Chapter six

What’s a Business Model?

A business model is an explanation of how value is created for customers, and making it explicit
can help us focus on how we can capture this in innovation. For example:
 A theatre uses scripts, actors, scenery, lighting and music to create a theatrical experience
which the audience values.
 A car company mobilizes an extensive supply network to bring together components and
services and assemble them into a car which the customer values.
 A supermarket procures various food and non-food products and makes them available on its
shelves to customers, who can collect them conveniently. They value this and are pre-pared
to pay more than the supermarket paid for the items because they value the service this
collection, storage and display offers them.
 An insurance company provides a guarantee of payment to offset the cost of losses owing to
accidental damage, theft or other incident, and customers value the peace of mind which this
brings and are prepared to pay for it.
 A smartphone retailer provides a platform across which communications, entertainment and
personalized applications traffic can flow and customers are prepared to pay to own or rent
the device for the functions it offers them.
Every organization, public or private sector, offers some kind of value proposition a product or
service or some combination which end users value. In commercial markets this is something
they are prepared to pay for, but in other contexts, such as the public sector, services like
education, welfare and healthcare are similarly ‘valued’ by those who consume them.
Innovation, as we have seen, is all about creating new or better ways of delivering such value
and so if we are concerned to capture value it makes sense to begin by making explicit the model
we are using to create it and to check whether it does the job well. And importantly, whether it is
sustainable in the long term or whether it is vulnerable to replacement or challenge by someone
else the idea of business model innovation.
6.2 Why Use Business Models?
The purpose of a business model is to provide a clear representation of where and how value is
created and can be captured. That’s useful for a number of reasons:

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  It provides a roadmap for how an innovation can create value. It won’t just happen; it
needs a framework.
 It provides a way of sharing the idea with others, making the business vision explicit.
That can be useful for entrepreneurs trying to pitch their ideas to venture capitalists or to
innovation teams trying to win resources and support for an internal innovation project.
 It offers a helpful checklist of areas to consider in making sure the idea and the route to
creating value with it is well thought out.
A close relation of the business model is the business case, The idea of a business case is
essentially constructing a story with enough detail about what we are trying to achieve, how we
will do it, for whom, when, what the costs and rewards will be, etc. In other words, it is the story
about the underlying innovative idea and how we are going to implement it. A business case
without a clear and robust underlying business model is likely to be limited in its impact.
Think of any innovation and you can see it as a story which has meaning for people. Henry
Ford’s was all about ‘a car for Everyman at a price everyone could afford’. George Eastman’s
was about putting photography in the hands of ordinary families: ‘You point and shoot and we’ll
do the rest
These examples have one thing in common. Their innovations weren’t a single idea but a
detailed and well-constructed story which gave the idea meaning and direction and helped
communicate it to others. Creating value social or commercial depends upon getting a good story
and telling it in a compelling fashion. Importantly it is not just a matter of telling the story to
potential customers. A key part of any entrepreneur’s task is sharing his or her vision with others,
to get their support, energy and commitment to the idea. Later the process involves pitching for
resources and again this requires compelling storytelling. And each time the story is told it is
refined and improved, embellished with new ideas and shaped by feedback and questions from
the audience.
A robust business model, like a good story, doesn’t at just happen; it is shaped and developed in
the process of telling and retelling. The plot emerges, the characters take shape, the scenery
moves and each time we tell it the story is refined and changed. Explaining It to others gives us
new insights about what to add or take away. People ask questions or make suggestions which
change the way the story unfolds the next time we tell it. They pick up the threads and spread the

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story, telling it to others so that the idea gradually takes on a life of its own and starts to make
sense in other people’s lives. And as it does so it becomes stronger and clearer.
6.3 What’s in a Business Model?
Value creation doesn’t just happen. It is the result of a structured process which involves:
 A value proposition: what is valued?
 A target market: by whom?
 A supplier: who?
 A set of activities: how?
 A representation of the value: how much?

6.4 Business Model Innovation

Business model innovation is about creating new models or changing existing ones to maximize
the value created and returns it to the organization which created it – capturing value. So,for
example, a pharmaceutical company spends around 20% of its sales on R&D, funding extensive
laboratories and facilities to create new drugs. It pays for testing and approvals, for manufacture
and packaging and for marketing across a global network.
People value the health benefits which a drug gives them and they or the agencies (insurance
companies, governments, etc. which represent them) pay for this. The flow of revenue funds the
direct costs and generates a surplus which can be reinvested. They can invest in refining the
business model, adding improvements to make it work better. But they can also change the
fundamental approach as is now beginning to happen in that industry. A combination of rising
costs and problems with tight regulatory frameworks have slowed down innovation and reduced
the chances of finding blockbuster drugs successfully to market; instead, the model is shifting to
one where research is increasingly being carried out by small entrepreneurial labs working in
rapidly changing technological fields like genetics and biotechnology.
6.5 Generic and Specific Business Models
In reality, there are some generic business models; Table 6.3 gives some examples. Once
established, there is competition about finding new and modified ways of deploying these
playing with the ‘4Ps’ in terms of streamlining or changing processes, modifying the
product/service offering or changing the positioning in new markets or in the story we tell about
our offer
For example, the basic airline business model is that people pay for the service of transportation.

