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Raphael Amit, Cristoph Zott: Business Model Innovation Strategy

Foundation and Mindset for Business Model Innovation

Why do business models matter

A business model is about “how to do business,” and business model innovation is about “how to do business in new ways.”

For decades, the key strategic decisions that managers and entrepreneurs were asked to address, which were also highlighted in management courses, centered on: corporate strategy issues, and business strategy issues.

Business strategy issues center on establishing and sustaining the competitive advantage of a firm. They include such questions as how to compete in a particular product market (e.g., compete on the basis of differentiation or cost leadership?), and what resources and capabilities to acquire or develop.

The advent of the internet did not undermine the importance of these classic choices; they remain as valid and relevant as ever. However, it added an essential strategic choice onto the entrepreneur’s and general manager’s plates, namely the question of how to do business.

The differences between the valuations of incumbents such as Hilton and Ford, and the new entrants into their industries such as Airbnb and Uber, respectively, can be attributed in part to their vastly different business model designs. More specifically, it can be attributed to their technology‐driven business model innovations.

Business model innovation refers to the conceptualization and implementation of new ways of doing business in order to better address the imperfectly met needs of customers and other market participants such as suppliers.

Car manufacturers like Volkswagen (VW) have clearly understood the strategic importance of business model thinking for their own future market positioning and success. The German company seeks to emulate in the auto industry Apple’s platform‐driven business model by providing a unifying chassis that serves as a basic building block for different electric car models. Powered by a proprietary operating system that will allow for over ‐ the ‐ air software updates and support various apps, much like an iPhone, the platform is intended to provide a new digital in‐car experience.

A business model is designed to capture a perceived market opportunity in a way that creates value for all stakeholders. We proceed to identify the four dimensions of a business model, namely:

  • Its content, i.e., what activities the business model is composed of
  • Its structure, i.e., how these activities are linked in the business model
  • Its governance, i.e., who performs the activities that are enabled by the business model
  • Its value logic, i.e., why does the business model create value and why does it also enable value appropriation through a revenue model

The value creation perspective of the business model, describes the business model as a source of innovation when, for example, it connects previously unconnected parties, links stakeholders in new ways, or introduces new transaction mechanisms.

Business models emphasize a system‐level, holistic approach to explaining how firms “do business.”

The business model extends the concept of the value chain by:

  • emphasizing value creation and delivery dynamics
  • spanning firm and industry boundaries
  • allowing for a non‐linear sequencing of interdependent activities

We formally define the business model as the system of interdependent activities that are performed by a focal firm and by its partners and the mechanisms that link these activities to each other.

The firm’s revenue model plays an important role in value appropriation. Akin to a pricing strategy for specific products or services, the revenue model refers to the specific modes in which a business model enables revenue generation.

A business model is geared toward total value creation – for all parties involved, not just the firm whose business model is under consideration.

Value appropriation, in turn, is the amount of value that is captured by individual stakeholders. In other words, value appropriation can be thought of as the proportionate size of individual slices of the value pie.

Business model innovation is about how to do business in new ways. It can be a crucial source of disruption and competitive advantage, and it goes beyond (but is highly complementary to) existing sources of innovation, such as product or process innovation.

A business model innovation strategy enables an organization to generate a stream of business model innovations.

One of the most important skills needed to become a good business model designer is the ability to think holistically about your firm’s current or future business model.

How Business Models Create Value in New Ways

Value creation through business models is distinct from other sources of value creation, such as products and services.

Five foundational theories of value creation:

  • Schumpeterian innovation
  • the resource‐based view
  • transaction costs economics
  • Porter’s value chain analysis
  • strategic network theory

The efficiency of Uber’s business model is compounded by network effects, where value builds as the network grows.

Michelin’s innovative new business model, of tires as a service, enabled value creation beyond its high‐quality products; the business model in and of itself became a source of value creation.

What was the appropriate unit of analysis for looking at this new breed of companies and their new ways of doing business? Since none of the established categories (e.g., industry, firm, business unit, or process) seemed fully satisfactory, a new one was developed: the business model.

A digitally driven business model reduces transaction costs and enables new transaction architectures or systems; and these new systems can address customer needs in new or superior ways and therefore create superior value.

Based on the insight that transactions link activities, and therefore transactions and activities can be viewed as two sides of the same coin, this early transaction‐based view of the business model evolved into the activity‐based framework.

Austrian economist Joseph Schumpeter (1883 – 1950) pioneered the theory of economic development and new value creation through the process of technological change and innovation. According to Schumpeter, the primary source of value creation is innovation, i.e., novel combinations of resources (and the services they provide) as the foundations of new products and production methods.

Schumpeter’s theoretical developments urge business model designers to consider how novelty in each and every one of the different dimensions of a business model can enhance the total value created .

The resource‐based view (RBV). The RBV states that marshalling and uniquely combining a set of complementary and specialized resources and capabilities (which are heterogeneous within an industry, scarce, durable, not easily traded, and difficult to imitate) may lead to value creation. Resources include physical assets and human capital, as well as managerial and organizational capabilities; they enable activities and the links among them.

In an increasingly digital world, the preservation of value is generally becoming more challenging because rivals may also enjoy easy access to substitute resources. Furthermore, since information‐based resources and capabilities have a higher degree of mobility than other types of resources and capabilities, value migration is likely to increase, and the sustainability of newly created value may be reduced.

The central question addressed by transaction cost economics (TCE) is why firms internalize transactions that might otherwise be conducted in markets.

The main theoretical framework was developed by Oliver E. Williamson. At its core, transaction cost theory is concerned with explaining the choice of the most efficient governance form.

Most business models today are at least partly digital, and one of the main advantages of digitization is the reduction in transaction costs it engenders.

Michael Porter’s value chain framework analyzes value creation at the business unit (BU).

Value chain analysis includes four steps:

  • defining the strategic BU
  • identifying critical activities
  • defining products
  • determining the value of distinct activities

Porter defines value as “the amount buyers are willing to pay for what a firm provides them. Value is measured by total revenue… A firm is profitable if the value it commands exceeds the costs involved in creating the product.”

