business-model-innovation

What Is Business Model Innovation And Why It Matters

Business model innovation is about increasing the success of an organization with existing products and technologies. By crafting a compelling value proposition able to propel a new business model to scale up customers and create a lasting competitive advantage. And it all starts by mastering the key customers.

Course: The FourWeekMBA Business Model Innovation Flagship Course

Contents

The importance of business model innovation

In the last years, I’ve been dissecting business models of any type, and companies of any size. At the same time, I’ve been talking, interviewing, and discussing business models and business model innovation with dozens of entrepreneurs and practitioners.

I’ve been doing that for several reasons:

  • To gain a better understanding of businesses around me. As I had the option to gain a Ph.D. on the topic or to create my Ph.D. I went for the latter, and in the process, I thought to document it all on FourWeekMBA. Over time I wanted to create the business school I always dreamed of.
  • Business models enabled me to gain insights into how companies worked at a holistic level so that I could become a better digital entrepreneur.
  • Business modeling also helped me test the assumptions around the business I was trying to build, thus reducing the time or potential financial resources spent on a project which was doomed to failure.

In short, I found myself using business modeling for several reasons, and those I believe are all legitimate.

At the same time, while researching the topic with the mindset of an entrepreneur but the depth of reach of a Ph.D. I noticed how the business model and business model innovation had become widely adopted concepts. And also (and probably for that reason) widely misunderstood.

Business model innovation is about increasing the success of an organization with existing products and technologies by creating a compelling value proposition able to allow an organization to scale up customers, with a better operating model.

At its core business model innovation is a subtle change, that as it becomes hard to dissect from the outside world (in many cases business model innovation is detected when an organization has achieved massive success), it is also hard to copy.

Thus, in a world where technology has become, in part a commodity business model innovation can make a huge difference.

Before we move forward toward deciphering and dissecting business model innovation, let’s bust three myths, existing in the entrepreneurship world, especially in the era of digital business models.

RelatedWhat Is a Business Model? 30 Successful Types of Business Models You Need to Know

Business model innovation enables you to create competitive moats

As technology becomes over time a commodity, creating a lasting advantage requires business model understanding, experimentation, and execution. 

That’s because business model innovation shifted the focus from the competition; which is what in the last decades we’ve all been looking at with frameworks like Porter’s Five Forces, to customers.

Without going through all the reasons why that happened today, business model innovation has become more important than technical innovation.

A quick caveat, before we move on.

When I say that the focus has shifted to customers, it doesn’t mean that you don’t need to understand your competition. It just means you need to start from customers and the problems they face. Only after that, you want to move to competition and what existing alternatives exist.

A multi-faceted concept

Although we like to give a single definition to each of the concepts we know, those concepts will adapt based on the context they sit into.

In short, that is fine to have multiple definitions of the concept, based on the objective that each practitioner might have.

Therefore, it’s okay that a concept translated in several fields will have different meanings.

Thus, let’s see some of those meanings.

Analysts use business models to produce financial analyses

Business modeling can be seen as a technique to dissect any organization and business for analysts and business people trying to gain a better understanding of those businesses.

Business and financial analysts use business modeling to have a better understanding of tech companies. They do it to give investment recommendation, financial reviews, and investment advice.

Academics study business models for the sake of classifying things

For academics, a business model might be just a holistic way to describe a business. And the purpose of an academic might seem more rigorous than an entrepreneur. The academic has to prove the business has certain features that make it different or similar to other businesses.

And from those features, the academic will derive classifications, that as they become more and more complex only live in theory land.

The research, therefore, doesn’t have necessarily a practical purpose. But instead the goal of uncovering universal classification systems for things in the real world. As such, they might lose a practical application.

Most people confuse business models for business plans

google-autosuggests-business-model

Among the top results, Google suggests “How to write a business model” when typing “how to … business model. When you click on the result that Google suggested, see what happens.

how-to-write-a-business-plan

When you click on the Google suggested result for “How to write a business model,” you get “how to write a business plan.”

For most people (those that didn’t study the topic), business models often resonate with business plans. I noticed it when I started to research the topic.

As Google makes accessible the searching data and behaviors of billions of people, it also adapts to those search behaviors.

To my surprise, in the past, I noticed how for the query “how to write a business model,Google served results around “how to write a business plan.”

I’ve learned to appreciate those “mistakes” as Google is a commercial search engine. And as such, it follows what most people search. If collectively people think that a business model is a business plan, Google might enable that to be true.

This means that if you are an entrepreneur searching for valuable resources either you are lucky to find the resource you need or you might end up writing a hundred-page business plan which won’t help much with your business.

