In the previous three decades, strategy has been the key to competitiveness, but the business model may be the key to sustained advantage in the future. In the 1990s, the confluence of information and communication technologies sparked a brief obsession with business models. Deregulation, technological development, globalization, and sustainability have reignited interest in the notion today. Since 2006, the IBM Institute for Business Value’s biannual Global CEO Study has found that CEOs prioritize establishing innovative business models. Seven out of 10 organizations are innovating their business models, and 98% are altering them. Business model innovation will continue.
So what? Pressure to open markets in emerging countries, especially the middle and bottom of the pyramid, pushes business-model innovation. The developed world’s economic downturn forces corporations to change or build new business strategies. New technology-based and low-cost rivals threaten incumbents, reshape industries, and redistribute profits. Indeed, firms’ business models are undergoing a global revolution in producing and capturing value.
Most companies haven’t mastered business model competition. Over the past seven years, our investigations reveal that organizations’ unwavering concentration on building innovative models and evaluating their efficacy in isolation is a major challenge. A company business model’s success or failure depends on how it interacts with other industry models. Almost any business plan will work if a company is the only one in the market. Companies develop failed business models without considering the competition.
The results are hard to anticipate when companies compete utilizing different business models. One company model may seem superior in isolation but provide less value when interactions are examined. Rivals may become value-creation partners. Stand-alone model evaluations lead to erroneous strength and weakness assessments and poor decision-making. This is why many new company models fail.
Ignoring the dynamic components of business models causes many firms to underutilize them. Few CEOs know they can build company models to create winner-take-all impacts like Microsoft, eBay, and Facebook. Firms can trigger winner-take-all effects if they choose the correct business models. Good business models produce virtuous loops that boost competitiveness. Smart organizations know how to reinforce their virtuous cycles, diminish rivals, and turn rivals’ strengths into weaknesses.
We’re often asked, “Is that strategy?” It’s not because managers won’t find the most effective ways to compete unless they understand business models, strategy, and tactics.
A Business Model Is…
Everyone agrees that leaders must understand busi ness models for their companies to prosper, yet no one can agree on a definition. Peter Drucker described a busi ness model as the solution to three questions: who is your customer, what does the customer value, and how do you give value at a reasonable cost?
Others characterize a busi ness model by its key features. Clay Christensen of Harvard Business School argues a business model should include a customer value proposition, profit formula, essential resources, and key procedures. Such descriptions help executives evaluate busin ess models, but they may hinder the development of fundamentally different ones.
Our findings imply that a busi ness model must include leadership choices about how the organization should operate, such as compensation policies, procurement contracts, facility locations, vertical integration, sales and marketing strategies, etc. Managerial decisions have repercussions. Pricing impacts sales volume, which affects scale economies and bargaining power (both consequences). These repercussions affect the company’s value generation and capture rationale, so they must be included. A company model consists of executive actions and their repercussions.
Creating bus iness models involves three choices. Policy choices determine a company’s functioning (such as using nonunion workers, locating plants in rural areas, or encouraging employees to fly coach class). Assets are a company’s tangible resources (manufacturing facilities or satellite communication systems, for instance). Governance options pertain to a firm’s decision to own or lease equipment. Despite appearances, policy and asset governance greatly affects their effectiveness.
Flexible or rigid: consequences. A flexible consequence adapts swiftly to a changed option. Increasing prices immediately reduces volume. By contrast, a company’s culture of frugality—built over time by regulations that require employees to fly economy class, share hotel rooms, and work in Spartan offices—is unlikely to fade instantly, making it a severe consequence. This affects competitiveness. Companies need time to develop stiff repercussions, unlike fluid ones.
Ryanair transitioned to a low-cost model in the early 1990s. The Irish airline lowered fares and eliminated frills. The company chose low pricing, secondary airports, one passenger class, billing for all additional services, no meals, short-haul flights, and a Boeing 737 fleet. It picked a nonunionized workforce, high-powered incentives, a lean headquarters, etc. High volumes, low variable and fixed expenses, acceptable fares, and an active management team resulted from these selections. (See “Ryanair’s Then and Now Business Model.”) Ryanair’s busi ness model allows it to give decent service at a low cost without reducing customers’ willingness to pay.
Business model virtuous cycles
Not all business models succeed. Good ones are self-reinforcing, robust, and aligned with organizational goals. (See sidebar “3 Busi ness Model Characteristics.”) Successful company models create self-reinforcing virtuous cycles. This is the business model’s most powerful and overlooked element.
