Business models and modelling

ADVANCES IN STRATEGIC MANAGEMENT VOLUME 33BUSINESS MODELS AND MODELLING EDITED BY CHARLES BADEN-FULLER Cass Business School, City University London, London, UK and Senior Fellow, Wharton

BUSINESS MODELS AND

MODELLING

ADVANCES IN STRATEGIC

MANAGEMENT

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ADVANCES IN STRATEGIC MANAGEMENT VOLUME 33

BUSINESS MODELS AND

MODELLING

EDITED BY

CHARLES BADEN-FULLER

Cass Business School, City University London,

London, UK and Senior Fellow, Wharton School,

University of Pennsylvania USA

VINCENT MANGEMATIN

Grenoble Ecole de Management (GEM),

Grenoble, France

Howard House, Wagon Lane, Bingley BD16 1WA, UK

First edition 2015

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INTRODUCTION: BUSINESS MODELS AND

PART I STRATEGIZING WITH BUSINESS MODELS

THE BUSINESS MODEL: NATURE AND BENEFITS

CRAFTING AN INNOVATIVE BUSINESS MODEL IN

AN ESTABLISHED COMPANY: THE ROLE OF

ARTIFACTS

BUSINESS MODEL INNOVATION: HOW ICONIC

BUSINESS MODELS EMERGE

BUSINESS MODEL IMPLEMENTATION: THE

ANTECEDENTS OF MULTI-SIDEDNESS

RESEARCH ON BUSINESS MODELS: CHALLENGES

AND OPPORTUNITIES

v

PART II MODELLING THE BUSINESS MODEL

FROM BUSINESS MODEL TO BUSINESS MODELLING: MODULARITY AND MANIPULATION

Paolo Aversa, Stefan Haefliger, Alessandro Rossi and

Charles Baden-Fuller

151

BUSINESS MODELLING AS CONFIGURING

HEURISTICS

A COGNITIVE MAPPING APPROACH TO BUSINESS

MODELS: REPRESENTING CAUSAL STRUCTURES

DOING WELL TO DO GOOD: BUSINESS MODEL

INNOVATION FOR SOCIAL HEALTHCARE

S Ramakrishna Velamuri, Priya Anant and

ANTECEDENTS AND CONSEQUENCES OF BUSINESS

MODEL INNOVATION: THE ROLE OF INDUSTRY

STRUCTURE

Florian Waldner, Marion K Poetz, Christoph Grimpe and Markus Eurich

347

BUSINESS MODEL CHANGE: MANAGERIAL ROLES

AND TACTICS IN DECISION-MAKING

viiContents

LIST OF CONTRIBUTORS

London, London, UK Charles Baden-Fuller Cass Business School, City University London,

London, UK and Senior Fellow, Wharton School, University of Pennsylvania USA Laure Cabantous Cass Business School, City University

London, London, UK Ramon Casadesus-

Masanell

Harvard Business School, Harvard University, Boston, MA, USA Benoıˆt Demil Institut d’Administration des Entreprises,

University of Lille, Lille, France and Cnrs UMR 9221, France

Economics, ETH Zurich, Zurich, Switzerland

London, London, UK Jonathan Gander London College of Fashion, University of the

Arts, London, UK

Organizational Economics, Copenhagen Business School, Copenhagen, Denmark

Stefan Haefliger Cass Business School, City University

London, London, UK

University, Boston, MA, USA

ix

Vasantha Kumar Riti Eye Care Hospital, Rewari, India

Xavier Lecocq Institut d’Administration des Entreprises,

University of Lille, Lille, France and IESEG School of Management, Lille, France and LEM-Cnrs UMR 9221, France

Yossi Lichtenstein Norwich Business School, University of East

Anglia, Norwich, UK Moritz Loock University of St Gallen, St Gallen, Switzerland

Grenoble, France Constantinos C.