Concepts such as open innovation, innovation value chain, industry architecture, and value networks came about in response to the limitations embedded in the value chain framework that were revealed by the digital transformation of the business landscape.

Strategic networks are “stable interorganizational ties which are strategically important to participating firms. They may take the form of strategic alliances, joint‐ventures, long‐term buyer-supplier partnerships, and other ties.”

In addition to enabling access to information, markets, and technologies, strategic networks offer the potential to share risk, generate economies of scale and scope, share knowledge and facilitate learning, and reap the benefits that accrue from interdependent activities.

A network effect occurs when a technology, product, or service becomes more valuable as the number of people using it increases. The network perspective is clearly relevant for understanding value creation in business models because of the importance of digitally connected firms, suppliers, customers, and other partners.

Corporate strategy issues answer such questions as in what businesses to be in, or when and how to enter and exit these businesses. The business model complements (but of course does not replace) these classic strategy questions. It adds an important, hereto unanswered, question of “how to do business” in each product market segment in which a firm chooses to compete.

Adopting a Business Model Mindset – A Prerequisite for Transformative Innovation

If the business model is conceived as an all‐encompassing concept, it becomes difficult to distinguish it from other “big” concepts such as the firm, or its organizational structure.

Similarly, the business model should not be confused with a business plan. These two concepts are not interchangeable. Unlike a business model, a business plan is a static, forward‐looking document.

Entrepreneurs and general managers often do not pay enough attention to the design of their business model, i.e., the What, How, Who, and Why of the activity system. Instead, they focus on more conventional strategic choices, such as what market segments to serve. How and when to enter into the selected markets. How to compete in the firm’s selected markets.

Managers and employees need to adopt a business model mindset to acknowledge and leverage the possibility that innovation can happen at the business model level – in addition to innovation at the product/service level.

A mindset determines what we expect to perceive, and what we are prepared to perceive. This can lead to the development of analytical blind spots.

That is why a business model mindset is needed in organizations. Those with a business model mindset, they think proactively and holistically about “how to do business.” That is, when analyzing business problems and opportunities, they think about their firm’s system of activities. Because of their holistic, system‐level nature, business models are often unfamiliar cognitive schemata, and therefore not “easy to see” for everyone.

There are three distinct aspects of the level‐of‐analysis mindset trap:

  • Failure to pay attention to fundamental questions and worries about the overall business logic.
  • Failure to pay attention to long‐term trends in markets and core technologies.
  • Failure to think strategically about the business model.

Business models can be difficult to change due to path dependencies, dominant logics, managers’ cognitive limitations, and resistance to change.

Given the importance of mindset for business model design and innovation, business models have a strong cognitive underpinning.

Regarding the relationship between cognition and business models, researchers distinguish between business models as cognitive structures, and cognition as an antecedent to business model design and implementation.

Business models as mental models have been described as design logics that delineate the activity system’s architecture in terms of its content, structure, governance, and value logic. While a firm’s business model may of course reflect the ideas and design aims of managers, it does not exist solely in the intangible sphere of their minds.

Another perspective on business models and cognition views business models as realized activity systems, but acknowledges their cognitive antecedents.

Two cognitive practices stand out that are used by founders of firms with highly innovative business models: industry‐spanning search and complex system thinking. Together, they could be viewed as constituting elements of a “business model innovation mindset.”

  • Industry‐spanning search occurs when managers actively search outside their industry for the stimulus to develop a novel business model.
  • Complex system thinking constitutes a second cognitive practice that promotes business model innovation. It occurs when the leaders of a business model initiative, and subsequently other members of the organization, display exceptional awareness of their industry structure and functioning.

The opposite of complex system thinking is internal efficiency thinking.

Building on the idea of a close link between human cognition and business model design, researchers have highlighted two generative cognitive processes – analogical reasoning and conceptual combination – that can be used to design innovative business models.

Analogical reasoning involves the choice of a source model from a domain that serves as an analogy in order to create novelty in another domain through a comparison at the system level.

A second cognitive process besides analogical reasoning is conceptual combination , which involves comparing one or more source models with a target business model , then focusing on the differences among them to generate ideas for modifying the target model , or for creating an entirely new one .

Adopting a business model mindset is crucial for successful business model design and innovation.

A mindset shift can be facilitated, however, by clear communication and specific training.

In addition to such immediate and tactical measures, leaders can also take more long‐term strategic actions in order to foster and establish a business model mindset among their employees. Three have been identified and described in the literature: employee selection, memorable mentoring, and role modeling.

A person’s sensitivity to business model issues can be fostered through a set of distinct cognitive actions, such as anticipating, distancing, abstracting, and reframing:

  • Anticipating: Exploring future business model concepts.
  • Distancing: Gaining perspective about the current business model through nurturing an “outside‐in” perspective.
  • Abstracting: Restating business models in conceptual terms.
  • Reframing: Generating new perspectives and new business model alternatives.

Business Model Innovation – A Fundamentally New Source of Innovation

For startups, the term business model innovation often refers to the introduction of a business model that is novel (in terms of its content and/or structure and/or governance and/or value logic) to the product‐market space in which the firm competes.

A business model design of an incumbent firm to be innovative when the firm changes its activity system so that the new system is novel for the firm and possibly also in the product‐market spaces in which it competes.

To determine whether a business model is innovative or not, two questions need to be addressed.

  • First, is the activity system novel in any of its key dimensions?
  • And second, for whom is it novel?

Innovations that should not be considered business model innovation (BMI). Below are three changes that do not constitute BMI: modified activities or exchanges; product or service innovations; and corporate venturing.

A product “is anything that can be offered to a market to satisfy a want or need, including physical goods, services, experiences, events, persons, places, properties, organizations, information, and ideas.”

A business model, in contrast, describes How a product is created through a set of interrelated activities in factor markets and also How it is offered to customers in the respective product market.