Good business model characteristics
What makes a business model successful? Three factors make it good. 1. Do company goals align? …
Our findings reveal that Apple, Microsoft, and Intel’s competitive edge comes from their installed base of iPods, Xboxes, and PCs. Leaders accumulated assets by making choices for wise pricing, royalties, product range, etc. They’re busi ness model repercussions. Any company can make choices that help it build sector-changing assets or resources, such as project management skills, production experience, reputation, asset utilization, trust, or bargaining strength.
Consequences allow more choices, etc. This creates virtuous cycles that enhance the company concept, comparable to network effects. As the cycles revolve, the company’s essential assets grow, boosting its competitive advantage. Smart firms develop business strategies to trigger virtuous cycles that expand value creation and capture.
Ryanair’s business model maximizes profits through low costs and pricing. (See “Ryanair’s Virtuous Cycles”). All cycles reduce costs, lower pricing, and improve sales and profits. Its competitive edge grows as its bus iness model’s virtuous cycles spin. Because of kinetic energy, well-functioning virtuous cycles are hard to interrupt.
Ryanair’s Good Cycles
Low fares > high volume Greater supplier bargaining leverage >> Lower fixed costs >> Lower fares
Not forever. They approach a limit and induce counterbalancing cycles or slow down because of different busi ness models. Interrupting synergies reduces competitive advantage. If Ryanair’s staff unionized and demanded greater compensation, the airline could no longer provide the lowest rates. The aircraft utilization would drop. Ryanair’s fleet investment anticipates high usage. Therefore any change would hurt profits.
Low-cost, no-frills players can create virtuous cycles, but so can differentiators. Irizar, a Spanish luxury motor coach bodywork builder, posted huge losses in the 1980s. Irizar’s leadership changed twice in 1990, and morale hit an all-time low, so Koldo Saratxaga made big reforms. He changed the company’s business strategy by fostering employee ownership, accomplishment, and trust. Eliminating hierarchy, decentralizing decision making, emphasizing teams, and giving workers ownership were options. (See “Irizar’s Unique Business Model.”)
Innovative business model
When Spanish manufacturer Irizar devised a fundamentally innovative…
Irizar’s major goal as a cooperative was to increase well-paying jobs in the Basque Country. Hence the company devised a high-value business model. Its virtuous cycle unites customers’ willingness to pay with low costs, yielding high revenues that feed innovation, service, and quality. Quality is Irizar’s foundation. During Saratxaga’s 14 years as CEO, the company grew at a 23.9% CAGR. Irizar produced 4,000 coaches in 2010 and generated €400 million in sales. Its business approach creates virtuous cycles.
When no competitors exist, it’s easier to inject virtue into cycles, but few business models work in vacuums. Companies with similar business strategies must soon establish tight consequences to produce and capture more value. When organizations compete against distinct business models, the results are unexpected, and it’s hard to determine which will do successfully.
Take the conflict between S Group, a consumers’ cooperative, and Kesko, which uses entrepreneur-retailers. We’ve followed the companies for over a decade, and Kesko’s model is superior. Its franchisee incentives should boost growth and earnings. Kesko’s business strategy harms the S Group more than it does. Since customers control S Group, the retailer reduces prices and provides customer perks, gaining market share from Kesko. This causes Kesko to decrease prices, which demotivates its entrepreneur-retailers. Kesko underperforms S Group. S Group’s opaque corporate governance framework allows slack to slip in, forcing price hikes. This helps Kesko to raise prices, enhance profitability, motivate its entrepreneur-retailers, and win back customers with its improved shopping experience. The rivalry continues.
Companies can compete through business models by strengthening their virtuous cycles, blocking or destroying rivals’ cycles, or building complementarities with rivals’ cycles, resulting in substitutes becoming complements.
Develop good habits.
Companies can adapt their business models to create new virtuous cycles that boost competition. These cycles typically strengthen business model cycles. Boeing and Airbus used similar virtuous cycles until recently. Airbus matched Boeing in every area except big commercial transport, where Boeing launched the 747 in 1969. Given the lumpy, cyclical demand for aircraft, pricing rivalry is fierce.
Boeing had the upper hand because of its 747 monopolies and could reinvest the money to boost other divisions. Analysts believe the 747 added 70 cents to Boeing’s early 1990s profits. Airbus was at a disadvantage since R&D expenditure drives customer willingness to spend. Low-interest European government loans kept it afloat. Without subsidies, Airbus would have spiralled.