If at all will prevent you from starting it. As you will start making things more complicated than what they should be.

Startups confuse business models for monetization strategies

airbnb-first-pitch-deck

An example of how Airbnb “confused” its business model for its monetization strategy (Slideshare)

wework-revenue-strategy

How WeWork described its business model in the report before the IPO. You might notice that what they’re talking about is their revenue generation strategy. (WeWork Financials)

And for many startups, the business model resonates with monetization strategies. I’m not saying this is right or wrong; it’s just what it is.

Overall that is fine. Startup pitches or financial forms are in many cases, also a marketing tool meant to communicate and simplify a concept.

Thus, if most investors want to know about your business model but what they mean is how you make money, that is fine to simplify it.

However, as an entrepreneur, if you do believe yourself that a business model is how you make money that might limit your options, as all day long you’ll think about monetization strategies, rather than having a more holistic and strategic approach.

Business model innovation is an experimentation mindset for entrepreneurs

Business model design is not about sketching a plan on a piece of paper, but rather a mindset of experimentation.

In business modeling, you can manufacture experiments (business models, and business model variations) that enable the entrepreneur to test the assumptions around the business quickly, cheaply, and with minimum effort. 

It is important to start testing (as practitioners like Ash Maurya highlighted) from the riskiest assumptions.

Those assumptions for which the business might not become sustainable over-time. Things like monetization strategy or key customer understanding are some of the riskiest assumptions, and they need to be tested, quickly.

An entrepreneur is not a scientist

An entrepreneur has different goals than a scientist. Where the scientist might try to uncover more universal truths. The entrepreneur needs business model experimentation to test the assumptions, uncover market opportunities, reduce the time to market, and eventually build a valuable business.

In short, an entrepreneur is a market-driven animal. Rather than starting from theories to find if that is true through experiments. An entrepreneur starts from a problem, and she, or he goes back to theory to understand what are the underlying assumptions which are preventing the business to succeed.

Once those assumptions have been streamlined, they can be tested, so that the entrepreneur can move on and make the product or service in target with the market.

Business model innovation is at the same time a mindset, a framework and a set of tools for entrepreneurs

Business model innovation, therefore, can be seen as a mindset, framework, and a set of tools for entrepreneurs to build relevant businesses in today’s marketplace.

Myth one: the best product wins

When you get online, and want to look for something, but you’re not sure what is that chances are you’ll land on a white page with a small search box on it, that is Google search results page.

Why in the first place do you get there?

Well, you get there because Google is an incredible product, able to find you anything on the web at a super-fast speed. Yet, is Google the best product out there? And how do we define best?

Well, Google is a great search engine able to give you relevant results to any question, but it also benefits from network effects. In short, one of the reasons why Google is good enough in intercepting search intents is the fact that billion people around the world use each day.

At the same time, Google is a decent product for what it gives us back (and it is free), but it also has drawbacks. For instance, in an experiment, an SEO expert tried to rank a Latin Language site (a language used by ancient Romans, no longer in use) and guess what? It did that successfully.

This is not to say that Google is not a good search engine. Google today is the most widely used search engine on earth, and part of the reason why is thanks to its distribution strategy.

Since its scale-up phase, Google aggressively acquired deals that made it the tech giant we know today. However, a few people realize it, and it is easy to think – especially in tech – that the best product wins.

A great product with a lack of distribution strategy won’t go far.

Myth two: technology is what gives a competitive advantage

Peter Thiel, former CEO of PayPal has shifted an important business paradigm. As the common business thinking goes “be the first and you’ll probably win over time.”

This is called in business jargon, first-mover advantage. Peter Thiel, instead of pointed out an important paradigm, especially in the tech industry, which is the last-mover advantage.

In other words, companies that come later, especially in the tech industry, can win over existing organizations, even when those were the first movers. For instance, Google and Facebook were not the first movers to move in the search and social media space. They dominated it.

What happened there? The answer is business model innovation!

Myth three: business model innovation is just about how you make money

When Google came out of the Stanford dormitory where the two P.h.D. had invented it, it was a great search engine. Many argue it was 10x better than competitors.

Yet it wasn’t financially successful until it managed via a couple of years of trial and errors to design an innovative business model. In short, Google introduced an auction system for advertising, whose aim was to remove the inefficiencies of how advertising had worked for decades.

That was not the primary innovation. Indeed, another search engine called Overture was already doing it successfully. Therefore, where Google innovated was the introduction of a few critical parameters to allow advertisers to show on top of Google text-based ads results.

In other words, it wasn’t enough to be offering a higher bidding rate on a keyword. Google crossed that with a few other parameters which allowed to show on top of the ads space on Google results, those that were most relevant and had a higher click-through rate.

