Change the Model, Not the Business

Andrew Campbell, Director of the Ashridge Strategic Management Centre, explains how changing the model can bring greater benefits than changing the product:

The focus of innovation in most companies is on new products or new market segments. Commonly used initials such as NPD (new product development) and BD (business development meaning finding new customers or new markets) point to the way most companies think about innovation. Yet, there is evidence to suggest that the big money lies in a different kind of innovation – business model innovation.

A recent Economist Intelligence Unit global survey of 4000 managers revealed that 54% believe that business model innovation is more important for success than product or service innovation. IBM found that companies whose operating margins had outstripped their competitors’ over the previous five years were twice as likely to emphasise business model innovation, rather than product innovation or cost reduction. So what is business model innovation?

Classic examples of business model innovation are provided by on-line businesses, such as Amazon or Egg. Amazon started by providing a better business model than the typical book shop. Amazon could offer a wider selection of books and deliver books to your door (rather than expect you to make another trip to the book shop to collect them) at a significantly lower price. This was because Amazon’s business model cut out the expense of high street retail locations and the knowledgeable people needed to staff them. Egg did the same in banking, enabling customers to complete their banking transactions without having to visit a branch and at any time of day or night. The root of their successes was not product or market innovation. It was innovation to operating activities enabled by a new technology, the Internet.

So, if business model innovation is the new frontier, how can companies get better at it? There are five dimensions to the operating aspects of a business model that can be the focus of innovation. First is the revenue model. The Evening Standard in London innovated by changing from a ‘pay per copy model supported by advertising’ to a ‘free model dependent on advertising’. While this innovation was driven by the success of the free paper Metro, it was a significant innovation for The Evening Standard. Academic research can be funded through government sources, by raising money from industry or foundations, by running courses or by patenting and selling the results of the research. Different research centres have chosen different revenue models despite having similar objectives. The question innovators can ask is “What different sources of revenue are available to us, and could we build a business with a radically different mix?”

The second source of innovation concerns the size of the company’s investment in assets or activities. Enron, the infamous electrical utility, was famous for its asset-light strategy, which worked within the energy industry, but failed in other sectors. Its leaders then innovated inappropriately by creating off balance sheet activities to hide losses. The question companies can ask is “what would happen if we doubled or halved our investment in this activity (e.g. research, sales or marketing) or these assets (e.g. working capital, factories, sales offices)?”

The third source of new thinking can come from the boundary between a company and its suppliers. Many companies are experimenting with outsourcing activities that used to be within the company. Pharmaceutical companies, such as Pfizer, now get basic research on new compounds done by small, third party research centres. Virgin money started out using an Australian bank to do all of its operating activities. It is also possible to redesign the relationship between the company and suppliers. The UK government’s PFI (Private Finance Initiative) changed the relationship between the government and the contractors who build hospitals and schools. The objective was to transfer the risk of cost overruns and contractual problems to the private sector. The question companies can ask is “What would happen if we move the boundary or if we create a completely new relationship with our suppliers and business partners?”

A fourth area for innovation is in organisation and people selection. The software firm FI succeeded by focusing on women who wanted to be hands on mothers while still keeping a job. They designed jobs that could be done from home. The consulting company Eden McCallum tapped into the large number of capable executives and ex-McKinsey or BCG consultants who had created portfolio careers and wanted to do some consulting work as part of their portfolio. Apple has succeeded in three industries – computers, mobile phones and music players – by centralising strategy and product development. This is in contrast to the typical organisational model based on decentralised business divisions in companies like Philips or Samsung. The question companies can ask is “What would happen if we hired different kinds of people or if we radically centralised or decentralised?”

The fifth source of innovation comes from technology and processes. Many companies have transformed their costs by re-engineering their business processes or, like Amazon and Egg, by bringing in new technologies. The questions companies can ask are “Is it possible for us to reduce the time or cost of this process by half or by ninety percent? What use can we make of new technologies, such as the Internet or printed manufacturing or nano-technology?”

Since success seems to be more closely correlated with improvements in business models than improvements in products, managers need to learn a new skill – Business Model Innovation.

Andrew Campbell is author of “The Growth Gamble” and ten other books on strategy and organisation. He directs a new course at Ashridge Business School titled Business Model Innovation.