If you put a new product in the market, sooner or later, somebody is going to clone it. To build sustainable shareholder value, companies have to create innovative business models, not just innovative products and services.
Cycle times have dramatically accelerated in every industry, says Janelle Hill, a research vice president at analyst Gartner: ‘Whether it’s inventory turn-over or the rate at which you have to introduce new products and services or the accounts receivable collection period, everyone is reporting that cycle times are much, much shorter, no matter how you measure them.’
In a recent IBM survey, Expanding the Innovation Horizon, The Global CEO Study 2006, some 65 per cent of chief executives and other business leaders said they will have to make fundamental changes in their businesses over the next couple of years.
‘New products and services remain a priority, but they are placing increasing emphasis on differentiating themselves through innovation in the basics of their business models,’ wrote Samuel Palmisano, IBM’s chief executive in the report’s preface.
Nearly a third of respondents said they would focus innovation efforts on their business models. The survey also found that companies that put an emphasis on business model innovation performed better than companies that did not.
Alexander Osterwalder, a partner at Swiss consulting firm Arvetica, says that while it is still important to innovate on products and services, it is more difficult to copy a business model innovation because it is much more complex.
Osterwalder gives the example of Apple and its success with the iPod. ‘The success does not just come from the iPod product, but from a whole bundle of things, including the iTunes software,’ he says.
‘That really is a business model innovation. It’s not just a product innovation of having an MP3 player that is powerful and elegantly designed. There are a lot of competitor products in the field, but it’s much more difficult to recall the products’ names.
‘Despite having quite powerful products, competitors do not have a business model to match that of Apple. Even if they have more powerful products than Apple, Apple won the market through its business model, not through the iPod itself.’
But unlike products, business models cannot be protected by patents. Nonetheless, it has been demonstrated in a number of industries that business models, because they knit together so many disparate things, are surprisingly difficult to imitate.
You cannot copy a business model in a piecemeal fashion, says Henry Chesbrough, author of Open Business Model – How to Thrive in the New Innovation Landscape. You have to copy it whole hog or you do not get the virtues of the business model.
‘Lots of airlines in the US and Europe have tried to imitate the low-cost carriers of Ryanair in Europe or Southwest Airlines in the United States, for example. Very few have had any success even though they are using the same aeroplanes, the same fuel and the internet to book tickets.
‘It has proved quite difficult to imitate the business models, not because of intellectual property protection, but because of the complexity and the interdependency of the different parts of the business model,’ says Chesbrough.
A business model is a story. It is the story of how a firm makes money. The problem with stories is the more they are repeated, the more sacrosanct they become. A company might focus on its core business, but if it does not repeatedly challenge the logic of their business model, they will eventually find that their revenue streams have run dry.
Charlie Simpson, a partner in the Strategy Consulting Group at PA Consulting, has encountered the difficulty of shifting mindsets. His client sold large capital equipment – such as graders and diggers – and they believed that that was their key business. But in a strategy review, Simpson saw that the real high-margin opportunities were actually in the rental, leasing and product-support business.
‘The mind set shift was the biggest challenge for this organisation,’ he says. ‘They perceive of themselves as sellers of large bits of metal, yet all of the bottom-line impact came from far more intangible, service-related issues.
‘In that particular organisation, there was the lack of flexibility, which made it difficult to realign their resources and focus on the real business opportunity. A lot of it is about moving away from the tangible to the intangible, which is a big cultural challenge for many companies.’
Open innovation
An even bigger challenge is openness. It is almost counter-intuitive to open the borders of your company. Until recently, companies operated like fiefdoms, battling each other for a share of the market. The modern metaphor that has rapidly taken root, is quite different. Today companies are seen as ecosystems with complex interdependencies. The message now is: you need to be open to survive.
Chesbrough believes that an open innovation and an open business model is the key to corporate survival in the 21st century. Companies should no longer rely on their research and development (R&D) departments to come up with all the good ideas, not when there is a network of talented, creative people across the globe to be tapped into .
‘I’m seeing the beginnings of a secondary market for intellectual property,’ says Chesbrough. ‘And that means companies with strong business models will be able to access other external intellectual properties (IP) more readily, provided it sits well with their business model. This will give them some extra fuel that will keep them going for a longer period.
‘This openness to external influence, also provides more outlets for internal ideas that will not be successful internally, but might find traction elsewhere. So it really does help to open up the innovation process both for things coming into the company and for things flowing out of the company to the market,’ says Chesbrough.
Companies spend an enormous amount of money on R&D, but only a tiny fraction of the patents are ever monetised. That accounts for a lot of wasted money and a lot of wasted opportunity.
Unfortunately, many companies still see their intellectual property as a weapon. ‘Many, if not the majority of, patents are taken out to strategically block known competitor activity as they are to protect something you want to do yourself,’ says Ian Rhodes, a partner in the Technology Group at PA Consulting.
Yet even the pharmaceuticals industry – a notoriously secretive cabal – is beginning to experiment with open innovation and open business models.
