Module 4: Business Models, Information Technology, and The Future PDF

Module 4: Business Models, Information Technology, and the Future In this module, we address the evolution of business models while considering the huge impact of the advances in information technology. Taking a long-term view, we see information technologies continuing to evolve along their current...

Module 4: Business Models, Information Technology, and the Future In this module, we address the evolution of business models while considering the huge impact of the advances in information technology. Taking a long-term view, we see information technologies continuing to evolve along their current performance trajectory. Period Covered Topics Activities Oct 18 – Oct 29 1. What is a business model? 2. Business model development 3. Business model in the company of the future 4. Conclusion Quiz Learning Objectives Discuss the concepts involved in a business model Discuss the impact of IT in the business model development Discuss the possible effects of IT in the company of the future 4.1 What is a business model? Business models are stylized models that describe how companies create and deliver value to their customers, and how they get rewarded for doing that. The business model construct encompasses the product or service, the customer and market, the company’s role within the value chain, and the economic engine that enables it to meet its profitability and growth objectives. Business models are often used by startups as modeling tools to help them design, prototype and build their new ventures. They are also used by established companies to plan, develop and support their innovation process. In this module, we will use the business model construct to predict how companies’ architectures and business model development processes will evolve into the future. A business model is a structured blueprint which attempts to bring order and discipline to the chaotic process of building, growing and operating a business. Some authors define the business model concept broadly, which reduces its usability. Our view of the business model concept focuses on the way the business creates value and extracts revenues and profits, which is defined by three core elements: a value-creation model, a profit model, and the logic of the business. Each of these elements is specified by answering a few basic questions: Value-Creation Model  Who are the venture’s customers and what is its product or service offering?  How does the offering create differentiated value for these customers?  What are the venture’s go-to-market strategies?  What is the value chain for the offering, and what parts of the value chain does the venture participate in? Profit Model  What are the venture’s sources of revenue?  What is the venture’s cost structure?  What are its key drivers of profitability? Logic  How will the venture meet its profit and growth objectives?Specifying a Value Creation Model The first step in business model construction or analysis is the specification of a value creation model. This involves first identifying the target customers and the offering that will create differentiated value for them. Differentiation is important: to attract customers and make a profit, the offering has to be better than the competition on a dimension that makes a substantive difference to customers. The dimensions of differentiation vary across companies. For example, Walmart creates differentiated value for cost-sensitive consumers by selling a large variety of products at low prices. Apple creates differentiated value for consumers who are willing to pay for well-designed, “cool,” innovative products. Having a product or service that truly solves a significant problem for a well-defined customer segment is a good start, but it’s not enough. Any business needs to have effective go-to-market strategies that focus on getting the product or service to market, acquiring customers, securing revenue and market traction, and growing the market. A go-to-market strategy specifies how the business will bring customers in and how it will ultimately deliver to them the value it creates. Finally, value creation takes place along an end-to-end value chain. However, companies have to choose which parts of the value chain they will actually participate in. For example, a company that develops new technology may choose to license its technology to an established player without being involved in either production or distribution. Or, the company may manufacture the product in-house and sell it as a component to a better-known company that embeds it in its own branded product. Another alternative is to manufacture and market the product under the company’s own brand name. As we proceed from the first option to the third, the company covers an increasing portion of the value chain for the final product. What is a value chain? A value chain is a business model that describes the full range of activities needed to create a product or service. The profit model of a business starts with an identification of its revenue streams and the associated costs. Since revenue = price × quantity and price is a key dimension of the value created for customers, it links the value-creation model to the company’s profit model. Revenue Models The most common revenue models are transactional: customers pay a fixed price per unit of the product or service, for example, ₱220 for a dozen eggs at the supermarket or ₱61 per liter of gasoline. Transactional revenues may also incorporate fixed fees and quantity discounts. A different type of revenue model is a subscription model under which customers pay a fixed fee per unit of time, and they receive in return a fixed number of units of the product or service (e.g, one copy of a newspaper each weekday) or unlimited use over the subscription period (e.g., monthly membership at the gym). Another revenue model, commonly used for intellectual property, is the licensing model whereby the customers pay a royalty or license fee which allows them to use, sell or copy the product within a given period of time (unlimited in time if the license is perpetual), subject to limits on the scope of use based on geography, nature of use, etc. For example, software is mostly sold using a perpetual license, and the owner of a patent may license its technology to other companies in return for a license fee.Businesses often receive multiple revenue streams, where different customers pay according to different formulas or revenue models, or hybrid revenue streams, where a given customer’s payments combine different