Even though it might sound trivial now, as the whole web, after Google has been built on the premise of click-through-rate, it was not back then. That business model innovation was critical to Google’s economic hypergrowth, scale, and domination.

Business modeling isn’t a simple concept, and in the mind of most people, that is about how you make money. However, business modeling is way more than that. It is how you make a great product or service so that your customers keep coming back.

It is about how you make that product or service scalable. And how you keep making financial sense of your business over time. But also the value proposition you’re able to deliver to key partners, which are a crucial ingredient of your business success!

Thus, even though business model innovation can be about changing the way you charge your customers and how you make money, it can also be about other critical aspects of the business that will allow you the scale-up.

There isn’t a single path to business model innovation, but there are a few critical questions to ask.

What kind of questions do you need to ask with business model innovation?

To understand how to innovate a business model you might want to think along the line of how to tweak and redesign your value chain, cost structure, key partners and in general what can help you scale:

  • How can I design a better value chain?
  • Can I improve the existing cost structure?
  • What is the distribution channel that can accelerate growth?
  • Why is my company experiencing bottlenecks in certain areas?
  • Is the organizational structure helping the company to grow as it should?

Paths toward business model innovation

There isn’t a single path toward business model innovation. At times you can design a business model drawing from your previous experiences in that industry.

Other times you’ll have to figure it out along the way. Among the many paths to business model innovation, we’ll see three paths that might be quite interesting for your business.

Engineer an innovative business model from scratch 

business-engineer
A Business Engineer is a hybrid between a business administration and technology expert, a person with the business acumen and engineering abilities to understand a complex organization and devise solutions and work as a liaison between commercial and technical teams.

As Reid Hoffman points out in his book Blitzscaling business model innovation is a key ingredient to success, especially in the digital space, where a countless number of companies offer innovative tools and solutions on the market.

That’s why in some cases business model innovation can be engineered before

This is what happened when I cofounded LinkedIn. The key business model innovations for LinkedIn, including the two-way nature of the relationships and filling professionals’ need for a business-oriented online identity, didn’t just happen organically. 

As explained by Reid Hoffman he used his understanding of the social networking world (he had founded a social network called SocialNet) to design an innovative business model for LinkedIn, which got acquired in 2016 by Microsoft for an astounding $26.2 billion.

In short, what gives a competitive advantage isn’t any more technology alone but a combination of technology paired with an innovative business model.

Yet designing a business model isn’t always possible beforehand. In some cases, you need to experiment, reiterate and find it

Find an innovative business model along the way

When Google was scaling up, it didn’t figure it all out right away. Although the tech giant has incredible technology and product, it still lacked behind in business model innovation.

When it finally, after a few trials and errors figure it out (Google was running out of investment money) it was a massive success. When Google had to show its numbers, when it got listed back in 2004 the company made already over three billion in revenues, a 155x growth in about four years!

history-of-google

In this scenario, you need to try and test many things before you can say to have a business model that makes you scale up sustainably and that it does make sense financially.

In the end, if you do find it, you’ve created a long-lasting competitive advantage!

Use business model innovation as a survival mechanism

Imagine if the next time you reserve an Uber ride, you’ll see coming to a self-driven car. Now stop imagining. Indeed Uber has been investing in self-driving cars since 2015.

Why would a company that is dominating an entire space make such a move? Well, a couple of reasons. First, if self-driving cars become mass adopted Uber would be out of business.

This implies that if Uber wants to thrive in the next era needs to be on top of this game. The second aspect is about business model innovation. Among its key partners, Uber has drivers across the world.

Yet those drivers also pose a significant threat to Uber’s success. Even though Uber might be pulling the plug or spinning off its self-driving cars business, this example is to show how the company never stop experimenting with business model innovation.

Business units like Uber Eats, Express Pool, Freight are all an attempt to tweak an existing business model until it allows the company to become financially sustainable, also at a massive scale.

Business model innovation examples

I will repeat over and over again; a business model isn’t something static. Thus, even if in this article we’ll look at how Google business model looks today, it might be probable that in a few years, the Google business model would have evolved as well.

Indeed, even though a business model does create a long-term competitive advantage, it does also require continuous tweaking to make sure all the pieces of it come well together.

Many argue that business model innovation is what makes a difference in a company’s success. Thus, even though many believe that product or technology is the most critical competitive advantages.

From a business standpoint, business modeling has proved to create a real edge, especially since digital businesses have taken over the business world. This is no exception for Google.

When the company started back in the late 1990s, it wasn’t the first search engine. It was a better product than many others on the market, yet it wasn’t just technological innovation that made Google successful.