The distinction between business model innovation and product innovation, however, can become conceptually more challenging the greater the service component of the product is.

Business model innovation is therefore neither a sufficient nor a necessary condition for product/service innovation, and vice versa.

Business model innovation can occur in a number of ways, such as:

By adding novel activities. A change along the What dimension.

By linking activities in novel ways. A change along the How dimension .

By changing one or more parties that perform any of the activities. A change along the Who dimension.

By changing the value logic of the business model, in particular by adopting a novel revenue model. A change along the Why dimension.

Just as a pricing strategy complements product design, a revenue model complements the design of a business model’s structure, content, and governance.

Measures of business model innovation either seek to dimensionalize the degree of novelty of a business model, or the scope of the business model innovation, or both.

Quantitative measures of business model innovation seek to numerically capture the innovativeness of a business model.

The basic premise of business model innovation is that it can increase value creation and/or value capture for the focal firm, and thus enhance firm performance.

Business model innovation entails several distinct benefits for the innovating focal firm.

  • First, it complements other forms of innovation.
  • Second, it does not usually require large upfront investment.
  • Third, it can serve as an effective barrier to imitation.
  • Finally, business model innovation can be a disruptive force in an industry.

As a source of innovation, business model innovation can have any of the following value creation effects.

First and foremost, it can increase customers’ willingness to pay, or lower the opportunity costs of suppliers in an existing market – beyond what could be achieved through product or process innovation alone. Business model innovation can also complement product innovation in the sense that it can create positive synergistic effects. What is more, business model innovation can create an entirely new market or allow a firm to create and exploit new opportunities in existing markets.

Resource configurations in the digital economy have enabled the creation of a broad range of asset‐light business model innovations. The digitization of businesses thus allows entrepreneurs and managers alike to reimagine the boundaries of their resource configurations with minimal CapEx, thereby enhancing the value creation potential of resources.

The novelty of a digitally powered low‐CapEx resource configuration may come from several sources:

  • The newness of the needs to be met.
  • The innovative ways through which the matching of resources and needs is enabled and more efficiently and effectively managed.
  • The uniqueness of the complementarity among all value co‐creators that the focal firm bridges and involves in the value‐creation process. Process is known as grafting, whereby a focal firm experiments with new combinations of hereto unconnected (or less connected) resources and needs.

Due to interdependencies among activities, competitors might find it more difficult to imitate and/or replicate an entire novel activity system than a single novel activity, product, or process. Research on imitation suggests three factors that facilitate imitation: identification of what to imitate, ability to imitate, and motivation to imitate.

Business model innovation can also entail industry disruption.

Business model innovation, like all other forms of innovation, also has its downsides – challenges, costs, and risks. Chief among these is the risk of business failure.

Business model innovations are hard to protect legally .

The incentives for incumbents to imitate the new entrant increase under conditions of uncertainty: the greater the uncertainty, the more incumbents will engage in social comparisons with other firms in all aspects of their business, which in turn increases the likelihood of imitation.

The message to managers is the following: when you innovate, look at the forest, not the trees – and get the overall design of your activity system right before optimizing the details.

Strategic Design and Evaluation of Business Model Innovation

Strategic Design of Innovative Business Models – How to Bring Design Thinking and Creativity to Your Business Model

Unlike other forms of innovation, such as product or process innovation, business model innovation rarely requires a technological breakthrough as a precondition.

One important outcome of business model design is business model innovation, which is consistent with the general idea that the design method is a powerful approach for generating innovation.

Design. It is a problem‐solving approach that often involves multiple players from a number of disciplines and has “recognizable phases, and these, while not always in the same order, nearly always include analytic phases of search and understanding, and synthetic phases of experimentation and invention.”

Design can therefore be “thought of as an integrated and disciplined innovation process that builds creative insight from deep knowledge.”

The design drivers – captured by the acronym DESIGN – that enable the business model designer to strategically consider factors that frame and focus the business model design task. These design drivers include internal factors, or constraints as they are referred to in the design literature (which we specifically refer to as Deployable resources), the focal firm’s External environment, Stakeholders’ activities, Incumbents’ templates, Goals to create and capture value, and the perceived Needs of customers).

Tim Brown, the Chairman of California design company IDEO, put it, “The willing and even enthusiastic acceptance of competing constraints is the foundation of design thinking.”

Deployable resources, which are also known as internal constraints, concern the availability of human and capital resources and capabilities that can be deployed to enable activities.

External constraints refer to the conditions imposed on the business model designer by the focal firm’s external environment, including its competitive market and its technological ecosystem.

Several technological trends have been converging that encourage companies to design new business models. Chief among these is the digitization of business.

A range of enabling technologies besides the internet have been introduced over the past two decades that can give rise to new business model designs.

  • Big data analytics: Big data analytics “examines large amounts of data to uncover hidden patterns, correlations and other insights.”
  • Mobile channels: Mobile channels provide a way for businesses to connect with customers through their mobile devices.
  • Social media: Social media strategies have become imperative for firms.
  • Cloud computing: Cloud computing is “the delivery of computing services – including servers, storage, databases, networking, software, analytics, and intelligence – over the internet (‘the cloud’).
  • Artificial intelligence: Artificial intelligence has been described as the study of methods for making computers behave intelligently.
  • Machine learning: Machine learning is a well‐developed subset of artificial intelligence.
  • Blockchain: Blockchain is perhaps best‐known today as the technology behind Bitcoin, but its applications are far‐reaching and will allow novel ways of structuring transactions and information.
  • The Internet of Things: Broadly, the Internet of Things refers to “everything connected to the internet but it is increasingly being used to define objects that ‘talk’ to each other.”
  • Autonomous cars: Autonomous (or self‐driving) cars employ a suite of sensors and technologies to drive from one point to another.
  • 5G: 5G is the “5th generation mobile network”.