revenue models. For example, in the eBay marketplace, sellers pay a subscription fee if they “rent” an eBay online store, a fee per listing, and a fee for each transaction which is consummated on the platform. These fees vary based on the nature of the listing or transaction, the product category, and the pricing format, but their averages can be estimated. We can thus write the periodic revenue as the sum of subscription revenue, listing revenue, and transaction revenue, where each of these in turn has different drivers. Logic of the Business The logic of the business explains how the business will meet its profit and growth targets. It comprises an argument showing why the business will be successful, that is, how it will attract customers, be competitive and profitable, and grow. This often takes the form of a “virtuous cycle” which shows how the basic elements of the business model reinforce one another. There are a few recurring business model archetypes, each characterized by its own logic. We outline below the logic of three archetypes: one based on customer intimacy, where the business tailors solutions to customer demand at the front end; one based on operational excellence, which is based on superior back-end processes; and one based on value chain coordination, which creates value by coordinating front- and back-end elements of the value chain. We chose these three business model archetypes as each will play an important role in structuring the company of the future. Customer Intimacy: Tailoring Solutions at the Front End Our first business model archetype uses customer information to tailor solutions that satisfy unique, or highly-targeted, customer needs. This logic is often called customer intimacy. The logic of customer intimacy is based on a continuous learning relationship with customers, which means that the business has to initiate explicit or implicit dialogues with them, capture information about their behaviors and preferences, and use that information to customize products or services to these preferences. Customer intimacy has been practiced for literally thousands of years, but as we see below, developments in IT will make it one of the central building blocks of the company of the future.As an example of traditional customer intimacy, consider Ritz-Carlton, the operator of five-star luxury hotels and resorts around the world. Ritz-Carlton is the first and only hotel company that received the prestigious Malcolm Baldrige National Quality Award twice, and is the winner of multiple awards for its high-quality customer service. Ritz-Carlton’s belief reads as follows: “The Ritz-Carlton Hotel is a place where the genuine care and comfort of our guests is our highest mission. We pledge to provide the finest personal service and facilities for our guests who will always enjoy a warm, relaxed, yet refined ambience. The Ritz-Carlton experience enlivens the senses, instills well-being, and fulfills even the unexpressed wishes and needs of our guests.” To achieve its mission, the company focuses on customer loyalty via customization which relies on extensive data gathering and capitalizes on both employee attitudes and IT capabilities. Information is gathered and recorded during each customer interaction and service request. The information is systematically entered into a database which is accessible to all Ritz-Carlton hotels worldwide. Using the database, hotel staff strive to anticipate on a daily basis the needs of each guest and initiate steps that ensure a customized, high-quality service experience. Returning guests give Ritz-Carlton increasingly refined information about their preferences and needs, which enables the company to provide them with a superior experience. Because of this experience, guests are loyal to Ritz-Carlton and tend to book a Ritz-Carlton hotel whenever possible. This in turn gives Ritz- Carlton information that enables its staff to serve guests better than the competition, creating a virtuous cycle: information enables a superior experience, resulting in customer loyalty which generates yet better information.Operational Excellence: Superior Back-End Processes A different logic governs operationally excellent business models, which strive to minimize the delivered cost of the products or services they offer to customers by creating superior back-end processes. Having a lower cost base, they can have a price advantage over competitors. Alternatively, operationally excellent businesses may price their products or services competitively while reducing the intangible costs borne by their customers as the product and service is delivered to them. Thus, operational excellence is not about price alone—consider, for example, FedEx, which attempts to differentiate its offering on timeliness and reliability (“when it absolutely, positively, has to be there overnight”—the company’s tagline during its formative 1978-1983 years). Walmart provides an example of operational excellence in retailing. Its tagline has evolved from “Always Low Prices” in the sixties to “Save Money. Live Better” in more recent years, but its value-creation model and logic have remained essentially the same. Customers consistently cite low prices as the key reason for shopping at Walmart. In the US, Walmart customers’ average income is well below the national average. Walmart is positioned at the inbound logistics and retailing end of a standard product value chain. It sells a large variety of quality merchandise at lower prices and higher availability than most competitors based on its back-end processes. The goal of operationally excellent business models is to minimize the delivered cost of the products or services they offer to customers Profitability in retailing is driven by the return on inventory investment, given by the product of inventory turnover (how many times a year the retailer turns over its inventory) by the markup over the cost of goods. A small, independent merchant may mark up its products by 100% and have two inventory turns a year, leading to a return of 200% on his inventory investment. A department store that reduces its markup to say 66.7% can achieve the same return on inventory investment by turning its inventory three times a year, attracting customers through lower pricing and greater product selection and innovation.Walmart’s superior back-end processes and lower cost structure allow the company to increase inventory turns to reach the same or greater profitability than full-price retailers in spite of its lower markup. A markup of 50% and an inventory turnover of four would be