Note: This article originally published by my colleague David Tang.
Most tech startups fail because they lack a viable business model. Even for enterprises with established business models, they often need to revisit and innovate on their business models.
To understand the essence of a successful business model, first, let’s look at its 4 core components:
- Customer Value Proposition,
- Profit Formula,
- Key Resources, and
- Key Processes.
Customer Value Proposition
A successful company helps its customers get a “job” done. Doing the “job” — this is the “value” the business is delivering for its customer. For instance, Google helps customers with the job of finding information online. McDonalds helps customers with the job of feeding a greasy appetite quickly and cheaply. Flevy helps customers with the job of finding business documents they need for work.
High customer value proposition is correlated with
- Importance of the job to the customer;
- Low customer satisfaction with alternative options in the market; and
- Higher quality (or lower price) of your product relative to alternative options.
It’s great to offer customers great value, but, as a business, the economics still need to work in your favor. We need to make money! This is the profit formula.
The profit formula is the blueprint that defines how the company creates value for itself, while providing value for the customer. The profit formula consists of numerous economic components, including:
- Revenue model
- Cost structure
- Margin model
- Asset turnover and velocity
Many tech startups fail because their “business models” lack this critical component: the profit formula. They aim to amass an impressive user base, but don’t have a practical way of making a profit from its users.
Key Resources and Key Processes
A company must have access to the key resources and processes necessary to deliver its value proposition and profit formula. In other words, the key resources and processes describe how value will be created for both the customers and the company, itself. For instance, for a consulting firm, the key resources are its people and its key processes are people-related (e.g. training, recruiting programs).
Key resources are assets, such as people, technology, products, facilities, equipment, channels, and brand required to deliver the value proposition to the targeted customers. It must also have the key processes to properly leverage these resources. Key processes of are usually characterized by operational and managerial processes that allow them to deliver value in a way that is repeatable and scalable. Processes can take the form policies, metrics, and culture, as well.
As alluded to, even with a concrete business model, there may come a time to modify and innovate it. So, the question is…
What circumstances require business model innovation?
There are five circumstances that often require business model innovation. They can be categorized into Opportunities and Needs.
Opportunity #1: Disruptive Innovation
The opportunity to address, through disruptive innovation, the needs of large groups of potential customers who are shut out of the market entirely because existing solutions are too expensive or complicated for them.
Opportunity #2: New Technology
The opportunity to capitalize on a new technology by wrapping a new business around it or the opportunity to leverage a tested technology by introducing it to a new market.
Opportunity #3: Focus on Unmet Need
The opportunity to bring a focus on a customer need that currently is unmet. This is common in industries where companies focus on products or customers segments, which lead them to refine existing products more and more.
Need #1: Low-end Disruptors
The need to fend off low-end disrupters. I.e., these are new entrants that are low cost, niche players.
Need #2: Shifting Competitive Landscape
The need to respond to a shifting basis of competition. It’s simply inevitable that what defines an acceptable solution in a market now will change with time, leading core market segments to commoditize.
Oftentimes, barriers exist that prevent a shift in business model. A barrier is not necessarily overt political opposition to a shift in way business has been done. Rather, with time, the fundamental understanding of the core business model often fades into institutional memory. These are considered institutional barriers and may be financial, operational, or strategic in nature.
To combat institutional barriers to business model innovation, many companies decide to launch a separate brand or business to adopt the new business model. It’s best for the new entity to be based in a completely separate office. This way, it won’t be mired down by any of the parent organization’s habits.
Changing an organization’s business model is a BIG change. We need to be patient — patient for profit. Successful companies usually revise their business models four or more times on the road to profitability.
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To be competitive and sustain growth, we need to constantly develop new products, services, processes, technologies, and business models. In other words, we need to constantly innovate.
Ironically, the more we grow, the harder it becomes to innovate. Large organizations tend to be far better executors than they are innovators. To effectively manage the Innovation process, we need to master both the art and science of Innovation. Only then can we leverage Innovation as a Competitive Advantage, instead of viewing Innovation as a potential disruptive threat.