Back to school: Everything you need to know about... Business models

By Christoph Zott Saturday, 01 July 2006

Business models are essential for companies. Entrepreneurs may be more familiar with the concept of starting with a clean slate and having to build a business from scratch, but that doesn't mean that big companies shouldn't bother.

When it comes to business models, CEOs should think like entrepreneurs. Companies should put business models at the top of their agenda. Not only will they focus a business on its strengths, they will also enhance its potential for value creation.

What a business model is - and what it isn't

A business model is a template to do business. It sets out how a company transacts with its external constituents, whether they are customers, suppliers or partners. It describes the broad architecture of how a firm connects with factor and product markets in order to create value. In that sense, it is not strategy 'a la Michael Porter', but it is part of the strategic arsenal of a company and can complement other tools, such as pricing, product market positioning and market entry timing.

The promise of the business model

Companies should not be complacent. New players could come up at any stage and established rivals make inroads where least expected. This is why business models are also relevant for large companies: it helps them to stay fresh and ahead of the competition. During a recent executive education programme at INSEAD, a well-known software company sent its top executives to work on the company's business model.

How to choose a business model

Designing a business model is about creating value - how to weave together partners, customers, suppliers and team to generate maximum value. Novelty in business model design is often the key, as demonstrated in Marks & Spencer (M&S) v Zara (see case below). The 2002 case explores the conundrum of how M&S underperformed compared with companies, such as Zara, that didn't have the product innovation record of M&S. The answer lie in the fact that Zara adopted a novel business model: the firm aligned all its processes with outside partners in such a way that new designs make it into the shops within five business days. The same process at M&S then took a year.

Enlarging the pie

Creating new business models is great for value creation. Developing a new model means opening new markets, as in the case of eBay with online auctions or Dell with direct customer sales of customised computers. It ensures that the 'pie' is enlarged (a new market) before being divided up - generally to the innovator's advantage (first mover, ahead of the game).

Part of the process

Apple and its iconic iPod are a good example of how a product and a business model can enhance each other. The company devised a great product and combined it with the well-rehearsed 'razor and blade' model whereby a part of a product is dependent on other parts made from the same company, generally at a high cost. In the case of iPod, customers can download music only from iTunes at 'a dollar a tune'. The website is now the single most successful website for music downloads.

Changing a business model

There are many examples of companies that changed their business model. Webraska (see below) is a well-documented case of a company that turned from turnkey solutions provider to software house. Similarly, Dell experimented with retail distribution in the 1990s before reverting to direct sales. Such changes may require an overhaul of a company's structure and profound rethinking of its organisation.

Christoph Zott is associate professor of entrepreneurship at INSEAD Fontainebleau