Markides

Department of Strategy & Entrepreneurship, London Business School, London, UK

Tilburg University, Tilburg, Netherlands Deirdre McQuillan Faculty of Management and Law, University

of Bradford, School of Management, Bradford, UK

Tatiana Mikhalkina Cass Business School, City University

London, London, UK

Organizational Economics, Copenhagen Business School, Copenhagen, Denmark

Universita` degli Studi di Trento, Trento, Italy

Grenoble, France Pamela Sharkey

Scott

School of Business, National University of Ireland, Maynooth, Ireland

Koen van den Oever School of Economics and Management,

Tilburg University, Tilburg, Netherlands

S Ramakrishna

Velamuri

China Europe International Business School, Shanghai, China

University of Vienna, Vienna, Austria Joanne Jin Zhang Norwich Business School, University of East

Anglia, Norwich, UK

INTRODUCTION: BUSINESS MODELS AND MODELLING BUSINESS MODELS

The business model topic has generated a lot of discussion since the phrasefirst gained currency in academic articles in the late 1990s (Zott, Amit, &Massa, 2011) This growing attention culminated in the 2010 Long RangePlanningSpecial Issue that brought the field’s leading scholars together toanswer questions about what the business model was and what was its pur-pose A key point that emerged was that a business model is more than astatement of how “value is created and captured”; it is a “model” and,like many other kinds of models can appear in many guises and servemany purposes These include being a “manipulable device” that can beused to help academics or managers understand the linkages between valuecreation and value capture more clearly; as well as being an artefact thatcan be used to convey knowledge about a business and its status to others(see, e.g., Baden-Fuller & Morgan, 2010; Morgan & Morrison, 1999;

Teece, 2010) The Special Issue (and subsequent pieces) also re-emphasizedthe critical question of how changing technology influences business modelchoice (Chesbrough, 2010;Gambardella & McGahan, 2010) and the modelitself (Baden-Fuller & Haefliger, 2013;Baden-Fuller & Mangematin, 2013);

a shift of attention away from matters internal to the firm toward whathappens at and beyond its boundaries, and the relationships between thefirm and its customers (see, especially, Teece, 2010); and the role of thebusiness model as an expression of the firm’s governance arrangements thatspan not just internally and backwards down the value chain, but all theway through to the customer (Casadesus-Masanell & Ricart, 2010)

Despite all this work, there are gaps to be filled, which include theexploration of business models as a process as well as an output By this wemean a proper expression of how business models emerge, and how theycan be and are used, and a realization that exploring these issues will shedlight on how and where the business model concept can be useful inour work as academics and practitioners; and assist in overcoming thefears and concerns of sceptics who feel that the “business model” isjust another concept that adds too little to our understanding of strategy

xi

(e.g., Markides, 2015) We use the words “strategizing,” “modelling,” and

“enacting” to emphasize the authors’ contributions to the process sions of business model work In particular, we dig into how the strategyagenda is being shaped by this understanding of “business models as mod-els,” and explore what it means to “model the business model,” and some

dimen-of the consequences dimen-of that modelling In this way, we clarify what the

“business model as a model” lens means for our understanding of strategicmanagement, and make links with other important literatures

PART I: STRATEGIZING WITH BUSINESS MODELSOur opening section (seeTable 1) presents five contributions that pay spe-cial attention, not just to what business models are, but also to how theyemerge, so sharpening our understanding of the value added nature ofusing “models” in that framing

Ramon Casadesus-Masanell and John Heilbron (2015) revisit what ismeant by the words “business model as a model” and how that conceptadds value to traditional strategy notions They emphasize an importantoverlooked profit opportunity “ambivalent value” making an impor-tant linkage between economic thinking and strategy that reveals a dimen-sion ignored by traditional strategy analysis

Benoıˆt Demil and Xavier Lecocq (2015)look at the processes by whichmanagers construct and reconstruct the business models that frame theirdecisions about their businesses Adopting the rigorous Actor NetworkTheory methodology, they pay attention not only to what managers say,but also to the artifacts that they construct as they build a new businessmodel This provides an important linkage for strategy scholars seeking toundertake empirical work on strategy process

Tatiana Mikhalkina and Laure Cabantous (2015) take categorizationresearch as a framing to understand and provide a systematic account ofhow strategy ideas get shaped and how they travel They do this by asking

“How did Airbnb emerge and subsequently become an iconic market-placeplatform business model and an exemplar of the ‘sharing economy’, andthus become a benchmark for other firms?” Their analysis provides a valu-able basis for others to understand how new business models come intobeing, and how they are interpreted by the media, and can thus be reinter-preted by other actors who can reuse the ideas in other situations

Table 1 Strategizing with Business Models.