sufficient to match the return on inventory investment of the department store and the independent merchant in the above example, and doing better would make Walmart more profitable (by 2014, Walmart increased its inventory turnover to 8 with a 32% markup). Walmart achieves lower markups coupled with high availability and low inventory levels by focusing on procurement, logistics, and distribution and using IT to track and identify demand on a product-by-product basis, to increase transparency and to lower supply chain costs. These increased efficiencies allow Walmart to lower prices, leading to increased volume and scale, which in turn enable Walmart to invest further in technology and process improvement. This virtuous cycle, which Walmart calls “The Productivity Loop” is shown below.Value Chain Coordination Value chain coordinators create value by coordinating the front- and back-end of the value chain. A value chain coordinator may orchestrate major activities along the entire value chain or be focused on a narrow slice of the chain. In the electronic commerce domain, value chain coordinators are often platform businesses which facilitate transactions or interactions among the users of their platforms. They relegate direct value creation to other participants in the value chain, while the platform itself coordinates activities, streamlines business processes, and reduces search and transaction costs. eBay is a classic online platform that enables buyers and sellers to find and trade with each other. While the platform users themselves shoulder the burden of direct value creation (eBay does not hold or sell product inventories—only the sellers do), the company is focused on matching buyers and sellers and facilitating transactions among them. Value chain coordinators such as eBay continuously improve and refine their platforms to enhance the performance of the value chain. They often engage in acquiring new customers and seeding new activities to create additional sources of value for their customers. The eBay.com marketplace is a platform business which is focused on the use of Information Technology to support and facilitate trading communities. All other activities are provided by others— merchandising and product inventories by the sellers; shipping by eBay’s logistics partners (such as national postal services or UPS); financing, insurance, and vehicle inspections in eBay’s automotive marketplace are provided by partners, etc. As a result, eBay can focus on the development of its technology platform and on creating a vibrant trading community and developing vertical marketplaces such as eBay Motors, its collectibles marketplace, and its event ticket marketplace StubHub. In the electronic commerce domain, value chain coordinators are often platform businesses which facilitate transactions or interactions among their users. They relegate direct value creation to other participants in the value chaineBay’s virtuous cycle illustrates the logic of value chain coordinators which are characterized by two-sided network effects, in this case between buyers and sellers. First, buyers attract sellers to the platform. With more sellers, buyers are more likely to find any product they are looking for at a desirable price, which increases the number of buyers and the frequency of their visits to eBay. This, in turn, makes the platform more attractive to sellers, who are looking for buyers, so more buyers join the platform, and the cycle continues.4.2 Business Model Development Customer-Driven Innovation As discussed above, business models play a key role in the innovation process. This process parallels the approach which guides the development of startups and established company innovations in Silicon Valley. Customer-driven innovation employs the business model construct in an iterative process that starts at the front end, centering on a target customer (this is sometimes called “customer development”). The process then proceeds to the back end and finally links them to one another. It is initiated by identifying a customer need which is not well addressed by existing marketplace solutions. It then proceeds with empathy, a deep dive into the life and/or work experiences of the target customer. Empathy comprises three types of activity:  Observe – view users and their behavior in the context of their lives;  Engage – interact with and interview users through both scheduled and short unscheduled encounters; and  Immerse – experience what your user experiences. The empathy stage is followed by a definition stage that unpacks and synthesizes our empathy findings into compelling needs and insights which allow us to come up with an actionable problem statement. This is followed by an ideation stage that generates multiple potential solution ideas. The goal of the ideation stage is to explore a wide (i.e., encompassing a broad range of diverse ideas) and deep (i.e., exploring a large number of ideas) solution space. The ideas are then sorted out using the business model construct discussed above: each idea is analyzed in terms of the value it may potentially create for customers, what it takes to deliver that value, and the resulting profitability and growth potential. This means that the analysis starts at the front end (focusing on value creation potential) but is then filtered using a back end perspective (focusing on feasibility, cost, and profitability). At the front end, the focus of the process is on customer needs and value creation. At the back end, the focus is on putting together a solution that efficiently fulfills that customer need, costing it out, and trying to make a profit. In both cases, the business model development process calls for extensive human judgment, combining experience and creativity. As a result, it takes months, quarters or years to develop a proven, viable business model.IT Trends and Business Model Development The business model concept has been used often in the context of electronic business. Indeed, the use of the term “business model” took off in the mid-nineties and paralleled the growth of the internet, and the vast majority of its definitions in the literature are related to applications of IT. This is not surprising, as IT has been a major force reshaping business models over the past twenty years. As Tim Berners-Lee, the inventor of the World Wide Web, put it before the turn of the century: The next century is going to turn our world upside down. The Internet combines people and ideas faster than they have ever been combined before. And that combination changes everything. The basic