Innovation is often widely thought about as using technology to create new value. However, innovation is much more than exploiting technology. Most innovations, even when related to technological change and especially those of the disruptive nature, require a strong dose of business model change or innovation. A lead researcher at IBM once said, “For us, innovation is our ability to create new value at the intersection of technology and business”. Further, some of the most impactful innovations have been business model innovations. A few examples include; Walmart, Dell, Metromile, Netflix, Apple iTunes and Apple Store. Against this backdrop, understanding the options and steps to create Business Model Innovation is important for organisations. Business Model Innovation can be used either in creating a new business or re-inventing an existing business.
Creating a new business
Creating new value via product or service more often than not means creating a new business model as part of the innovation. In creating new business models, organisations should consider using a 5-step process to maximise the probability of success.
(1) Identify Value Creation. Whilst many approaches define value proposition as part of business model design, a better approach is to isolate the exercise of identifying the value creation. This way there can be focus on truly understanding how the customer is going to benefit and what will make the customer buy in to the idea of a product or service ahead of similar offering or potential substitutes. Additionally, the need to explore multiple business model options (as discussed in step 2 below) is another reason why the value proposition stage should be separate from the business model design.
In identifying value creation, if the innovation is driven by technological advancement or internally derived value denial, then the value proposition must be validated with the target customer group.Doing a lot of work screening an idea and validating the value proposition at this early stage will save a lot of effort and perhaps pain further down the line. This need is emphasised by our InnoScreen methodology for objectively assessing innovation projects.
(2) Explore Business Model Options. The best business models emerge out of a structured selection approach of examining options. When looking to generate business model options, an organisation must bare two critical factors in mind – the creation of a sustainable competitive advantage and economic viability at scale. A great business model must be able to hand the organisation some sort of competitive advantage, preferably one that is sustainable, and generate profit when scaled up. Despite knowing what constitutes a great business model, unfortunately, there is no fixed formula for generating one. However, organisations can take one of the below approaches.
One approach is to scan the competitive environment, either in similar markets or adjacent markets, understand the business models that are being used to deliver similar value propositions, evaluate the strengths and weaknesses of these different models, then improve or reconfigure them to develop a new business model that delivers sustainable competitive advantage and economic viability. This is exactly what Wal-Mart did when it took the supermarket model and applied it to combine supermarket and retailing, whilst building a highly cost effective supply chain. This helped it to deliver a wide variety of goods that cuts across both the supermarket and retailing segments, at lower cost than competitors.
A Second approach is to consider how existing concepts and technologies can be brought together to deliver a different business model to the existing market. This is what Uber did by combining the concept of a gig (mobilising freelancers on an ad hoc basis - which had already been pioneered 9 years earlier by Liveops) and the power of technology (smartphones) to create a business model that delivers and improves an existing value proposition – taxi ride.
(3) Assess Risk & Select Business Model. A sobering statistic is that a large number of innovations fail.On the product side, the number is as high as 80%. The good news however, is that probability of success can be increased by good risk management. A precursor to managing risk is to understand the risks inherent in the business model options. In the Wide Lens, Tuck Business School Ron Adner’s classification, provides a good classifications of potential innovation risks.Ron identifies three classes of risks that innovators must be aware of.
The first is execution risk, which relates to the ability of the organisation to deliver the actual promised value proposition and capture the value at the end. This risk is characterised by the competencies and resources of the organisation itself and its ability to pull of what has been envisioned. Does the organisation possess the competencies and resources to deliver the value and successfully compete in the target market via the chosen business model?
The second is co-innovation or interdependency risk, which is related to the extent that the innovation depends on other players or co-innovators. For some innovations to be successful, they require other players outside of the organisation to satisfy certain commitments to the innovation within a required time frame. An example of interdependency risk in play was Nokia’s race to develop the first 3G phone in 2002. Whilst Nokia focused on execution in reaching its target with the 6650 phone; promising fast data speeds, video streaming and all the frills, the content providers and data networks would not be ready to provide infrastructure and service to enable 3G performance until more than a year later. This resulted in Nokia missing significant revenue and profit targets.By the time the entire 3G ecosystem was ready, other players were able to launch similar 3G phones, leaving Nokia with very little advantage in terms of pioneering. The more co-innovators there are, the higher this class of risk.
The third is adoption risk, which is related to the extent to which other parties in the value chain must adopt the innovation before it reaches the final consumer. An example that crystallize adoption risk is a company that developed a new generation of electrical switches and sensors that could dramatically reduce energy waste in buildings and deliver substantial savings to occupants. However if these products require new training, upskilling and installation requirements, building contractors, electricians and a host of other actors in building industry may refuse to adopt and offer these products to their clients.Under this circumstance, the value of these innovations would never be realized.
All business models should have their specific risks in each of the above classes identified. Ideally, all business model options should be tested via business experiments to understand which risks can be minimised, controlled or eliminated. Organisations that have the resources and time can go down this route. However, if there are either time or resource constraints to run multiple business experiments, the identified risks should be qualitatively assessed. Empirical data can be used here as a source of understanding the likelihood and potential impact of each type of risk. Once the risks are assessed from a view point of potential impacts and possible mitigations, the organisation should then decide which business model to take forward. Decision on selected business model may not necessarily be based on lowest risk, but instead should be a combination of risk, economic viability and competitive advantage.