It was when Google finally found its business model, that revenues took off. In 2004, Google’s had to reveal its numbers for the first time to the public. As the company was going public, when it opened its financials to the public everyone was astounded.

Google was among the first few companies that proved the internet wasn’t just a cool new thing. But instead what would give rise to new, disruptive business models.

Nonetheless, the dot-com bubble that would wipe out most of the companies that had a “.com” in their company’s name, the few that survived became also the basis for a technological revolution that would also spur a business revolution and vice-versa.

For instance, the so-called FAANG companies at the time of this writing represent the hottest companies on earth:

fang-companies
FAANG is an acronym that comprises the hottest tech companies’ stocks. Those are Facebook, Amazon, Apple, Netflix and Alphabet’s Google. The term was coined by Jim Cramer, former hedge fund manager and host of CNBC’s Mad Money and founder of the publication TheStreet:

Why is it so? If we look at each of those companies, there are a few things to notice.

Netflix business model innovation (case study)

netflix-business-model
Netflix is a subscription-based business model making money with three simple plans: basic, standard, and premium, giving access to stream series, movies, and shows. The company is profitable, yet it runs on negative cash flows due to upfront cash paid for content licensing and original content production.

Netflix has been able for the first time to move the needle of “culture creation” from Hollywood to Silicon Valley. While today Netflix invests billions in creating original content which is also what makes it so successful today.

Netflix’s main contribution is in its business model innovation. Where people hated so much Blockbuster’s late fees, Netflix introduced a new way of renting movies. Initially, Netflix had found its perfect medium of delivery of its new subscription business model via DVDs.

Where Netflix wasn’t able to compete with established Blockbuster, it needed to rethink the way it delivered its service. Thus, in exchange for a fixed monthly fee, people could rent as many movies as possible, with no late fees!

While the new technology of DVD allowed Netflix to deliver a better service. In the end, Netflix had to wait for more than a decade before streaming would pick up.

Therefore, Netflix’s CEO and founder set out to wait for Moore’s law to make streaming possible. Today streaming is the key delivery channel of Netflix service.

Amazon business model innovation (case study)

amazon-business-model
Amazon has a diversified business model. In 2018 Amazon posted over $232 billion in revenues and over $10 billion in net profits. Online stores contributed to nearly 52% of Amazon revenues, followed by Physical Stores, Third-party Seller Services, Amazon AWS, Subscription Services, and Advertising revenues.

When Amazon started as an internet store, its founder Jeff Bezos started from a niche, books. Rather than trying to sell everything to everyone (that would happen later on), Amazon began to form one relatively smaller market, dominated it and then moved on.

Once again, while Amazon invested from its early years in infrastructure and technology, it also shifted the conventional business model for publishing upside down.

On Amazon, you could find an extensive collection of books, at a lower price compared to physical bookstores. Thus, the initial value proposition was convenience.

Amazon cut off its margins by putting up a cash machine business model, or a model where the company lowers its profitability but generates a lot of short-term cash flows in return.

People could pay for a book right away, Amazon would have delivered, and would pay its vendors later on. The model worked because people could get any book they wanted at a lower price.

Vendors could have higher exposure and visibility through the Amazon store, and Amazon, in turn, would use all the additional short-term cash to invest in the growth of the organization.

This process performed many times over, for over two decades Amazon has expanded to sell anything. It also allowed the company to create a few other businesses (AWS, Prime and Physical Stores) that run at high profitability compared to the online store!

Once again, it all starts with business model innovation. Technology is an enhancer of this process but not necessarily what makes the real difference in the outcome.

Apple business model innovation (case study)

apple-business-strategy
When looking at the Apple Business Model, it is easy to assume that it is solely a product company, which sells devices that are beautifully crafted. However, there would have been no success for the Mac without its OS operating system. There would not have been iPod success without iTunes. And no success for iPhones without the Apple Store. What’s next for Apple’s success?

When Steve Jobs went back to Apple the company needed to be rebuilt from its ashes. Sales were plummeting, too many unsuccessful products had been introduced.

As soon as Jobs joined Apple again, it made sure to cut and simplify the product offering, but most importantly it started to create the infrastructures that would make its products successful: iTunes for the iPod and the App Store for the iPhones.

Those devices are great, but without an environment made of developers willing to create interesting applications for the iPhone, or if people had to pay for entire albums to listen to in the iPod.

Apple changed the way music was consumed, and it created a whole new industry with its smartphone. Also here, sales didn’t pick off because of great devices, powered by a suitable software (that of course contributed) but the business model crafted by Jobs and his team created commercial viability of those products and a massive amount of traction!