social conventions of the industrial era—the stable career, the 9-to-5 job, the gradually (but steadily) increasing salary—were all built around the notion that people moved their bodies in response to information. If you wanted to buy something, you went to a store. If you wanted to build something, you worked in a factory. In the Net economy, the creation of value doesn’t require that kind of physical movement. Income accumulates not in the form of cash but in the form of clicks… The great thing about technology is that it forces us to figure out the world from scratch. In so doing, it gives us a chance to rediscover what’s really important. So maybe the 21st century won’t turn your world upside down. Maybe it will turn that world right side up. By changing the focus of innovation from atoms to bits and from hardware to software, IT has dramatically accelerated the process of business model development. Prototyping and testing that used to cost hundreds of thousands of funding and took months to execute can now be effectively completed in a week at a fraction of the cost. Software is more malleable than hardware, making it possible to adapt to customer needs faster than ever before. And, the development of cloud computing has made IT infrastructure highly elastic, making it possible to test and implement new software-based business models quickly and effectively. The end result is that IT has greatly accelerated the business model development process 4.3 Business Models in the and with it the pace of innovation. Company of the Future The previous discussion suggests that IT will not only accelerate the process of business model development—rather, it will lead over time to a substantial qualitative change. A market comprising customer intimacy agents, suppliers/producers, and value chain coordinators will be able to provide better solutions than today’s firms. The customer intimacy agents will specialize in identifying customers’ current and future preferences and in helping customers to choose among alternative solutions. Producers and suppliers will specialize in developing and selling physical or digital products. Value chain coordinators will match supply and demand, configuring solutions that use existing physical or digital products (or components), as well as mediate the creation of new products based on the information they receive on customer preferences and supplier capabilities. Emerging seeds of this structure already exist today. Multiple marketplaces are matching supply and demand for products (eBay), business supplies (Ariba), people’s time (TaskRabbit), space (Airbnb) and transportation options (Uber), to name just a few. Some of them offer value added services and customized solutions. In most cases, however, customers have to explicitly state their preferences in crude form and they then have to spend time and effort and exercise judgment to make the final selection. And, new product development is within the domain of producers. To explain the transformation in concrete terms, consider the case of industrial products, customer intimacy agents represent potential buyers’ preferences, suppliers offer products and capacities that, put together, create potential solutions, and value chain coordinators may match buyers and sellers, create value-added solutions by adding solution providers to the mix, suggest the creation of unique custom products, or commission the development of new products that may be sold to multiple buyers. This structure automates key parts of the customer-driven innovation process. For preferences and needs that have already been captured by the customer intimacy agents, empathy can be performed in software. Importantly, this will not eliminate the traditional form of empathy; rather, it will raise it to a higher level. Customer intimacy agents will engage in a more traditional form of empathy to innovate their own business models —for example, to augment the data they already capture electronically and to suggest what new forms of data might be valuable to capture. Value chain coordinators will engage in an electronic form of ideation, based on electronic enumeration of potential product concepts. They will test each candidate product configuration in software, aggregating demand and preference data from the customer intimacy agents and capacity, supply and cost data from suppliers. By comparing value and cost, they will be able to determine which of the candidate products are viable, although the ultimate tests of the resulting products will take place in the marketplace.A simple analogy to this form of automated innovation is provided by the use of combinatorial chemistry in the pharmaceutical industry. Drug development is a process which can take ten to twenty years using traditional techniques. With combinatorial chemistry, molecular constructions are automatically synthesized and tested for biological activity. The technique takes a few molecular building blocks and uses an automated process to create numerous combinations by mixing and matching these building blocks. Thus, rather than engage in a manual, time-consuming screening process, machines create thousands of drug leads each day by mixing the chemicals under pre-specified test conditions. This high throughput screening process enables parallel testing of drug leads which dramatically accelerates the drug development process. And, once the results of these screening analyses are determined, they are stored in digital libraries, replacing in vitro laboratory tests (i.e., “test tube” tests) by in silico (i.e., computer-aided) tests, using computer programs to quickly sift through digital combinatorial libraries. Turning to the business model of suppliers/producers, they will involve three types of activities:  Offering pre-configured components and products as well as customization options in the marketplace, typically through value chain coordinators;  Engaging in electronic customer-driven innovation along with the value chain coordinators, as discussed above; and  Engaging in traditional customer-driven innovation for new products and service ideas that were not inferred electronically. The latter form of innovation will continue to be important. While electronic customer- driven innovation can work well for products that are natural extensions of existing products, there will always be breakthrough products whose success cannot be inferred from the available data. In fact, the ability to engage in more traditional customer-driven innovation may be a strong differentiator for the most successful product developers.