(4) Run Business Experiments. Having selected a business model, the assumptions and risks should now be tested for validation and potential mitigation respectively. Business experiments are particularly crucial for innovation, as they help to uncover biased or misplaced assumptions, validate credible assumptions and resolve risks, where possible. Whilst it may be desirable to keep business experiments as short as possible, the scope and length of business experiments should be context specific.In other words, there should be no prescription about how succinct or detailed a business experiment should be. Since the aim of the experiment is to test assumptions and resolve or identify how risks can be managed, experiments should be done until either there is sufficient evidence for a positive outcome or it becomes clear that the business model is not viable. However, experiments should be highly focused and targeted to necessary internal stakeholders, value chain participants and intended customer group. Where applicable, a prototype should be built to test and understand user perception. By working with potential customers and understanding their perception, prototypes should be able to provide insights into uncertainties and the learning can be used to make modifications that could be key to innovation success.
(5) Roll-out. Roll-out is the final stage of the innovation process. There two issues organisations must pay attention to regarding rollout.
The first issue is to decide what scale of market entry should be taken. Empirically based studies have generally reported that new ventures with aggressive entry strategies were more successful than ventures with less aggressive strategies. Despite this, there remains huge risk attached to an aggressive large scale entry. An overly optimistic estimate of demand may leave an organisation over invested in assets and resources. At the other end of the scale roll-out on a small scale may leave an organisation susceptible to quick followers, where the competition can respond with an imitation and steal significant market share. As such, there is no one size fits all when it comes to entry scale. Consequently, if an organisation cannot be fully confident of demand projections to make a large scale entry, then what should be considered for roll out should be based on the industry’s equivalent of minimum efficient scale. With this approach, the entrant can rapidly scale up if it becomes evident that there is scope for aggressive growth in the market.
The second issue is preparedness for roll-out.Whilst roll-out is the final stage of the process, the foundations for a successful roll-out must be built into the whole process from the moment the value proposition was agreed. Both internal and (to the extent that is possible, without giving away competitive intelligence) external stakeholders as well as co-innovators must be engaged and aligned with both the value proposition and the business model. The fact is successful commercialisation is not a given, even for the most impressive innovations and this is why such engagement is necessary to ensure, where relevant, all necessary licenses, regulatory approval and any other internal or external support required for successful rollout are in place.
Re-inventing the business
By definition, business model is the relationships and activities relating to how a company gets the value created from its centre of operations to its customers. In essence, it is the path to value capture from the origin of value creation to the target customer. There are 3 areas that an organisation can exploit whilst trying innovate by re-inventing its business model.
(1)Targeting Current Unserved Consumers or Non-consumers
Unserved customers or non-consumers exists for every organisation’s product or service, either because the organisation is not targeting them and the value proposition is not obvious to them or because there is something in the price-performance dimension that makes them stay away. Whatever it is, unserved customers and non-consumers represent a significant segment to any business and organisations can re-invent their business model to access this group. An example of an organisation that has continually and successfully target unserved customers is McDonalds. From its origins as a fast food joint with a large focus on meat based and arguably unhealthy diet for adolescents and adults, McDonalds has continually modified and added to its offerings to target unserved consumers, including; kids, vegetarians, vegans and those that are more health conscious. Another company that has re-invented part of its business model in this area is GE. GE targeted non-consumers, focusing on the price-performance dimension of its ECG machines. GE wanted to gain access to a significant pool of non-consumers in rural India healthcare centres and other developing countries where a lot of people who required the performance of its ECG machine could not afford the value delivered via its early generation $10,000+ EGC machine. To serve this non-consumers, in 2005, GE launched a striped down portable version of its ECG machine for less than $1000. This gave the company access to a sizeable market of non-consumers. This type of innovation, which focuses on the late C.K Prahalad’s Bottom of The Pyramid concept is aligned with what the late Clayton Christensen, along with Efosa Ojomo and Karen Dillon describes as Market Creating Innovations, represents huge market opportunities for organisations. Consequently, whilst organisations should ensure they are satisfying their current customers, they should also continually explore where they can use business model innovation to target unserved customers or non-consumers.
(2) Improving Supply Network
Organisations can re-invent their business model by making innovative changes to the supply chain. Toyota’s Just in Time manufacturing, which is partly credited for its overtaking General Motors in 2008, is a well-known example. What Toyota did was business model innovation that resulted in low inventory costs and elimination of waste via a highly efficient production line. However, to make this possible, Toyota had to develop a fast, efficient and reliable network of suppliers thus making its supply chain highly responsive to execute its just in time manufacturing model.
Another avenue for using supply chain to innovate is by leveraging the competence of another company in order to improve product or services or widen the scope of products or services provided to the market. This can either be by working with a company in the same market (coopetition) or collaborating with a company in a different market. The collaboration approach is what Unilever and Pepsi used to deliver the innovative bottled ice tea. Lipton, which is a Unilever brand, brought the decades of experience, resources and brand recognition in the tea market, whilst Pepsi contributed the bottling expertise and distribution network of bottled drinks.
(3) Modifying the Value Proposition
Organisations can re-invent their business model by making slight changes to the value proposition that they deliver to the customer. This type of business model innovation can include moves such as bundling and unbundling. Bundling is an approach where, as an example, a company add services to currently sold products, to either cross sell the service or bundle the service with existing products. This is an approach to business model innovation that typically IT hardware companies such as HP, Dell and IBM have exploited. These companies have all successfully bundled IT solutions service to their offering up to the point that services now represents a large proportion of their yearly revenues.
By adopting the option relevant to your organisation's context during business model innovation, organisations should have set themselves up for a successful outcome.