Business Model Definition Focus of Attention Linkages Key Findings Casadesus-

Economics Business model perspective unlocks

hidden value at the firm’s boundary

Demil and Lecoq A cognitive model requiring

artifacts to become an organizational reality

The decisions of managers and the artifacts created

Socio-materiality and

A prototype story that

provides inspiration for others to copy

How a firm can develop its story to become an iconic exemplar business model for others

Social category theory

Role of audience engagement in business model emergence Rumble and

Multisided-platform business models (in France) are created by analogy rather than logic

the challenge faced by business model scholars

Traditional strategy

Ryan Rumble and Vincent Mangematin (2015)look at the role of gical versus logical thinking in the formation of new business models Theyargue that the complexity of the multi-sided-business-model platform busi-ness is much greater than the traditional product and work-for-hire busi-ness, so that firm formation happens differently Multisided-platformbusiness models are utilized by firms that simultaneously engage with twodifferent customer groups, a user group that receives something for zeropayment, and another group that either pays to be allowed to advertise tothat first group, or to buy data about it They use QCA analysis to showhow firms choosing to operate multi-sided platforms have different trajec-tories to those operating single-sided BMs: and that, typically but per-haps surprisingly the former eschew rational planning but instead relyheavily on analogical reasoning The results are strongly suggestive thattraditional strategy thinking and toolkits are not up to the task of compre-hending and assisting modern businesses a gap that needs to be filled byacademics and practitioners.

analo-Constantinos C Markides (2015) reviewing the interface between egy and business models, reminds us that that new ideas need to show howthey add value rather than merely repeat and rebadge older, alreadyestablished knowledge In this volume, the contributions recognize thischallenge

strat-PART II: MODELLING THE BUSINESS MODEL

In Part II, we present four contributions that focus on the modelling cess that is, what it means for business models to be designed andmanipulated (summarized inTable 2)

pro-Paolo Aversa, Stefan Haefliger, Alessandro Rossi, and Charles Fuller (2015)address the critical question of how best to model the businessmodel Drawing on the work of Simon (1962) on how systems can benearly decomposable, and paying attention to the literature on modularity,they explore the necessary conditions for effective manipulation of a busi-ness model something that requires the user to “black-box” or “hide”parts of the system to avoid confusion They draw parallels between thisapproach and the modularity of technology debates; and they borrow from

Baden-Baldwin and Clark’s (2000) manipulation mechanisms to explore what itmeans to manipulate business models The article contributes to our appre-ciation that it is not just a question of thinking with models, but also

Table 2 Modelling the Business Model.

Aversa,

Haefliger,

Rossi, and

Baden-Fuller

Business model design and

manipulation and its relation to technology

Decomposability and manipulation of model

That effective manipulation requires a focus of attention and that there is an important difference when that is internal to the firm from when it focuses on the boundary

Technology, decomposability, and modularity

Loock and

Hacklin

Business models as a cognitive tool for

modelling

Heuristics Business models are founded on heuristics and

rely on gestalt theory for their legitimacy Gestalt theory

Furnari Causal structure of business model

when used as cognitive representation of business value creation and capture

Cognition and modelling mental maps

Cognitive maps can be a powerful method to unpack the nature of cause and effect;

especially complexity, focus, and clustering Zhang,

Lichenstein,

and Gander

How choice of business model permits

young businesses to scale more effectively

Scaling in economics and strategy

Role of customer learning, customer networks, and technology in scaling of digital businesses

specifying what their focus is a matter argued persuasively by Morgan(2012)in the context of economic models and modelling.

