“Free is not a business model” declared the CEO of Box, a cloud based enterprise storage and collaboration company, feeling the price pressure of the competitive battle between Amazon and Google in the storage space. While his lament is self-evidently true, it does open the broader question: what is a business model? Business model is one of the hot topics in management today, usually alongside the adjective ‘disruptive’.
The term business model really only took off in the first internet boom. Ironically, at the time if you asked a more traditional business executive what his business model was they would look a little confused: it wasn’t in their lexicon. But today everyone is talking about business models. HBR reported a few years ago “7 out of 10 companies are engaging in business model innovation … 98% are modifying their business model to some extent”.
Drucker first described the business model in terms of: Who is my customer? What do they value? And how do I deliver it to them? Implicit in this articulation was the profit dimension: what is the economic logic? The business model represents the organisational and financial architecture of a business (see below). Note that the revenues and costs are the ‘consequences’ of ‘choices’ made in terms of the market model and the operating model.
This basic framework has been expanded and popularised as the Business Model Canvas. It specifically addresses the customer relationships (the market model) and the channels, resources and activities, and partners (the operating model).
How to Design a Winning Business Model1[1] (HBR: 2011) presents an alternative approach: the business model is described as the ‘logic of the company’. This brings into focus the integrating logic which is fundamental to a good business model but which isn’t explicit in the simplified business model canvas. The focus in this articulation of the business model is on the operating model, and particularly the critical choices management makes in designing the model and the consequences of those choices. It describes the choices around three dimensions:
· Policy choices … eg. Location of plants; unionised vs. non-unionised workforce
· Asset choices … eg. Fleet choices; manufacturing technologies
· Governance choices … eg. Who holds decision rights across the policies and assets.
Take Ryan Air as an example. RyanAir’s target customer group is young/leisure travellers. Their most fundamental choice then is ‘low fares’. From this flows much of their business model design. They choose to use secondary airports which dramatically reduces their fixed costs: it is less convenient but their customers are happy to make this trade-off. Low fares also mean low expectations of the customer for services on the flight and on the ground. No meals is not an issue: no one expects a meal on a cheap flight. And you pay for everything that you want beyond just a seat on the plane. Want luggage? Pay extra. Want to reserve a specific seat? Pay extra. Want to move to the front of the queue to get onto your flight? Pay extra. You get the picture.
They only run short haul flights, so that they don’t have to pay for overnight stay-overs for staff: low variable costs. Short haul also means better utilisation of the fleet. And the short haul choice is also consistent with the ‘no meals’ choice.
Their choice to use only one type of aircraft is also driven by the same logic. Combined with high volumes resulting from their low fare offer, choosing one type of plane gave them greater buyer power; it also leads to lower maintenance costs (easier to train staff, greater efficiencies); and reduced spare parts inventory.
And their choice to offer ultra-low costs delivers high traffic numbers, which reduces the fixed costs per passenger. This in turn allows them to drive their prices lower. This is a ‘virtuous cycle’ or self-reinforcing feedback loops shown below.
So which of these business model approaches work best? When I teach business models on the MBA strategy program teams of students are asked to use both the canvas and the ‘systems’ model above to describe the business model of various companies: Aldi; Louis Vuitton; the AFL; DOME; McKinsey; AxiomLaw. Their feedback after the exercise is typically that the canvas offers a simple way to begin to understand the business, but that they find they get more insight into the dynamics of the business through the latter method.
Once you can map out your business model you are ready to explore the potential threat (or opportunity) of disruption. This will be the focus for my next couple of blogs as we look at what’s happening in various sectors.
[1] Casadesus-Masanell, Ramon, & Ricart, Joan. (2011). How to design a winning business model. Harvard Business Review, Jan-Feb.
