Business Models, Business Strategy and Innovation

1 Business Models, BusinessStrategy and InnovationDavid J. TeeceWhenever a Business enterprise is established, it either explicitly or implicitly employsa particular Business model that describes the design or architecture of the value creation,delivery, and capture mechanisms it employs. The essence of a Business model is in de-fining the manner by which the enterprise delivers value to customers, entices customersto pay for value, and converts those payments to profit. It thus reflects management shypothesis about what customers want, how they want it, and how the enterprise canorganize to best meet those needs, get paid for doing so, and make a profit. The purposeof this article is to understand the significance of Business models and explore theirconnections with Business Strategy , Innovation management, and economic theory.

2 2009 Published by Elsevier in the global economy have changed the traditional balance between customer andsupplier. New communications and computing technology, and the establishment of reasonablyopen global trading regimes, mean that customers have more choices, variegated customer needscan find expression, and supply alternatives are more transparent. Businesses therefore need tobe more customer-centric, especially since technology has evolved to allow the lower cost provisionof information and customer solutions. These developments in turn require businesses to re-eval-uate the value propositions they present to customersein many sectors, the supply side drivenlogic of the industrial era has become no longer new environment has also amplified the need to consider not only how to address customerneeds more astutely, but also how to capture value from providing new products and a well-developed Business model, innovators will fail to either delivereor to captureevalue from their innovations.

3 This is particularly true of Internet companies, where the creation ofrevenue streams is often most perplexing because of customer expectations that basic servicesshould be Range Planning 43 (2010) 172e194 $ - see front matter 2009 Published by Elsevier Business model articulates the logic and provides data and other evidence that demonstrateshow a Business creates and delivers value to customers. It also outlines the architecture of revenues,costs, and profits associated with the Business enterprise delivering that value. The different ele-ments that need to be determined in Business model design are listed inFigure issues related to good Business model design are all interrelated, and lie at the core of thefundamental question asked by Business strategistsehow does one build a sustainable competitiveadvantage and turn a super normal profit?

4 In short, a Business model defines how the enterprisecreates and delivers value to customers, and then converts payments received to profitfrom Innovation , Business pioneers need to excel not only at product Innovation but also at busi-ness model design, understanding Business design options as well as customer needs and techno-logical trajectories. Developing a successful Business model is insufficient to assure competitiveadvantage as imitation is often easy: a differentiated (and hard to imitate)eyet effective and effi-cientebusiness model is more likely to yield profits. Business model Innovation can itself be a path-way to competitive advantage if the model is sufficiently differentiated and hard to replicate forincumbents and new entrants essence, a Business model embodies nothing less than the organizational and financial archi-tecture of a is not a spread sheet or computer model, although a Business model mightwell become embedded in a Business plan and in income statements and cash flow projections.

5 But,clearly, the notion refers in the first instance to a conceptual, rather than a financial, model of a busi-ness. It makes implicit assumptions about customers, the behavior of revenues and costs, theFigure 1. Elements of Business model designIn essence, a Business model [is] a conceptual, rather than financial,model of a Range Planning, vol 43 2010173changing nature of user needs, and likely competitor responses. It outlines the Business logic re-quired to earn a profit (if one is available to be earned) and, once adopted, defines the way the en-terprise goes to market . But it is not quite the same as a Strategy : the distinction and therelationship between the two will be discussed lineage going back to when societies began engaging in barter exchange, Business modelshave only been explicitly catapulted into public consciousness during the last decade or so.

6 Drivingfactors include the emerging knowledge economy, the growth of the Internet and e-commerce, theoutsourcing and offshoring of many Business activities, and the restructuring of the financial ser-vices industry around the world. In particular, the way in which companies make money nowadaysis different from the industrial era, where scale was so important and the capturing value thesis wasrelatively simple the enterprise simply packed its technology and intellectual property intoa product which it sold, either as a discreet item or as a bundled package. The existence of electroniccomputers that allow low cost financial statement modeling has facilitated the exploration of alter-native assumptions about revenues and impetus has come from the growth of the Internet, which has raised anew, and ina transparent way, fundamental questions about how businesses deliver value to the customer,and how they can capture value from delivering new information services that users often expectto receive without charge.

7 It has allowed individuals and businesses easy access to vast amountsof data and information, and customer power has increased as comparison shopping has beenmade easier. In some industries, such as the recording industry, Internet enabled digital downloadscompete with established channels (such as physical product sales) and, partly because of the ubiq-uity of illegal digital downloading, the music recording industry is being challenged to completelyre-think its Business models. The Internet is not just a source of easy access to digital data; it is alsoa new channel of distribution and for piracy which clearly makes capturing value from Internettransactions and flows difficult for recording companies, performers and songwriters alike. Moregenerally, the Internet is causing many bricks and mortar companies to rethink their distributionstrategieseif not their whole Business how the Internet has devastated the Business models of industries like music re-cording and news, internet companies themselves have struggled to create viable Business models.

8 In-deed, during the boom and bust of 1998e2001, many new companies with zero or negativeprofits (and unprecedentedly low revenues) sought financial capital from the public markets, whicheat least for a short whileeaccommodated them. Promoters managed to persuade investors that tra-ditional revenue and profitability models no longer appliedeand that the companies would(eventually) figure out (highly) profitable Business models. Few have, causing one commentator toremark that the demise of a popular but unsustainable Business model now seems inevitable .3No matter what the sector, there are criteria that enable one to determine whether or not one hasdesigned a good Business model. A good Business model yields value propositions that are compel-ling to customers, achieves advantageous cost and risk structures, and enables significant value cap-ture by the Business that generates and delivers products and services.

9 Designing a businesscorrectly, and figuring out, then implementingeand then refiningecommercially viable archi-tectures for revenues and for costs are critical to enterprise success. It is essential when the enter-prise is first created; but keeping the model viable is also likely to be a continuing task. Superiortechnology and products, excellent people, and good governance and leadership are unlikely to pro-duce sustainable profitability if Business model configuration is not properly adapted to the com-petitive environment. Some preliminary criteria for Business model design are suggestedthroughout this article, and summarised in a later concept of a Business model has no established theoreticalgrounding in economics or in Business Models, Business Strategy and InnovationBusiness modelsethe theoretical foundationThe concept of a Business model lacks theoretical grounding in economics or in Business simply there is no established place in economic theory for Business models; and there is nota single scientific paper in the mainstream economics journals that analyses or discusses businessmodels in the sense they are defined here.

10 (Possible exceptions are the literature on investmentin basic research, which economists recognize as being unsupported by private Business models(see below), and the literature on bundling, inasmuch as it dealseindirectlyewith different rev-enue models.) The absence of consideration of Business models in economic theory probably stemsfrom the ubiquity of theoretical constructs that have markets solving the problems thatein the realworldebusiness models are created to theory implicitly assumes that trades take place around tangible products: intangiblesare, at best, an afterthought. In standard approaches to competitive markets, the problem of cap-turing value is quite simply assumed away: inventions are often assumed to create value naturallyand, enjoying protection of iron-clad patents, firms can capture value by simply selling output inestablished markets, which are assumed to exist for all products and inventions.