Key to dealing constructively with constraints by creating novelty and/or adopting elements from existing business models is therefore the adoption of a design attitude that views constraints as stimuli and creative challenges, rather than as obstacles that require taken‐for‐granted responses.

The next business model design driver – stakeholders’ activities – is rooted in the design concept “collaboration.” This concept refers both to collaboration with partners during the design process, and to collaboration as a defining characteristic of the resulting business model design.

Designers can draw inspiration from the templates (i.e., the established business models) of incumbent firms in their industry with which they may be familiar, or from another industry that may be applicable to the design task at hand. In other words, designers routinely draw on existing templates.

To be a potentially viable design, each design task must have a goal.

In the context of business model design, the “goal” design driver is often closely linked with customer (or, more generally, stakeholder) needs, another important design antecedent.

A business model design should not only consider customers’ needs, but the needs of all stakeholders – chief among them the focal firm, but also suppliers and strategic partners – and satisfy their incentive compatibility constraints. Put differently, it needs to fulfill the twin objectives of value creation (for all involved in the business model) and value appropriation (for the local firm).

Mindful business model designers are keenly aware of their options when they work around constraints, engage with stakeholders, consider templates, and keep client needs in mind.

Mindfulness defined as a state of active awareness is related to, but distinct from, mindset.

Nurturing a business model mindset can help designers be more mindful (and vice versa), because it sharpens their awareness about what to design, and from where to seek information and inspiration.

Robust business model innovations are those that are both legitimate and do not lend themselves easily to imitation.

To increase the legitimacy of new business model content, business model innovators can select legitimate customer‐facing activities for inclusion in their designs, built around features that are already familiar to their clients.

How do you reduce the likelihood of imitation of legitimate business model content:

  • One way is by generating incompatibilities with incumbents’ existing business models.
  • For designing robust business model structure, firms reveal selected aspects of their business models while concealing others.
  • By outsourcing some activities to legitimate partners, firms can reassure customers and other partners about the legitimacy of their new business model governance arrangements.
  • Partnering with incumbents contributes to reducing their willingness to imitate business model innovation by offering them a strong value proposition, for instance in terms of a revenue‐sharing agreement.

There are two additional aspects to consider in the application of design to business models. Alongside the DESIGN drivers, these increase the likelihood of successful business model innovation.

  • The first is mindfulness.
  • The second important factor to consider is robustness.

How to Design a New Business Model – A Dynamic Design Method

For many design thinkers, the process is the key to successful design: “What really matters for a modern company is building design processes – lightweight methods for problem‐solving, creativity and iteration.”

Design as a process broadly consists of two steps: an analytical step of finding and discovery, and a synthetic step of invention and making.

We relabel the three generic IDEO process stages – ideate, iterate, and implement – as BMIdeate, BMIterate, and BMImplement, respectively, where “BM” stands for “business model,” and “BMI” suggests business model innovation as a possible outcome.

The first business model innovation design phase is BMIdeate. This entails observing business models in use, synthesizing insights, and finally generating innovative new business model solutions. Observation for the purpose of designing new business models is more encompassing and complex than for designing new products or services. It requires the business model designer to gain a profound understanding of the DESIGN drivers. For firms with an established business model, observation should be preceded by careful documentation and analysis of the current model.

“Each of man’s advances was started by a question. … Knowing what questions to ask and how to ask them is sometimes more important than the eventual answers.”

Following observation of business models in use, the designers need to “identify interesting nuggets or stories from the data collected, to find patterns of behavior… and to see what is missing within the use, usability, and meaning” of the current business model design solution. More specifically, synthesizing in the context of the business model means gaining a comprehensive, holistic understanding of the design challenges and influences that the focal firm is facing. Synthesizing key insights from a vast amount of data may be the most difficult task in the design process. Besides identifying and crisply articulating the problem to be solved, synthesizing insights about the business model may also involve the formulation of a new preliminary value logic and its associated value propositions. These can be used to map out the potential “opportunity” space. The overarching objective of this step is to creatively organize and lay out all the pieces of the puzzle from which the new business model will eventually be constructed.

After synthesizing the insights derived from observing stakeholders, the business model designer needs to generate solutions. Ideas for new business models are often rooted in the work conducted prior to the brainstorming, keeping in mind previously gathered facts, the themes identified, and the DESIGN drivers.

To break out of existing mental models, it is desirable that the brainstorming team be interdisciplinary and carefully composed of domain experts, business model experts (academics, business executives, or consultants), and a diverse group of outsiders (non‐focal‐firm members) with the ability to adopt a higher-level, system‐wide perspective (“bird’s eye view”). Teams with consensus‐based decision‐making practices may not be as effective for realizing business model innovations.

In the context of business model innovation, the next stage after ideating new business models involves:

  • consolidating the various ideas into a coherent whole to yield one or possibly several alternatives
  • evaluating these alternatives according to relevant criteria
  • prototyping the highest‐ranked alternative(s) to the extent possible, i.e., experimenting on a small scale and keeping expenditures low.

Consolidation is a necessary step because otherwise the designers might get caught up in an endless loop of generating new ideas, without knowing exactly which ones to use and combine, or when and where to stop.

  • Consolidation might be based on specific constraints, and how well the new ideas address the constraints.
  • Another possibility would be to cluster business model ideas that leverage stakeholders’ activities to a similar degree.
  • Another clustering principle might be to order ideas around powerful and inspirational templates.
  • Ideas for new business model designs that emerge during the generation phase could also be grouped around the specific problems that they will likely help to address.

Following the consolidation of business model ideas, the various emerging alternatives need to be evaluated. The most highly rated alternatives could subsequently be prototyped.

Prototyping involves building a mock‐up of the business model at the lowest possible cost. “Go fast” and “no frills” are typical guidelines for prototyping services that could also apply to prototyping business models. “The prototype is an attempt to solve the problem, but its main value is as a vehicle for learning.”

