20240127 - Business Models.pdf

COMPETITIVE STRATEGY Business Models 27th January 2024 © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS What are business models?  Business models depict the value creation and value capture logic of a firm in a given business  They represent a...

COMPETITIVE STRATEGY Business Models 27th January 2024 © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS What are business models?  Business models depict the value creation and value capture logic of a firm in a given business  They represent a set of choices relating to how a company operates and the consequences of those choices  In sum, a business model represents those choices that create and deliver the value proposition and how the value so created is captured by the firm in profits © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS: CHOICES What kind of choices does a firm make related to its operations?  Policies, that determine actions taken by the company across its value chain activities (e.g. a price reduction decision, a capacity expansion decision, etc.);  Assets, that refer to the tangible resources that companies employ to create value (e.g. manufacturing plants, raw materials, etc.);  Governance, that determines the decision-making rights for the firm’s policies and assets (e.g. decision to own production facilities or outsource them to partners; to engage full-time employees or contract workers etc.) © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS: CONSEQUENCES What are the typical consequences of the choices made by a firm? Consequences can be of two types:  Flexible, that change immediately with the choice causing it (as in price discount leading to increase in market share immediately);  Rigid, that are more persistent and do not change in the short run (as in ‘innovative culture’ does not change immediately due to change in employee incentive policy) © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS: THEORIES The arrows that connect choices to consequences are called theories Theories are essentially foregone conclusions that have come to become accepted in the field as mostly true Some theories connecting choices and consequences are highlighted (in brown) below:  Standardizing product design results in cost savings and reduced overheads because scale effects bring unit costs of the production down  Product innovation increases customer willingness to pay because innovation typically results in a more reliable, safe, good-quality or high-performance product  A supportive organizational culture produces committed employees because they will be motivated to display organizational citizenship behaviour © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS: FUNDAMENTALS How are business models different from the value chain of a company? The business model as well as the value chain representations essentially explain how firms are organized to create and deliver value to customers in a given business However, business models are dynamic representations of a firm’s value creation process (as the choices and consequences essentially occur over time), while value chains represent the value creation process at a particular snapshot in time © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS: FUNDAMENTALS Why perform business model analysis? To understand how firms create value and make profits in a business at a disaggregate level using only variables that matter (i.e. cost drivers and value drivers) To explain and evaluate the value creation potential of a firm in a given business (such as “Will this company create value in the business in future?”) To understand the impact of external shocks such as regulation, demographic changes etc. on the value creation potential of a firm To study the impact of competitor actions on the various choices made by the firm © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS: FUNDAMENTALS What is the level at which business models are analyzed?  Business models are analyzed for a firm as represented by its resources, capabilities and competencies (that are eventually bundled into activities)  A business model is specific to a WHO–WHAT–HOW combination. If one of these three change, the business model changes as well (because the underlying value proposition changes)  If a firm serves multiple customer needs, it has multiple business models © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS: FUNDAMENTALS Adapted from Seddon and Lewis (2004) Business Models are essentially lenses that we wear through which we witness strategy unfolding in the real world © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 BUSINESS MODELS, STRATEGY AND TACTICS Strategy is an integrated set of choices that create a unique and valuable position for a firm in an industry Business models refer to the logic of a company – how it operates and how it creates and captures value for people in the marketplace Tactics are the residual choices available to a company by virtue of the business model it has chosen for itself An analogy that captures the three concepts better is:  Making choices for achieving profits in different businesses taking into consideration the unique opportunities, threats, strengths and weaknesses in each of them -> Strategy  Organizing the choices to achieve value creation and capture in each of the businesses to fulfil the desired outcomes -> Business Model  Decisions taken while operating the business model -> Tactics © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 CHARACTERISTICS OF A GOOD BUSINESS MODEL A good business model:  Must display alignment to company goals. Goals here are restricted to the customer context and represent how the company has chosen to create value for them  Must contain self-reinforcing choices that do not conflict in creating and delivering value to the customers  Must be robust, in the sense that the advantage that it generates should be sustainable over a long period of time © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 CHALLENGES TO BUSINESS MODEL ROBUSTNESS The robustness of a business model is threatened by four factors:  Imitation: This refers to replication of business models by existing and potential competitors of the firm. For example, over time, several smartphone brands have imitated OnePlus’ choice of invite-only smart-phone sales, exclusive distribution relationships with specific retailers, etc.  Hold-up: At times, firms make specific investments in the business that makes the business model inflexible. If the firm is unable to make short-term changes to its business model, it suffers a hold-up problem. For example, investments in supplier development makes it difficult for IKEA to change suppliers in response to issues in the supply chain  Slack: Over time, firms become complacent due to badly-designed business model choices. This makes their business model less robust. For example, despite identifying digital cameras to be the future early, Eastman Kodak continued to emphasize the film rolls business in its choices and was unable to make a successful pivot in time to digital cameras  Substitution: In the presence of substitution, the perceived value of the firm’s offering decreases due to availability of alternatives to the firm’s customers. This makes the business model less robust. For example, with free shipping, free returns and low prices, e-commerce becomes a credible substitute to store-based retail business models © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 VIRTUOUS CYCLES AND VALUE LOOPS Good business models result in virtuous cycles (or value loops) that, over a period of time, result in competitive advantage. Virtuous loops help sustain the value creation of the firm over a longer period of time because firm profits pay up for the subsequent investments Large Customer Volume Low Fares Economies of Scale Advantages Profits Lower Operating Cost The sustainability of indigo’s low cost business model hinges on its ability to sustain its virtuous cycles like the above © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 VIRTUOUS CYCLES AND VALUE LOOPS Great Selection of Homes More Hosts on Airbnb Amazing Travel Experience for Customers Better Payment Terms for Hosts More Travellers Profits Revenues The virtuous loop determines the velocity of the business model. The greater the velocity, the faster profit realization from business model choices when compared to competitors © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24 VIRTUOUS CYCLES AND VALUE LOOPS A business model can have multiple virtuous cycles. More the number of virtuous cycles in a firm’s business model, the higher the value the firm creates, and higher the competitive advantage it generates over rivals Lower Platform Management Costs Improved Selection Customer Experience More Sellers More Customers Lower Prices More Sellers More Customers Amazon’s Multiple Virtuous Cycles /Value Loops © Mukundhan K.V., All rights reserved PGCSM03 – Competitive Strategy – Dec ‘23-Jan ‘24