Moritz Loock and Fredrik Hacklin (2015), delve into the logic behindbusiness model framing, exploring what exactly is the model of a businessmodel They argue that the foundations of business models should be seen

as heuristics (e.g.,Gigerenzer, Hertwig, & Pachur, 2011) that model dual cognition By drawing on gestalt theory to specify the principles ofmodelling as rule-based form-giving, they unpack the meaning and logicbehind the proper use of business models Their paper provides a strongmicro-foundation for the use of business models and modelling with busi-ness models in cognitive research (and action) in the field of strategy

indivi-Santi Furnari (2015)examines another aspect of the challenge of ling with business models the causal basis of reasoning He argues thatcognitive maps are a useful mechanism for visualizing the cause-and-effectrelationships that underpin business model thinking in the minds of man-agers (or academics) These maps shed light on four important dimensions

model-of their causal structure: complexity, focus, clustering and characterization

Joanne Jin Zhang, Yossi Lichtenstein, and Jonathan Gander (2015)takethe classical strategy question about scale and success identified by

Chandler (1990), and explore it in the context of digital businesses Theyidentify four important issues that determine successful scaling: engagingboth paying and non-paying user-customers through learning by using andthrough network externalities; leveraging these by exploiting informationalincreasing returns in production and distribution; exploiting technologicalrelatedness; and distributing resources effectively While none of these fac-tors is individually unknown, analyzing them together shows how, whereand when they relate and cumulate

PART III: ENACTING BUSINESS MODELS

Our last four contributions examine how businesses enact business modelsand business model thinking (see Table 3) S Ramakrishna Velamuri,Priya Anant, and Vasantha Kumar (2015) examine the extraordinarysuccesses of three Indian healthcare organizations that have scaled success-fully and provided care for enormous numbers of poor patients at thesame time Their business models combine Fordist principles of quality andscale, and more modern notions of business model thinking that stress theneed for customer selection and customer engagement They do not rely on

Table 3 Enacting Business Models.

Novel Dimension of Enactment

Velamuri, Anant,

and Kumar

What are the dimensions

of effective economically sustainable but social business models in healthcare?

Key to effectiveness is having a single business model built on Fordist principles of scale and efficiency, without

Choice of the business model takes place at the level of the project not the firm.

Coherence matters, but uniformity is not essential for success Middle managers play

a key role

10 firms that internationalized successfully but in different ways

Theories of internationalization should have the business model as unit

of analysis

Waldner, Poetz,

Grimpe, and

Eurich

How does (and should)

the firm innovate its business model over the life cycle of an industry?

Firms (inside the industry) innovate more at the start of the industry life-cycle, and less when competition is intense

Cross section sample of 1,242 Austrian firms and business model choices

Industry factors as a moderator of business model choice

Van den Oever

and Martin

How do (and should)

middle managers identify and champion business model change

in large firms?

Middle managers play a key role

in championing business model innovation, particularly when outside stakeholders are pressing for change They can combine the external pressures with their own concerns to effect

Significant change in business models taking place in Dutch water authorities charged with dams and other land protection

Framing theory and the role of middle managers in bridging stakeholders to achieve business model change

traditional notions of charity money being collected from individuals orgovernments to subsidize the poor nor on the notion that low cost meanslow quality: but rather show how an effective “for profit” business modelcan be socially oriented, resulting in valuable direct outcomes for lowincome groups in need of quality healthcare and even more potent indir-ect ones for national healthcare models This is quite a departure from tra-ditional thinking and conventional practice.

Deirdre McQuillan and Pamela Sharkey Scott (2015)explore how fessional service firms internationalize, and show how the business modellens can increase the power of traditional explanations Most internationalbusiness theories look at the firm as the unit of analysis: these authorsshow that shifting attention to internationalizing events adds explicatorypower otherwise missed They show how a business model perspective onsuch events focuses on the client and the firm/client interfaces, and howsuch service firms run portfolios of contrasting dominant and secondarybusiness models

pro-Florian Waldner, Marion K Poetz, Christoph Grimpe, and MarkusEurich (2015)look at the interface between the firm and its industry envir-onment, claiming that industry factors moderate the firm’s propensity toinnovate and its choice of business model They contribute by providingone of the first really large sample works on business model innovation,examining how industry life-cycle stages and sector competitiveness affectthe likelihood of Austrian firms innovating their business models, and theeffects of such innovation on firm performance

Finally, we end with a piece byKoen van den Oever and Xavier Martin(2015)that looks carefully at the critical role middle managers play in howbusiness models are chosen and enacted Drawing on the framing literature

of change management, they show how middle managers in Dutch waterauthorities leveraged their understanding of micro and macro situations todrive change, using issue selling and championing techniques to guidesenior managers and their boards towards approving plans for radical busi-ness model change