Implementation in the context of BMI requires putting together all the elements that are envisioned by the new design. Distinctive challenges may arise at this stage for new and existing firms. If the new business model represents a radical departure from the existing model, implementing the new business model will require a number of changes that need to be carried out simultaneously. The implied magnitude and complexity of these changes can entail high – and maybe even prohibitive – costs (both monetary and in terms of the time needed to carry out the changes).

A process for building a business model innovation capability. Our three‐stage framework points to the roles of raising awareness among organization members (Phase One) and carefully framing the design process (Phase Two) that is subsequently carried out (Phase Three).

The key idea behind this framework is that building a business model innovation capability requires an initial spark provided in Phase One (awareness stage), then gradual development through iterative cycling between Phases Two (framing stage) and Three (design stage) across various business model innovation initiatives.

A dynamic process of business model design that can lead to the development of a firm‐level capability. The three‐stage process – BMIdeate, BMIterate, and BMImplement – is inspired by the IDEO design process, but specifically adapted to business model design.

  • The first phase, BMIdeate, has three steps: observing business models in use, synthesizing insights, and generating new solutions.
  • BMIterate, the second phase of the business model design process, has three steps: consolidating business model ideas, evaluating alternatives, and prototyping the best ideas.
  • Finally, in the implementation phase (BMImplement), the elements of the new business model that have been identified in the previous steps are set into place. This phase often overlaps with prototyping of BMIterate.

BMImplement, however, is less well scripted and explained in theory and practice than the preceding stages. At this stage, business model designers and innovation managers often resort to employing techniques from other fields, such as entrepreneurship or organization, to identify and apply suitable processes for converting design ideas for new business models into practice.

How to Design a New Business Model – Methods Championed by Startup Entrepreneurs

Three distinct entrepreneurial processes. Two of these processes (discovery‐driven planning and effectuation) have been proposed by entrepreneurship scholars, and the third has been widely adopted in practice (lean startup).

As the name suggests, discovery‐driven planning (DDP) is a normative entrepreneurial technique that combines the discipline of planning with an openness to unexpected discoveries. Originally developed by Ian C. MacMillan. Discovery‐driven entrepreneurs are guided through “enlightened trial and error” and learn their way into an uncertain future.

The discovery‐driven implementation process thus creates a series of decision points at which the project can be discontinued – or adapted in response to the improved information base.

More specifically, discovery‐driven planning consists of six interrelated steps:

  • framing
  • benchmarking
  • specification of deliverables
  • testing of assumptions
  • managing to milestones
  • parsimony

Framing (step one) asks the entrepreneurial managers to define long‐term success by asking a series of questions. In the context of strategically designing an innovative business model, framing in DDP corresponds to the “goal” design driver in the business model design process.

Benchmarking (step two) asks the entrepreneurial manager to peg the key revenue and cost metrics (e.g., from the reverse income statement) against the market, and against the firms with the most comparable business models.

Specification of deliverables (step three) is also conceptual, as it involves laying out all the activities that are required to generate and deliver the customer experience. At this stage, key assumptions are made that should be carefully documented in a Key Assumptions Checklist. Establishing this list requires a conversation among all those involved with the project.

Testing of assumptions (step four), managing to milestones (step five), and parsimony (step six), are no longer merely conceptual steps of discovery‐driven planning, but involve action. These steps, which refer to the careful use of resources and a reluctance to make large upfront expenditures, are most powerful when they are combined with each other.

Additional advantages of discovery‐driven business model implementation include the following:

  • It promises to increase the overall return on investment.
  • It creates a series of decision (go/no‐go) points.
  • It requires extensive communication among all those involved in the business model project.
  • It fits well with the systematic, disciplined, and process‐oriented way in which many businesses are run.
  • It sends an important message about failure to members of the organization.

There are also a number of challenges with applying discovery‐driven planning to business model development.

  • Business models are sometimes difficult to grasp conceptually, because they are a system‐level construct.
  • Performing market tests of entire business models (as opposed to prototyping and/or testing particular products or services) can be challenging and requires careful thought.
  • It can be inherently difficult to admit that you do not know everything, and that you may even have significant knowledge gaps.

One of its main advantages – that it requires a great deal of communication among business model stakeholders and those involved in implementing the new model – could also be a main source of difficulty.

Despite its process‐based and systemic nature, discovery‐driven planning goes against the conventional planning philosophy.

Scientific evidence about the DDP approach is scant.

Building on the key ideas and principles behind discovery‐driven planning, scholars have proposed other closely related business model implementation approaches. One of these approaches has been termed Parallel Play. Parallel Play helps entrepreneurs with their choice among various alternative business model designs.

The key idea behind discovery‐driven planning is to successively reduce uncertainty by engaging in active, deliberate, low‐cost, and low‐commitment experiments that make it possible to test key assumptions about business models.

Effectuation denotes a logic of entrepreneurial action that starts with a focus on means. Means are the resources that entrepreneurial managers and business model designers have at hand, and can use for imagining different effects, or possible ends toward which the resources can be deployed.

That action is characterized by the following five main principles:

  • Leveraging resources at hand: Resources at hand (also called the “deployable resources”)
  • Keeping in mind affordable loss: Instead of adopting a profit‐maximizing attitude, effectual business model designers are mindful about what they are prepared to lose in the worst‐case scenario.
  • Building partnerships: Instead of being obsessed with competition, effectual entrepreneurs seek to build strategic partnerships with the other firms and customers around them.
  • Leveraging unexpected contingencies: Sometimes, uncertainty is so severe that possible outcomes, let alone the associated probabilities, cannot be identified.
  • Controlling the near future: Given that the future, especially in highly ambiguous environments, is essentially unpredictable, effectual entrepreneurial action calls for focusing on its controllable aspects.

Effectuation is reassuring in the sense that everybody should be able to perform it; it lowers the bar for taking entrepreneurial action. Effectuation is reassuring in another sense, too: its main principles serve to lower both the cost and the risk of failure in entrepreneurial venturing. Effectuation also has limitations. First, it is largely driven by coincidence and trial‐and‐error.