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Over the years we have seen competition amongst airlines based on incremental Innovations in
the service offered different destinations, different catering, different aircraft, different seating
and sleeping options, provisions of lounge accommodation, transportation to/from the terminal,
etc. Process innovations have reduced the costs and improved the flow in areas like check-in,
reservations, fuel efficiency, terminal turnaround times, etc. Position innovation has segmented
the market, first into different classes and experiences and, in recent times, radically opening up
the market through low-cost short-haul flying. And this has led to a paradigm innovation: from
being seen as a luxury service for the few flying has now become the possible mode of travel for
the many, rather as Henry Ford changed the earlier transport paradigm with his Model T.
The generic pattern of innovation is played out by many different players each of whom is trying
to compete by modifying some aspect of the business model through innovation. So transatlantic
carriers offer flat beds or different customer lounges. Low-cost carriers compete on price,
translating their savings through process innovations into lower ticket prices. Niche airlines offer
services to remote locations or serving specialist segments, for example helicopters serving oil
platforms.
We can see a similar pattern of ‘generic’ business model innovation strategies routes along
which there may be rich opportunities for entrepreneurs to rewrite the rules of the game. For
example:
User-driven instead of supplier-led, in which the role of active and informed users is
reshaping the trajectory of innovation.
Servitization, in which manufacturing operations are increasingly being reframed as service
offerings. As we’ve seen, the aircraft engine maker Rolls-Royce redefined its business model
as ‘power by the hour’, recognizing that what its customers actually valued was the provision
of power, not the engines themselves. It now charges users for usable hours of power
Chemical companies are increasingly looking to provide rental models in which they offer
services to support the effective use of their products rather than simply delivering bulk
chemicals.
Rent not own, in which the value proposition moves to making available the functionality
rather than the asset. For example, people are beginning to move to renting music via
streaming services like Spotify rather than needing to buy record collections, while in city
centers the idea of bicycle and even car rental is displacing the need for ownership.

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6.6 Building a Business Model
Let’s look in more detail at how we could construct a business model as a representation of how
value is created and how we could best capture it. There are plenty of models for how to do this,
but they have the same underlying architecture, which can be expressed in a small number of key
questions:
 What? The value proposition.
 By whom? The supply side.
 For whom? The demand side.
 How? The key activities by the supply side to create value for the demand side.
If it is going to be robust then the ‘revenue’ from the demand side needs to be greater than the
costs on the supply side of doing it. Beyond that there are important questions about timing (can
we ensure the flow of resources out is supported by the flow of revenue in?) and long-term
sustainability. How can we protect our model so that others can’t instantly copy it, and how can
we develop our idea in the long term to counter other competitors coming in to try?
We can build the model in simple fashion; first, what is the core value proposition?
A. Value Proposition
Here we need to think about the features of the innovation and how it represents something new
which people will value over what they currently have. What differentiates it what is our unique
selling proposition (USP)? ‘Why hasn’t someone already done this?’ is often a useful question to
ask at this stage.
We may be reinventing the wheel or we may be trying to do something which others have found
to their cost is impossible! But we may also find that things have changed and we are now able
to do something which was previously impossible, for example the opportunities offered by
having GPS positioning in smartphones opens up a whole set of possibilities for location-based
services which couldn’t have been offered ten years earlier.
B. Target Market
Next, we need to think about the demand side. Who is going to value this? It’s important here to
think about targeting as precisely as we can, for example not just saying we will offer a bicycle
for rent in a big city but specifying for whom (tourists who want to explore, business people who
want to avoid congestion of public transport or taxis, etc.). And we need to think about how we
would reach those people which channels would we use to find them and make our offer clear to

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them? Online advertising? Point of sale little advertising stations where the bikes can be found?
Newspaper or TV advertising? Then we need to think about how we will interact with them: do
we have someone in a stall renting the bikes out personally like a shop or do we go for an online
booking and self-service unlocking model?In other words, we need to think hard about the
specifics of the demand side and how best to make sure the value we are offering in our
proposition reaches and is appreciated by the target market.
C. Creating and Delivering
We need to create and deliver it. So we also need to think hard about the supply side. What are
the key activities we’d need to do to be able to offer our value proposition? For example, we’d
need to purchase or build a fleet of bikes, we’d need to distribute them around cities and we’d
need to track them so we know where they were. We’d need to maintain them and make sure
they were available and fit to use – and we’d probably need some kind of emergency response
service in case of accidents or breakdowns. We’d certainly need a way of taking money for the
bikes! We might not choose to do this all ourselves – we could partner with others
For example local shops who could offer the bikes and take the money on our behalf, or a local
bicycle repair shop to undertake the maintenance side of things for us. But we’d need to build
this network and manage the key relationships in it. In other words, we need to think equally
hard about the specifics of the supply side and how we are going to deliver the best version of
our value proposition.
D. Value Capture
Next, we need to think about how we will capture the value from this. What are the different
sources of ‘revenue’ or reward which flow to us from people in our target segment who value
what we offer them? This is certainly the money they are prepared to pay but it may also be
information useful feedback about how to improve our offering. We can also build up
information about the kind of people who are using our offering and use that to help design other
products and services for them. (For example, Amazon and Google not only provide a service
but also gain huge understanding of the people consuming it which can be recycled into a variety
of other innovations.)

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 E. Cost Structure
The other side of this equation is, of course, the resources we need to spend – time, energy,
money in creating and delivering our offering: the cost structure. What are these and how do
they break down? How much of it is fixed and how much varies with the volume of demand?
When do these costs kick in – at the start-up stage or through the operation of our model? We
also have to think about the timing of these flows and make sure the balance between what we
spend and what we get back is positive and we don’t spend all our resources before we get
something back to help refill the tanks!
F. Sustainability
Finally, we need to think about the model in the long term. How easy is it for someone to copy
right now and where are the places where we can protect and defend ourselves from
competition? And looking ahead, how could we develop the idea further to add new kinds of
value, or do it for more people on the demand side, or with different players on the supply side?
In other words, how would we go about business model innovation?

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