Managers frequently rely on innovation to drive profitable growth. In many industries new products and services are fundamental. However, although product and service innovations are and have been important to firms for decades, competitive pressures and the search for increased profit have pushed business model innovation higher on the priority list.

What is a business model?

The business model describes how a firm takes resources, often in the form of technology, as inputs and converts them through customers and markets into economic outputs, thereby connecting resource potential with the realization of economic value. The business model, thus, refers to the customer segments being served, and the customer offering, how the firm configures its resources, and how it sells and distributes its offering, creating value for its customers, and profiting from these activities through its value-capture mechanism. Firms may offer products, or services, but their offering is embedded in a system of activities and relationships that comprise their firms’ business models.

A product or service innovation is the introduction of a product or service that is new or significantly improved with respect to its characteristics or intended uses. A firm can gain competitive advantage by introducing a new product or service, which increases demand and mark up.
What then is a business model innovation?

A business model innovation is the introduction of a new way of creating value for customers, the way the value is delivered and/or the way the firm appropriates value from the customer offering. A business model innovation does not discover a new product or service; however, it may redefine an existing product or service, how it is delivered to the customer and/or how the firm profits from the customer offering.

A business model innovation, by itself, can create strong competitive advantage. Although product or service offerings may be technologically similar they can render radically different performance. Hence, technology alone is not the fundamental engine of profit growth.

Difficult but important

The reason for why business model innovation has become so important to firms is that it usually has a stronger impact on profit margins than product and service innovations and, at the same time, it can disrupt established industries.

Business model innovation usually has  a stronger impact on margin growth than product and service innovations.

The effects of business model innovation have been underestimated by firms and are often difficult to manage.

There is a wide range of business model innovations, such as IKEA, SouthWest Airlines and Wal-Mart, that have reshaped entire industries. From a look at the Fortune 500 list of companies it can be seen that many newer entrants have transformed established industries or created completely new ones: business model innovation seems to be more difficult for established firms, and most create new products and services without changing the logic of how they conduct their business. In other words, most products and services go through changes, but business models tend to remain fixed.

Match your business model to your offer

A successful business starts from creating value for customers, usually by solving problems. However, it is a big step from creating potential value to realizing it, and simultaneously appropriating parts of that value.

Sometimes an offer will successfully employ a business model already familiar to the firm, but sometimes it is necessary to identify a new business model in order to capture value.

Failure to find the appropriate business model will cause an investment to yield less value to the firm than it might otherwise, or even may cause the firm to withdraw from its commitment.

Challenge old habits

For decades, many successful firms have employed a single, dominant business model that represents their key choices. They have likely integrated manufacturing, in-house R&D and product sales based on per-unit price. Since the 1990s however, this pattern has been changing, with external collaborations and outsourcing, for example, becoming of great importance to many firms.

At the same time, firms are employing more extensive repertoires to appropriate value, than ever before. They offer financing, solutions, value sharing, downstream participation in the value chain, licensing, and so on.

Focus more on the business model

Failure to find an appropriate business model will cause a technology investment to yield less value

My studies, and the companies that I have been working with, show that firms in general are aware that making changes to the business model may increase the opportunities for them to appropriate more economic value. Nevertheless, they are often reluctant to abandon their traditional ways of doing business.

Sometimes firms also fail to recognize the need to change their business models. Many appear to focus on and put a lot of effort into the development of products and services, but expend less effort on how to turn them into a viable business. This may result in poor realization of its economic value.

It can be assumed that many innovations and product augmentations are not implemented because managers do not see how they can realize value from the development. This raises the issue that management needs to focus more on the business model, especially if the aim is to reshape the industry.

Implementation may be difficult

There are several reasons why it is difficult to change the business model. The first is related to institutional memory. When firms grow and their business models have proven successful, this establishes powerful norms and values within the mindset of the organization.

Another problem involved in changing the business model is uncertainty. Although, the actual decision to change may be easy, implementation may be far more difficult. Firms may be uncertain about their customers’ reactions to business model changes. Hence, although managers may be well aware of the benefits of a new business model, they may be uncertain about the consequences.

Reduce uncertainties

These uncertainties seem to be especially high if changes imply ways of conducting business that are new to the industry. Managers generally tend to opt for changes that are in line with other parts of the industry. This is argued to be an unintended consequence of the uncertainty managers face: they need to communicate by word and example within the industry.

Business models, therefore, can be seen as part of an ‘industry recipe’, where managers share a set of ideas to respond to the uncertainties they face. This is also a major reason why most incumbent firms find it difficult to reshape their industries through innovating in their business models. Managers need to experiment with their business models.

For example, they might set up a system whereby the traditional model operates alongside the new one until the latter proves completely effective. One of the biggest mistakes that management can make is to not design its firm’s business model for profitability. To achieve greater profitability, there is a need for an increased focus on the business model.