Lean startup is a methodology that builds on the central ideas behind the methods mentioned earlier (design thinking, discovery‐driven planning, and effectuation). The lean startup is anchored on the observation that entrepreneurs’ subjective perception of a business model opportunity may be very different from a validated one.

At its core, the lean startup method rejects strictly planning‐based entrepreneurship processes and embraces an iterative approach driven by efficient experimentation with early customers. It has therefore also been characterized as hypothesis‐driven entrepreneurship, and described as a scientific approach to entrepreneurship.

The goal of the lean startup is to shorten product development and rapidly discover a viable business model. Essentially, the key promise of applying the lean startup method to building innovative business models is to search in an efficient and effective manner.

Two associated benefits are:

  • Reduced market risk.
  • Reduced capital expenditure (CapEx) and initial funding needs.

The limitations of lean startup that mirror some of the disadvantages of discovery‐driven planning and effectuation, especially within the context of an established firm. These include:

  • Cost of experimentation
  • Disclosure of strategically important information
  • Cost of damaged reputation
  • Noisy signals
  • Cost of organizational change

Value Propositions – The NICE Framework for Measuring the Impact of the Business Model

In today’s highly interconnected world, customers are no longer passive recipients and consumers of firms’ products and services, and suppliers are no longer just arm’s ‐ length vendors of services and goods. Instead, customers are becoming increasingly involved in the development, production, and delivery of the very same products and services that are intended for their consumption, and suppliers are becoming tightly integrated into many firms’ research and development (R&D) and production activities. This phenomenon can be described as the “co‐creation” of value within a focal firm’s business model.

Crowdsourcing information to improve product quality is another form of digital co‐creation.

What is a value proposition in the context of a business model?

A value proposition is a hypothesis formulated by a focal firm about how much value it creates for a stakeholder by way of providing tangible as well as intangible benefits that fulfill the stakeholder’s needs, net of any costs that the stakeholder incurs and/or perceives.

Value propositions are subjective, not objective.

Value propositions, according to our definition, are promises of value creation for stakeholders. A business model therefore needs to be geared toward total value creation, i.e., value creation for all parties involved.

  • The customer’s share is the value they capture, which is equal to the customer’s willingness‐to‐pay minus the price paid.
  • The focal firm’s share is the amount of value it manages to capture, which is equal to the price the customer paid minus the cost paid to the supplier.
  • The supplier’s share is the value it captures, which is the price the firm paid, minus the supplier’s opportunity cost.

Four “value‐based” strategies have been identified in this simple model.

  • The first way is to increase the willingness‐to‐buy of customers of the firm
  • The second way is to lower the opportunity cost of suppliers
  • The third way is to lower the willingness‐to‐pay of customers for competing firms’ products
  • Finally, the fourth way is to increase the opportunity costs to suppliers of working with other firms

Some of the common design themes that orchestrate and connect the elements of an activity system include Novelty, lock‐In, Complementarities, and Efficiency (summarized by the acronym NICE).

The essence of novelty‐centered business model design is the adoption of new activities (content), new ways of linking the activities (structure), new ways of governing the activities (governance), and/or new ways to monetize the activity system by the focal firm.

The unique characteristics of virtual markets make the possibilities for business model innovation appear almost endless.

Business models can also be designed for lock‐in, the power to keep stakeholders such as customers and partners as business model participants. Lock‐in can be manifested as switching costs, or as network externalities that derive from the structure, content, and/or governance of the activity system.

The value‐creating potential of a business model also depends on the extent to which it motivates customers to engage in repeated transactions. This characteristic can also be described as the “stickiness” or “lock‐in” property of a business model.

Network externalities are usually understood as positive consumption externalities in which “the utility that a user derives from consumption of the good increases with the number of other agents consuming the good.”

There may also be indirect network externalities that arise when economic agents benefit from the existence of a positive feedback loop with another group of agents.

In “winner‐takes‐most” or “winner‐takes‐all” markets, it is paramount to be the first to enter.

Complementarities are present whenever bundling activities within a system provides more value than running activities separately. Complementarities are also present whenever having a bundle of goods provides more value than the total value of having each of the goods separately. Business models may also create value by capitalizing on complementarities among activities and complementarities among technologies thereby unleashing new value.

Efficiency‐centered design refers to the ways in which firms aim at achieving greater efficiency through the design of their activity systems. An efficiency‐centered activity system aims at reducing transaction costs.

Efficiency enhancements can be realized in a number of ways. One way is by reducing information asymmetries between buyers and sellers through the supply of more up‐to‐date and comprehensive information. Marketing and sales costs, transaction processing costs, and communication costs can also all be reduced in an efficient business model.

Evaluating Existing Business Models and Designing New Ones – Your Essential Toolkit

Business model analysis refers to the set of practices and tools that enable managers to:

  • define precisely how their current business model works
  • evaluate the current business model’s strengths, weaknesses, and impact on firm performance
  • design, implement, and evaluate innovative new business models
  • redesign existing business models

The business model told as a story revolves around activities, like our business model framework. The story as a tool for articulating a business model is therefore perfectly consistent with our key concepts. According to Magretta, a good story fulfills two conditions.

  • First, it needs to make sense.
  • Second, it should have a satisfactory “ending,” in the sense of delivering a profit for the focal firm.

Condition 1 refers to what we called the value proposition. Condition 2 refers to what we called the value logic of the business model.

Building on the holistic and compact narrative form of the business model story, it is useful to drill down further and elaborate on the different dimensions of the business model.

Business Model Elaboration should be performed after, or in addition to, producing the Story of “How It Works,” which it complements.

A single picture is worth more than a thousand words. In line with this conventional wisdom, it is helpful to represent the entire activity system as a chart, which we refer to as an Activity Map. In an Activity Map, the key activities (What) of the business model are represented as boxes.

Activity Map Visualize the business model through boxes (What), arrows between the boxes (How), different colors of boxes (Who), and additional text if necessary (Why).