‘Most biotech firms, for example, do not take their compounds from inception all the way to the market,’ says Chesbrough. Instead, the biotech firm tends to take the compounds into early human trials, and then agrees a deal with another company, usually a pharmaceutical firm, to complete the remaining human trials and take the drug to market.’
Chesbrough uses the example of Millennium, a biopharmaceuticals company, that licenses IP rights to promising compounds by field of use, so that multiple companies can use the same compound for different indications.
In his latest book, Chesbrough argues the case for extending the value chain outside of the four walls of the company and creating an open business model based on open innovation.
Of course, openness is not just about intellectual property. After all, not all companies are dependent on it for their success. Sometimes openness can simply mean the openness to try different business models.
And as the pace of change accelerates, companies will increasingly need to experiment with different business models. It is important to be flexible enough to seize opportunities when they arise. Fortune favours the prepared company.
Supermarkets, for example, are good at experimenting with different revenue streams. Many UK supermarkets now offer financial services, such as banking and insurance. Their broad customer base and deep customer databases put them in an ideal position to cross-sell. By diversifying, they are simultaneously growing their business and spreading their risk.
Supermarket business models are layered, says John McGee, professor of strategic management at Warwick Business School. ‘At the business unit level, look at Marks & Spencer’s retailing operation. There is a business model for the food business and a business model for the textile business and both of them added together give you financial flow characteristics that are a synergistic combination of the two,’ says McGee.
‘You then add the financial services business, which again has its own business model. And then you add those financial characteristics to the food plus textiles business and the three together have even more synergistic characteristics. So at a corporate level you end up with a combination of different models from the various businesses in the portfolio.’
Together, says McGee, the business model should look more attractive than separately. Typically, you would achieve higher growth, more stable margins and a less risky profile. It is a synergistic corporate business model that benefits from collaboration. What you do not want from collaboration, warns McGee, is to replicate the business model characteristics that you already have because that will increase your risks rather than diversifying them.
Companies have to experiment and take risks, says Ash Patel, chief executive of Intel Capital. ‘There is no one person who can predict where a business model will be in two years’ time,’ says Patel. ‘If there’s anyone who tells you they can, they are lying.’
And Intel does know something about changing business models. It started life manufacturing memory chips, but by the early 1980s, much of the DRAM market was being eroded by Japanese manufacturers. Intel’s chief executive, Andy Grove, made the brave decision to switch focus to making microprocessors. It was a controversial decision at the time, but the risk paid off handsomely.
Lower the risk
‘In my mind, the risk is that if you don’t invest now there is a chance that you will lose half your business 10 years down the line because someone else has beaten you to it,’ says Patel.
‘I don’t think companies have any choice but to invest risk capital to try to evolve the business model as they go along.’
And today, when it comes to business model design, companies are spoiled for choice, according to Osterwalder. ‘Before, it was more difficult to differentiate your business model in one industry because you had less choice in the design,’ he says.
‘But today, you can have several business models coexisting in one industry. You can have Skype and Cable & Wireless both competing in the telecoms space, but with very different business models.’
There are two reasons why there is more choice when it comes to designing a business model, says Osterwalder. The first is the ever-decreasing cost of transactions, and the second is the co-ordination costs.
Communication technology has made it much easier to communicate between different companies, suppliers and buyers, on the business side. This has led to distributed value chains. Companies are working more with partners instead of trying to do everything in-house.
‘In terms of the customer, the internet now facilitates more distribution channels,’ says Osterwalder. ‘There are blogs and mobile telecommunications, for example, so you have much more choice in every area of the business model in terms of customer relationships.’
‘Today you have the technologies that make it possible to offer much more sophisticated customer relationships than before, simply because you have affordable technology to do it, which wasn’t the case maybe 10, 20 or 30 years ago. You have much more choice in designing the way you conduct business.’
Business model redesign
So we have all this choice of how to design a new business model, but who should be involved in its design? Osterwalder recommends keeping the design team as broad as possible. Unfortunately, many companies are still very silo-based.
‘What is interesting about the business model concept is that it is quite holistic,’ he says. ‘It gives one view of the company, the business logic that brings different areas together, so if you get different people of these areas together then it will be likelier that you get an innovation that makes sense for the business logic itself, and not just for one specific area.’
The IT department plays an important role in business model redesign because it has a good view of the underlying capability for meeting the demands of a new business model – see case study, above. However, Osterwalder fears that there is still a gap between the IT department and the rest of the business.
Chief information officers (CIOs) are often involved at the business process level of an organisation, but Osterwalder feels that this is too concrete and too close to implementation and execution to be of real strategic value.
‘If you want to talk about business strategy and information system strategy you would want to stay on a higher level of abstraction,’ he says.
‘I propose that a business model is an interesting place to do that. Obviously, CIOs can then talk about the application portfolio and map the portfolio to the business model. They can show how the applications in a company enhance the business model, suggest how support should be structured, and, at the same time they can justify infrastructure service and expenditure through the business model.
‘It gives the CIO an effective way of connecting directly to the strategic issues of the business.’
reader comments