DISCUSSION

So what next? By taking a process perspective, our papers mobilize gizing, modelling, and enacting perspectives to bring the business modelagenda closer to the core considerations of strategic management; ourpapers also signal some further gaps

strate-The first challenge is to discern the extent to which the triadic businessmodels of market-places such as Uber or the multi-sided platforms such asGoogle require a different set of managerial capabilities and capacities inboth thinking and doing Three of our papers suggest that firms that adoptthese business models face unusual challenges, whether it is in the antece-dents of their thinking (Rumble and Mangematin), in how they aredesigned and manipulated (Aversa, Haefliger, Rossi, and Baden-Fuller), or

in how they become iconic (Mikhalkina and Cabantous) Firms adoptingthese business models have to be creative in how they use technology, assuccessful platform business models appear to use digital technologies both

in delivering the content (which can be wholly digital as with Google, orcan contain strong elements of creativity, as in video games) and also inusing technology to alter the dynamics of the pricing and engagementaspects of the business (the charging mechanisms of most multi-sided plat-forms depend on computer based algorithms, and the linking mechanisms

of the sharing economy also have algorithmic aspects) This view hasstrong support from leading economists such as Rochet and Tirole (2003)who explain that multi-sided business models obey different economic pri-cing laws to those that govern traditional product firms

The second challenge is to consider what business model innovationmeans for strategists (both academics and practitioners) The traditionalheartland concerns are shifting away from being about how technologychanges the cost side of the firm (providing better production, better deliv-ery, new ways of configuring assets, and new ways of outsourcing work)toward novel ways of engaging customers and getting them to pay This iswhere the concept “business model as a model” becomes vitally important,because the business model concept asks: “Who is the customer?”, “What

is the value created for that customer in his or her interaction with thefirm?” and “How is that value to be monetized (directly or indirectly)?”seeTeece (2010),Baden-Fuller and Mangematin (2013), Baden-Fuller andHaefliger (2013) This highlights new dimensions that encompass not justtriadic business models, but also features such as the sharing economy thatare hard to grapple with using traditional strategy tools These businessmodels require academics and managers to recognize how the same productcan be delivered to customers in quite different ways, with quite differenteffects So competition between firms has become not just a question ofcompetition based on better product offerings, but also on more effectivebusiness models Inferior quality offers at zero price from multi-sided plat-form business models (YouTube or advertising supported video games),and offers from sharing economy business models with different cost

xixIntroduction

structures are (for some audiences) highly competitive with higher qualityoffers from more traditional players using traditional product businessmodels Put another way, a product based business model firm that asks

“Who is the customer?” is faced with the possible answer that there maynot be just one customer but several because a competing firm operating

a multi-sided platform or sharing economy business model will interestother customer groups, and is altering the dynamics of whole industries.For academics, this is challenging The firms under study may not havechanged their business model at all; but if others have done so, then theindustry and its eco-system have changed and traditional analytical toolsthat measure the value of an asset, how competition takes place and howcompetitive advantage is created and distributed will have to be reconsid-ered and recalibrated

This leads to the important corporate strategy agenda that has beenalmost completely overlooked Business models do not map on to firms in

a one to one manner Many firms run portfolios of business models: in thecase of large diversified firms it is typically the consequence of diversifica-tion moves that involve exploiting competencies in different ways acrossmultiple customer groups This results in different divisions capitalizing oncommon capabilities to sell products one way in one market, and in a dif-ferent way in another market For small firms, such portfolios are oftencreated out of necessity: there may not be sufficient demand for their pre-ferred product for the entrepreneur to survive, so he or she will sell consul-tancy time to monetize their slack capacity We know almost nothing ofthe merits of running these portfolios, and whether firms that have repli-cated business models across time and space (as is common in the fast foodindustry with McDonald’s being an exemplar) are more successful thanthose that seek to adjust to specific circumstances in each instance, riskingcreating coordination challenges How replication, modification, and adap-tation influence firm success in running portfolios becomes an importantresearch question, that has been highlighted by writers such asWinter andSzulanski (2001)