  • To identify the Goals and Needs of customers, managers can formulate a problem statement or a questionnaire.
  • To identify Incumbents’ templates, they can draw inspiration from incumbent business model templates.
  • To evaluate the External environment, Stakeholders’ activities, and Deployable resources, there are two important tools at the disposal of managers: environmental PEST scanning, and resource and capability scanning.

The Problem Statement. This tool assumes a business model innovation project within a focal firm, a project sponsor and an innovation team charged with carrying out the project.

A powerful problem statement is one that:

  • is centered on key business model stakeholders, in particular customers, not the focal firm
  • considers customers as human beings, with all their goals, human needs, desires, and motivations
  • represents an important and meaningful issue for the customers
  • is ambitious, yet feasible (i.e., it is possible to solve it in a way that makes economic sense)

To design a useful questionnaire for interviewing business model stakeholders, one needs to take the initial problem statement and develop a range of questions that probe it more deeply in terms of its relevance for the stakeholder.

The central purpose of asking questions at an early stage in the business model innovation process is to achieve a better understanding of the problem to solve, rather than to find a solution for what could be a poorly defined problem.

  • Business Model Questionnaire – Define who should be interviewed, when, and by whom.
  • Business Model Templates – Using visuals, videos, or stories, present examples of firms that have innovated their business models along the key dimensions (What, How, Who, Why).
  • Environmental PEST Scanning – For each of the main external factors cited above (Political, Economic, Social, and Technological), write down a comprehensive list of the elements that shape the industry and firm.
  • Resource and Capability Scanning – (Step 1) Assess the capability gap. Evaluate the extent to which the focal firm’s resources and capabilities can be redeployed in alternative uses in the envisioned business model, to determine the type of capabilities that the focal firm would need to access through partnering with other firms.
  • Ecosystem capability scan – With the information on the type of capabilities that would need to be accessible to the focal firm established in Step 1, scan the ecosystem of the focal firm to identify potential partners.

Four tools that can help structure the design and implementation of business model innovations.

  • A popular tool for generating, or ideating, creative new business model ideas is brainstorming.
  • Next, recall the importance of experimentation when designing new business models. To this end, managers can use a storyboard to visualize and communicate the idea to others for preliminary feedback.
  • They can then use a Test‐Assumption‐Matrix (TAM), which highlights the key assumptions of a low‐cost business model experiment.
  • Finally, for implementing innovative business models, the Business Model Canvas is a well‐known tool that can help guide the development of a business plan from a business model design.

Research on creativity has shown that individual brainstorming is more productive than brainstorming in a team in terms of the number of non‐overlapping ideas generated per person.

Brainstorming – Establish a set of brainstorming rules, and appoint a facilitator to monitor and guide group behavior during the brainstorming session.

In its most simple and basic version, a business model prototype can be constructed in the form of a storyboard – a set of visual frames or a brief video explaining how the new business model works, i.e., that highlight the essence of the new story.

Storyboard Draw a series of comic book‐style frames to explain the essence of the new business model story, i.e., how the new model works.

It may not be feasible (or necessary) to test the entire model. Instead, the focus could be on the most critical assumption(s) behind the model (termed “key assumptions”).

Which assumptions to test, when to test them, and through which specific tests should be documented in a Test‐Assumption‐Matrix (TAM) table. In such a matrix, the rows represent the critical assumptions behind the business model, and the columns represent milestones (i.e., key events such as customer visits, or other experiments) at which assumptions can be tested. Checkmarks in the cells of the table indicate which assumptions will be tested at which milestones. Additional rows contain critical information about the envisioned test, for example: type of test, expected cost of test, parties involved in the test and plan for making them participate, individuals responsible for executing the test, test timing and deadline, expected test outcomes, realized test outcomes, key learnings from the test.

A tool that can help translate a business model idea into a full‐fledged business plan, namely the Business Model Canvas.

It contains nine distinct fields, each representing one of the following concepts: key activities (KA), key resources (KR), key partners (KP), value propositions (VP), customer relationships (CR), channels (CH), customer segments (CS), cost structure (C$), and revenue streams (R$).

A logical implementation sequence would be: Business model (What, How, Who, Why) → Canvas (KA, KR, KP, VP, CR, CH, CS, R$, C$) → Business plan.

Business Model Canvas Develop an actionable plan that maps the holistic idea for a business model innovation onto the key components of the Business Model Canvas characterizing the organization that will be built to enact the new model.

The Value Driver Matrix as a tool for business model evaluation.

Value Driver Matrix Construct a matrix where the What, How, Who, and Why dimensions of the business model constitute the rows, and the Novelty, lock‐In, Complementarities, and Efficiency value drivers form the columns.

The ultimate arbiter of a business model’s strength is whether it enhances the focal firm’s ability to create value for its shareholders and employees, as well as for customers, partners, suppliers, and even society at large.

13 distinct business model analysis tools:

  • Tools for articulating and understanding business models:
    • Tool 1: Story of “How It Works”
    • Tool 2: Business Model Elaboration
    • Tool 3: Business Model Activity Map  
  • Tools for framing and guiding the design effort:
    • Tool 4: Problem Statement
    • Tool 5: Business Model Questionnaire
    • Tool 6: Business Model Templates
    • Tool 7: Environmental PEST Scanning
    • Tool 8: Resource and Capability Scanning
  • Tools for designing and implementing business model innovations:
    • Tool 9: Brainstorming
    • Tool 10: Storyboard
    • Tool 11: Test‐Assumption‐Matrix
    • Tool 12: Business Model Canvas
  • Tool for critically evaluating business models:
    • Tool 13: Value Driver Matrix

Making Business Model Innovation Happen

Implementing Business Model Innovation in Established Firms – Organizational Barriers and How to Overcome Them

We define BMI implementation as all the choices that need to be made to ensure that the new business model can be fully operational and fulfill its main objective in the specific context of the focal firm.

