An MBA perspective on business models
Business Models brings many familiar management models to bear on the elements of a business model. Author Allan Afuah examines effective business model design by exploring internal and external components as well as industry factors. He looks at market positioning , competitive landscape, resources and capabilities, pricing, revenue options, financing, and planning activities related to effective business model design.
Many of the elements Afuah covers (costs, resources, partners, revenue model, customer segments) map well to Alex Osterwalder’s Business Model Canvas. However, this textbook doesn’t cover distribution channels, which are a key element of the Business Model Canvas. Afuah approaches business models from corporate strategy, functional, operational and financial perspectives, but does not spend much time on marketing and sales. Unlike Osterwalder’s Business Model Generation, Business Models won’t walk you through creating and testing a business model–it’s more like an owner’s manual than a cook book.
For Afuah, “a business model is a framework for making a profit” and each element of the business model is evaluated in terms of its ability to contribute to that goal. To make a profit, a firm must either offer its products at a lower cost than its competitors or occupy a premium position in the market through differentiation so Afuah begins by examining positioning.
A firm can position itself as either a low-cost provider or as a differentiated by features, reputation, physical location, timing, and other factors. Low-cost positioning is typically the result of optimization around cost structure, supply chain, and operations. Differentiation is in relation to competitors and benefits customers perceive as important.
The book illustrates positioning relative to competitors along dimensions that are relevant to customers using multi-dimensional scaling. The customer’s perceptions of benefits form the X and Y axis of a graph; products and companies can then be graphed for relative position.
Pricing and Revenue Models
Pricing is an important consideration because positioning alone does not provide the means necessary for a profitable business model. Afuah covers common pricing strategies such as skimming and penetration along with rationale for price cuts and increases. Although value pricing pricing at the customer’s reservation price is ideal, its usually possible, so many companies default to cost-plus pricing.
Once a pricing strategy has been established, sources of revenue can be identified:
- direct product or service sales (product sales, subscriptions, fee-for-service, markup, commission)
- post-sale services
- indirect content sales (e.g., advertising is sold to create media like TV, radio, and magazines)
- product financing (e.g., automobile financing, GE Capital)
- collect-early, pay-later financing (e.g., Dell Direct where the customer pays first and then the PC is manufactured)
- intellectual property royalties (e.g., licenses)
Afuah covers customer segmentation to ensure a match between revenue model and market. Consumers can be segmented by demographics, psychographics, behavior, geography or a combination of factors. Selecting the right target involves asking questions about market size, affordability, competition (Five Forces), and internal readiness.
Internal and External Factors
From an operational perspective, examining the value chain within which a company exists is important. The concept of a value chain spans the Partners and Activities boxes on the Business Model Canvas. Reviewing the value chain can give insight into cost reduction opportunities as well as new value creation possibilities.
When discussing resources and capabilities, which are equivalent to the Key Resources box on the Business Model Canvas, Afuah uses the VRISA (value, rareness, imitability, substitutability, and appropriability) framework as an evaluation tool. A higher rating on these attributes increases the chances of a profitable business model.
To successfully execute on a business model, organizational structure, systems, processes, and people need to be aligned. Changing a business model means changing your operating model.
Business Model Evolution
Afuah presents an interesting framework for business model evolution: block, run, and team-up. Blocking consists of defending a firm’s business model from competitors; running requires continually innovating a business model to stay ahead of the pack; teaming-up involves finding complementary partners to strengthen a business model. In all cases, companies must innovate. Innovation and change can be incremental, radical, disruptive, systemic, or dynamic. Disruptive innovation is best described in Clayton Christensen’s The Innovator’s Dilemma. Systemic change is a value chain perspective that seeks to take into account all consequences and impacted elements of innovation. Dynamic change describes the idealized scenario of “curve-jumping” where, once a technology or product matures, a new one is waiting to take its place.
Like the Business Model Canvas, Afuah calls out costs as a separate category to evaluate. He advises using a value chain, value network, or value shop approach to assess cost structure. A value chain portrays the flow of resources that the firm participates in and allows the firm to understand its role in the final customer deliverable. A value network depicts the broader ecosystem of players involved in the industry. A value shop can help identify the range of services and value that an organization provides.
Afuah identifies a set of five cost drivers ordered by stage of the business system: research & development, product design, manufacturing and operations, marketing and sales, and distribution. Each cost driver is affected by the industry the company is in along with internal considerations.
The Seven C’s
Because “too often, firms spend time performing strategic planning without really understanding the reasons behind success or failure”, Afuah includes a “Seven C’s” framework. These seven components form the backbone of the book and are elaborated in each chapter.
- Competitive Position – is the firm lowest cost or differentiated?; what market segments are served?; what are sources of revenues?; what is the pricing model?
- Connected Activities – what is the value chain?; how does it contribute to profitability?
- Competitive Forces – how do Porter’s Five Forces play into profitability?; what other macro environmental factors are relevant?
- Critical Industry Value Drivers – what drives cost?; what influences differentiation?
- Capabilities – VRISA analysis
- Change and Sustainability – how does the firm innovate its offerings and business model?
- Cost of Activities – what are primary costs and how can they be reduced?
The book also covers various financing and valuation models for determining the funding required for operating a business. To finance a business, a business must choose the right type of investor and present a convincing case for funding. Afuah includes some considerations for selecting the timing and type of investment to seek.
In terms of planning, Afuah advises using a standard strategic planning process and using the Seven C’s model as the basis of the business plan.
The book concludes with a set of ten in-depth case studies which dissect the business model challenges of companies including Borders, eBay, and LEGO. Although not targeted at startups or business model reinvention specifically, the book uses many familiar management theories as building blocks of a comprehensive business model. As an academic treatment of business models, it works well and provides many diagnostic and discovery tools. It’s a thorough workbook for evaluating all aspects of a profitable business model.