subscribe to the FourWeekMBA Newsletter | Or Get in touch with Gennaro here

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