Business model implementation encompasses the steps involved in moving from a business model prototype to a full‐fledged, thriving organization that works well with the new business model (creating internal fit); making sure that the new business model and the organization mesh fluidly with their ecosystem (creating external fit); and adapting and aligning strategies (creating strategic fit).

When an established firm works toward adopting a new business model, the new model typically does not replace the old one right away, but the two models coexist side‐by‐side for some time.

New business models are often designed for new customers that an incumbent does not currently serve (so‐called “noncustomers”), in market segments and at price points that the incumbent might currently perceive as unattractive. They may also rely on resources and capabilities that the incumbent does not yet possess or is unable to access.

Firm managers, however, tend to allocate resources to what they perceive are the most profitable uses. These are often associated with the old business model, because the legitimacy, scalability, and/or profitability of the new model are unproven.

Successful business model innovation requires two things.

  • First, it requires strong and decisive leadership.
  • Second, it requires a specific set of attitudes and skills among the firm’s managers and employees.

There is a vast repertoire of knowledge and suggestions on how to overcome the resistance to change among managers and employees. The proposed solutions often focus on a combination of soft skills (e.g., communicating, convincing, coercing) and structural measures (e.g., adjusting incentives, hiring outsiders, and creating separate organizational units).

Corporations are increasingly adopting diverse institutionalized approaches for systematically promoting innovation from within. These approaches, which also work in the context of business model innovation, include: accelerators, incubators, innovation labs, cross‐functional teams, scouting missions, and challenges (e.g., hackathons).

According to recent research involving over 140 business model innovation projects in 44 corporations in Germany, Austria, and Switzerland, the key parameters of success (where success is defined as the degree of innovativeness of the resulting business model) are as follows:

  • High level of task differentiation between the BMI initiative team and the respective business unit.
  • High level of social integration – not among team members but between team members and the business unit.
  • The joint positive effect of task differentiation and social integration on the degree of innovativeness of a business model is enhanced when the right form of initiative governance is adopted.

Implementing Business Model Innovation in New Ventures – Balancing the Prospects of Shooting for the Stars with the Risks That Can Sink the Ship

Two of the most salient BMI implementation challenges are internal resistance to change from members of the organization (active resistance), and organizational inertia (passive resistance).

Indeed, conceptualizing and defining the business model is one of the most fundamental strategic decisions that every founder needs to make. Furthermore, the possibility of adopting an innovative business model offers all founders a lever to create value.

Internal hurdles to BMI implementation can be expected to be lower in younger firms than in older ones.

Risk and uncertainty are inherent characteristics of the entrepreneurship process.

Although there can be many types of risk, startup risks generally cluster around five types:

  • demand‐side risks (e.g., customer acceptance of the offering may not be as expected)
  • supply‐side risks (e.g., risk associated with the management team, the product/service, the technology, partners, and vendors)
  • competition risks (e.g., imitation of the offering by competitors)
  • capital market risks (e.g., funding, timing, and value at exit)
  • environmental (e.g., macroeconomic, regulatory, and political) risks

While some of the risks from business model innovation can be partly addressed through designing the business model in a robust way, others have to be addressed through entrepreneurial risk management techniques like business planning or discovery ‐ driven planning.

A particular risk that needs to be highlighted for new ventures implementing business model innovations is their potential dependence on third parties.

New ventures thus face the so‐called “sharks dilemma,” namely, under which circumstances do they choose partners with high potential for abuse of market power or misappropriation over less risky partners?

The previously mentioned business model‐specific barriers for established firms – complexity, inertia, lack of business model know‐how, lack of able and willing leaders, and lack of agreement about the right model; also apply to new ventures, in particular to the challenge of managing complexity.

Some effective risk management approaches, such as business planning, building trust with external stakeholders, lowering dependence on third parties, using strategic considerations in adopting a revenue model, and improving internal governance.

Business planning refers to the process of thinking through a new venture with an innovative business model in a thorough and systematic fashion. This process may be more important than its actual outcome (the business plan), because it promotes a holistic mindset.

The business plan constitutes an important decision‐making tool for entrepreneurs.

Founders tend to choose risky partners when they urgently need partners’ unique resources and capabilities. Defense mechanisms are legal protection (e.g., from patents), secrecy (e.g., trade secrets), and timing (i.e., involving risky partners at a later stage, when the costs of knowledge and resource leakages are smaller).

Three main revenue model types have been identified:

  • The first is the straightforward paid revenue model, where a product or service is provided in exchange for a stated price. Paid models can be further broken down into subscription revenue models, where payments are made on a recurrent and stable basis, and transaction payments models, where payments are made per transaction.
  • The second type of revenue model is the advertising revenue model. Under this model, users do not pay for a product, but revenue is earned through the ads that are bought by advertisers and shown to users.
  • The third dominant revenue model is the freemium model, where two products are offered – a premium paid version and a more basic (and/or ad‐sponsored) free version.

Some risk mitigation strategies for young ventures implementing innovative new business models.

  • The first strategy is business planning.
  • The second strategy is building trust with external stakeholders.
  • The third strategy to manage business model implementation risk is lowering dependence on third parties.
  • The fourth strategy is using strategic considerations in adopting a revenue model.
  • Finally, business model implementation risks can be mitigated by improving internal governance.

Business Model Innovation Strategy in the Digital Age – What Does It Mean for You?

A business model innovation mindset has indeed become a prerequisite for transformative innovation, and entrepreneurial leaders of all firms need a business model innovation strategy.

The opportunities and threats presented by the emergence and growth of digitally enabled multisided platform business models, which enable digital interactions, exchanges, and commercial transactions among multiple parties, further strengthen the case for having a business model innovation strategy.

A business model mindset is a state of mind and perspective that helps entrepreneurial leaders consider the firm’s entire activity system as a way to capture business opportunities.

A business model innovation strategy has become one of the core strategic choices that entrepreneurial leaders of all kinds of organizations need to consider.

Entrepreneurial leaders are therefore faced with an indispensable and complementary strategic choice, namely the conceptualization, design, implementation, and management of transformative digitally enabled business models.

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