This post is an extract of my forthcoming book on business model innovation. The innovation book looks at why business model innovation is needed and how it works. You can read more about it here. These posts are early drafts of planned content and I’m putting them out to get feedback. Please do comment below, or subscribe to these pages to get each new section as it is published. In today’s post, we will be looking at finding opportunities in this new world.
Now we are going to dive into the theory a little bit to understand when and how companies have to innovate their business models.
The above diagram shows how business models are born, grow, mature, and die. In many ways, a business model goes through the same lifecycle as a human does. To start with there is unbounded potential and not a lot of continence, sorry competence. By the end, the business model becomes equally incontinent as it stagnates into senescence.
Let us start by thinking about a very new business model. Most of the time, new business models arise in response to some change in the market, driven by either social or technological change.
Entering the Market
An entrepreneur sees an opportunity to enter the market, and from some sort of insight, he decides that he or she is going to do something different. The result of this is a new business model.
Typically at this stage, he will think of himself to be fairly unique, and the business model may be. However, the market opportunity that has been opened up is not. A good way of thinking about this is imagining that a tall tree has fallen in a forest. As it falls, it has crushed several other trees and formed a small clearing. With the new sunlight seeds of many types of plants, all germinate at once. There is a mad scramble for sunlight.
It is the same for entrepreneurs. For almost every market opportunity, even quite bizarre ones, there are many entrepreneurs who see the possibility. They enter the market with a variety of business models. Some will be unique. Some will use as a template business model adapted from an existing or adjacent market.
Survival
What we see then is a Darwinian fight for survival. Darwin talked about survival of the fittest. He did not talk about the survival of the best. So a business model may seem to be highly effective, but it loses out to competing business models. One of the key reasons for this is competence in execution. Other reasons are market distortions. For example, one business model owner had access to political power that can restrict the operators of other business models. There also seems to be a fair amount of luck involved.
From talking to scholars in the field, there seems to have been very little research done in this area. What we can see empirically is like caddis fly larvae, most innovative business models at this stage die a death along with the startups that engendered them.
As the startups look at each other and get a sense of what works in this new market, there is a slow focus on a relatively small number of business models. Again, we don’t have detailed studies of emerging markets, but it seems that at an early stage there are just a few business models remaining, with perhaps 10- 20 companies running them.
There is a sense in the industry that these are the best way of doing things.
Convenient Illusion?
Is this actually correct, or is it a convenient illusion? There are huge advantages to an industry in consolidating down on a few business models. It makes companies more comparable which enables greater capital investment. Similarly, by being structured and operated in the same way, there is a larger pool of workers available to the companies, and customers find it easier to understand the companies and their offerings. A new business model inevitably requires some customer education which reduces the conversion rate of the marketing and overall profitability. Finally, by concentrating down on a relatively small number of business models, it is easier to support the supplier base and undertake mergers and acquisitions. A company with a very different business model is difficult to integrate, and if it is kept as a stand-alone, then synergies from the mergers are even harder to achieve than normal.
The startups with their new business model have to overcome the chasm, which is where they leap from early adopters to mass-market adoption. This is more relevant to the innovation process as a whole. What is noteworthy here is the question. Are some business models better fitted to crossing the chasm than others? At the moment, we have no idea.
Mass-Market Adoption
Once the chasm is crossed and the business model achieves mass-market adoption, it’s rarely in a position to change much. The overall template is laid out. The skeleton exists, and the business model is not going to start swapping out bones to reconfigure itself into a new shape. Too costly. Too difficult. Especially, when there are far more interesting possibilities.
The first of these emerge from the market’s agreement that one or more business models are the fittest for the market opportunity. With the overall business model providing little opportunity for competitive advantage, the business focuses its efforts on improving the quality of its products and services.