With funding drying up, Airbus developed the 380, a big commercial transport. Boeing announced a stretched 747 to discourage Airbus. Boeing is unlikely to launch the plane since it would cut into 747 profitability. The 380 helps preserve Airbus’s cycle in small and midsize planes and slows Boeing’s. Increased competition may make Boeing’s 747 less profitable. It’s building the 787 to enhance its position in midsize aircraft, where the competition will be harsher once 380 sales begin.
Reduce rivals’ cycles.
Some organizations go successful by weakening new entrants’ virtuous cycles with limited options. Whether a new technology disrupts an industry depends on its intrinsic benefits and other participants. Consider Microsoft vs Linux, which is free and allows users to contribute code enhancements. Microsoft has worked to weaken Airbus’ positive cycle. It employs OEMs to preinstall Windows on PCs and laptops to impede Linux’s growth. It spreads fear, uncertainty, and scepticism about Linux’s free operating system and applications.
Microsoft may improve Windows’ value by learning more from users and offering special discounts to increase education sales or diminish Linux’s value by undercutting strategic buyer purchases and prohibiting Windows apps from running on Linux. Linux’s wealth generation potential may be larger than Windows’, but its installed base won’t surpass Microsoft’s as long as it disrupts its entire virtuous cycle.
Different business models can provide value together. Betfair, an online betting exchange, took on British bookmakers like Ladbrokes and William Hill in 1999 by allowing anonymous betting. Betfair allows clients to place bets and offer odds, unlike traditional bookies. One-sided firms have different virtuous cycles. Betting exchanges incur no risk, but bookmakers create wealth by managing risk and offering odds. They create value by matching market sides and taking a portion of net wins.
Betfair has affected Ladbrokes and William Hill’s gross winnings, but not as much as feared. Betfair’s better odds reduce gamblers’ losses. When bookies pay off, bettors put more wagers, continuing the cycle. This has boosted the British gambling market more than improved odds suggest. Better odds from Betfair help traditional bookies evaluate market sentiment and hedge risk more cheaply. When a new business model complements competitors, incumbents are less inclined to react aggressively. Bookmakers were initially antagonistic to Betfair but have recently warmed to it.
Models, strategies, and tactics
Strategy, business models, and tactics are the most misunderstood management ideas. Many use the terms interchangeably, leading to bad decisions.
Three are linked. Business models describe how a firm runs, develops and captures value for stakeholders in a competitive marketplace. Strategy is the plan to create a unique and valuable position through a collection of activities. This definition implies the company has chosen its market strategy. Choices and outcomes represent the strategy, but it’s the company model. A business model strategy is a strategy. Strategies include plans for various scenarios (such as rival moves or environmental shocks), whether they occur or not. Every company has a business model, but not every company has a strategy.
Ryanair. In the 1990s, the airline was nearly bankrupt, rebranding as Southwest Airlines of Europe. Ryanair’s new business model was based on producing and collecting value for stakeholders.
Changing strategic choices can be expensive, but businesses have straightforward and inexpensive ways to compete. These are a company’s residual choices based on its business model. Business models determine market techniques. Metro, the world’s largest newspaper, has a free, ad-supported product. Metro can’t use price to compete.
Business models are like cars. Distinct car designs—conventional engines vs hybrids, standard vs automatic transmissions—create different values for drivers. The car’s design determines the driver’s tactics. A low-powered compact would be better than a giant SUV for navigating Barcelona’s Gothic Quarter’s tiny streets. Imagine a driver who could customize a car’s design, power, fuel economy, and seating. Such changes aren’t tactical; they’re strategic since they change the machine (the “business model”). Strategy is building the car, the business model is the car, and tactics are driving it.
The strategy builds a competitive advantage by protecting a specific position or leveraging idiosyncratic resources. Executives should establish company strategies that activate virtuous cycles to produce roles and resources. This is difficult since they compete with competitors, complementors, customers, and suppliers to generate and capture value. Competitiveness is about generating strategy, tactics, and innovative business models.
Most executives feel business model competition is key to success, but few know how. The authors’ analyses demonstrate that enterprises’ unwavering focus on building innovative models and measuring their efficacy in isolation is a common mistake. How a company’s business model interacts with its competitors determines its success or failure. Almost any business plan will work if a company is the only one in the market. Companies develop failed business models without considering the competition.
Many organizations disregard the dynamic features of business models and fail to grasp they can create winner-take-all impacts like Microsoft, eBay, and Facebook. Good business models produce virtuous loops that lead to competitive advantage.
Smart corporations strengthen their virtuous cycles and undercut rivals and ours.