Google business model innovation (case study)

googles-business-model

When Google launched its search algorithm proved to be quite good compared to other search engines. For one thing, Google didn’t look spammy with all the ads other search engines provided, and it was quite fast.

The tool was free, and it made it scale quickly. However, it wasn’t until Google figured out a new business model for advertising that revenues took off. Indeed, at the time Google combined its technology with a business model first crafted by a – at the time – Google’s competitor, called Overture.

Overture for the first time had introduced a system of auctions for advertising, which had proved quite successful. Yet Google took that model and improved on it with its seamless advertising machine (Google AdWords, now Google Ads).

When Google introduced a mechanism of ads based on auctions and introduced a quality score. This is a 1/10 scale rating comprised of components like expected clickthrough rate, ad relevance, and landing page experience. 

This means that ads weren’t only judged on the price paid by the business but also if that ad was relevant. In 2017 Google had generated over a hundred billion dollars in revenues from advertising! 

Also here, a great technological product without a proper business model would have been doomed. 

Facebook business model innovation (case study)

facebook-business-model
Facebook is an attention-based business model. As such, its algorithms condense the attention of over 2.4 billion users as of June 2019. Facebook advertising revenues accounted for $31.9 billion or 98.66% of its total revenues. Facebook Inc. has a product portfolio made of Instagram, Messenger, WhatsApp, and Oculus.

When Mark Zuckerberg came up with Facebook in its dorm room, it wasn’t the first social media network. Yet it grew exponentially over the years. While Facebook managed to grow very fast thanks to investments and a free model initially.

It then transformed its social network in targeted ads money-making machine. Facebook at the time of this writing is among the most profitable companies in the world, and still among the most popular apps.

Other social media applications, like TikTok, are trying to disrupt it. Facebook has managed over the years to build a strong brand, and it figured how to monetize the so-called “social currency.” In short, companies and marketers pay Facebook to gain visibility on the platform.

That visibility is sold in the form of impressions, clicks or other actions people can take on a targeted ad! Facebook’s hidden revenues business model has proved the only worthy competitor to Google advertising business.

Is business model innovation for anyone?

In theory business models innovation is for anyone. Think of the case of a small consulting business that operates in a traditional industry, where most of the competitors charge by the hour.

Yet instead of keeping to do that the small consulting business starts only to charge a small retainer and a success fee. This kind of model might be not financially viable at the beginning, but it might wipe out competitors over time.

Indeed, with a larger customer base, the retainer becomes an essential base for the company’s revenues. And the success fees the scalable part of the business.

In other cases though, business model innovation might require massive financial resources. Think of a business that decides to dominate an existing industry, and it does that by introducing an innovative business model that grows at a reckless pace.

That pace might be attractive for investors looking for high returns on their investments, while it might also burn a lot of cash!

Key takeaways

Business model innovation is a popular topic, and as such, there are a lot of misconceptions around it.

In my research around the topic, I’ve figured the reasons behind those misconceptions and how and why they exist.

We also uncovered how business modeling has a meaning based on the reason why you’re using it. At the end of it all, business model innovation is a dynamic concept, at the apex of its evolution, and as such, it’s interesting to see how it can have different meanings and interpretations.

At the same time, if you’re an entrepreneur, it’s essential to understand what it can do for you, and this article might clear things up.

The Business Model Innovation Playbook in PDF

business-model-innovation-playbook-cover

Business modeling crash course

Business model innovation FAQs

What is business model innovation?

Business model innovation is about increasing the success of an organization with existing products and technologies. By crafting a compelling value proposition able to propel a new business model to scale up customers and create a lasting competitive advantage. And it all starts by mastering the key customers.

Why business model innovation is the new competitive advantage?

In an era where technology becomes over time commoditized. The ability to intersect revenue generation, distribution, and technology help organizations to build a viable business model that has a long-lasting advantage. Thus, business model innovation starts by obsessing over customers to deliver products and services that are 10x more valuable.

How business model innovation differs from technology innovation?

Innovation gains different meanings based on the context of reference. More precisely, in the business world, innovation is not about technical solutions but the ability to master key customers to understand what problems they are facing. In short, innovation in business starts from problems rather than technological solutions.

How does business model innovation impact the market?

Business model innovation can impact the marketplace by reshaping entire industries. It all starts by looking at how current players are solving problems to look at them from a different perspective. Companies like Google, Amazon, and Tesla began to with a new playbook in mind, enhanced by innovative business models.

Other resources for your business:

Learn how tech companies business models work and the lessons you can learn to scale up your own company:

Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over 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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