Product Innovation
Product innovation falls under this part of the cycle. There is a huge flurry of new features. The amount of value that the customer receives rises dramatically year after year. There are multiple small steps happening in quick succession. It is a time for engineers and designers to let rip and chase down every possibility of customer happiness that they can find. Companies are, by and large, pretty good at this.
This happens across the whole industry as a company copies company there is a competitive race to improve the products to achieve the corporate goals of market share, brand dominance, or profitability.
But there comes a time when product innovation starts to run out of steam. As the companies work up the learning and experience curves, the returns that they can achieve for the same amount of effort reduce. It gets harder and harder to achieve an extra percentage point of product performance, efficiency or effectiveness.
So the company slowly starts to switch attention from working out how to make better products to working out how to make products better. This opens up an era of process innovation. This starts another period of frantic growth, as the company figures out how to extract ever more value from the business model. At this point, the business model can start to change as organizations see ways to become more effective.
Eventually, all good things come to an end, and most of the gains from process improvements are achieved.
Marketing and Sales
The next focus of the company is on the marketing and sales of its products. There is lots of slow incremental improvement of the marketing systems. The product goes from being sold based on its features and functional impact on the customer’s life to an emotional sale, focusing on how ownership of the product makes the customer feel. This is because many of the products by this stage in the business model lifecycle are functionally indistinguishable.
There are differences, whereas earlier in the business model lifecycle these were significant, now the differences between companies are smaller than the differences between how they segment products. It is hard to tell products apart. The low-hanging fruit has been taken. Marketing brings higher branches closer to the ground so that fresh fruit can be picked.
At a similar time, the company also starts experimenting with its value chain. Where can it find the additional value that it can provide to customers? Or retain for itself in the form of profits? The whole process from concept to the final consignment of the product to recycling is examined and poured (sic) over to find areas for improvement.
And then, the company and its business model are perfected, finalized.
Evolution
If the world doesn’t change, hasn’t changed, then life can go on indefinitely. With the company churning out profits at a consistent rate. For the lucky owners of Kongo Gumi (the oldest business in the world), this has been true for 1700 years. For a smattering of other companies – give examples, they have managed to do the same thing for half a millennia. In the case of others, such as Kodak, as it manufactured digital cameras, and the makers of HDD in the 70s and 80s they died in just a few years.
What determines the lifespan of a business model in the mature stage? Again we have no idea. Part of the problem is that we don’t have a standard language to categorize business models and maps the changes they make through their lives. We don’t have the data to do this. Though we could go through millions of corporate reports to do this, and we haven’t done it. So, again this is informed speculation rather than empirical evidence.
We’ve reached a point where the company starts a long slow decline. It knows how to do everything that it needs to do, and it does it well. Almost any change that could be tried has been considered before, by them or a competitor, and offers something worse than what it now achieves.
Decline of the Company
It is not worth experimenting with. The company, through a long period of trial and error, has found a local maximum. It has found the highest hill around and is standing on the top of it. If it wants to go higher, it needs to head down into the valleys. Then start an uncertain process of climbing back upwards again. Is it sensible to do that? In many cases, the answer is no. And so companies, with their business models, cluster on the heights unwilling to change.
Unlike the hill in the distance, as I look out of my apartment, the landscape does change in business. Those changes are slow but fare faster than the glacial or tectonic base of landscape change. And slowly, the commanding positions that business models have in their companies are eroded.
This is the business model depreciation that we have talked about earlier.
Let’s imagine the water is slowly rising. More and more business models cluster around the hilltop. Competition becomes more intense, and increasingly managers and investors see the market as a place where they don’t want to do business any longer.
They then have a choice. Do they treat it as a cash cow and extract as much cash as they can? As the business model sentences and slowly dies. Or do they try and reinvigorate it? In some cases, do they even care? Eventually, the business model, and often the company that is wrapped around it dies. A shriveled husk of its former glorious self. Look at Kodak today.
That’s been a bit long. Let’s jump into a couple of case studies and see how this has worked in real life.
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