Vincent MangematinCharles Baden-Fuller

Editors

ACKNOWLEDGMENTS

We gratefully acknowledge the support of Brian Silverman, Senior Editorfor allowing us to undertake this project and supporting us at every stage,

and we thank all the participants at the Business Model Mini Conference

at Cass Business School for their precious suggestions We thank JonMorgan of Paraphrase, who has copy-edited all the papers in this volume.This work was supported by the EPSRC UK Research Council (EP/K039695/1 Building Better Business Models)

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PART I STRATEGIZING WITH BUSINESS

MODELS

THE BUSINESS MODEL: NATURE AND BENEFITS

Ramon Casadesus-Masanell and John HeilbronHarvard Business School, Harvard University, Boston, MA, USA

ABSTRACTThis paper considers the nature of the business model and its strategicrelevance to negotiations We elaborate a substantive definition of thebusiness model as decisions enforced by the authority of the firm; thisdefinition enables the analysis of business models through the analysis ofindividual firm choices We situate negotiation outcomes within the strat-egy literature by considering “ambivalent value” value produced bythe interaction of partner firms that does not necessarily accrue to any ofthem The extent of “ambivalent value” is unclear, but its persistence,despite changing structural market features, promises to help sustainsuperior profits in the long run We conclude with an exploration of someways in which firms’ business models may impact their negotiation out-comes Several of the proposed pathways work intuitively through theintrinsic characteristics (motivation, personality, etc.) of agents nego-tiating on behalf of the firm; others operate independently of thosecharacteristics

Keywords: Business models; value capture; value-based businessstrategy; ambivalent value

Business Models and Modelling

Advances in Strategic Management, Volume 33, 3 30

Copyright r 2015 by Emerald Group Publishing Limited

All rights of reproduction in any form reserved

ISSN: 0742-3322/doi:10.1108/S0742-332220150000033002

3

INTRODUCTIONWhen firms participate in transactions, they create and must divide valuebetween themselves Some value may be assured to each firm based onhow much they would get from their “next best option” but the sum ofwhat each is assured does not necessarily equal the total value produced.The leftover value is “ambivalent value,” pulled in two directions at once,and must be split arbitrarily This essay considers what a business model is,locates the pursuit of “ambivalent value” in the strategy literature, and pro-poses a new strategic role for the business model as a means of negotiat-ing for a portion of that “ambivalent value.”

We provide a substantive definition of the “business model,” a collection

of decisions enforced by the authority of the firm on its employees Thereare two aspects of a business model the internal constitution of the firmand the firm’s external alignment and these are the result of the differentdegrees of authority a firm has over its employees as opposed to other mar-ket actors A firm may make a variety of decisions regarding either its inter-nal constitution or the types of transactions it facilitates Conceiving of abusiness model in this way has a variety of benefits, including the ability toanalyze discrete firm choices

Setting aside this discussion temporarily, we turn our attention to egy The careful design of activity systems and the deployment of privilegedresources promise to help firms create and sustain competitive advantage inmarkets that have stable structural features (technological development,consumer tastes, resource barriers, etc.) There are reasons to believe, how-ever, that such structural features change in the long run; so, to sustainsuperior returns, firms must find other, more reliable opportunities for cap-turing value The dynamic capabilities approach identifies a set of opportu-nities to capture value that persist despite changing structural marketfeatures opportunities that are due to imperfect competition The persis-tence of “ambivalent value” in markets despite their structural changeoffers firms another set of value capture opportunities

strat-We conclude by returning to the discussion of business models, and theways in which firms can manipulate them to negotiate for a bigger cut ofthe “ambivalent value.” While scholars have considered business models asbeing strategically important for their ability to differentiate and createadded value, they have not considered their importance in negotiatingambivalent value We outline a variety of ways in which a firm’s businessmodel may be a means of doing so: in particular, we develop an approach

that incorporates transaction cost considerations into such negotiations,and proposes the strategic value of negotiating with multiple transactionpartners.

WHAT IS “AMBIVALENT VALUE”?

In order to understand ambivalent value, consider an example developed

byBrandenburger and Stuart (1996, p 12)to explain the concept Imagine

an economy made up of two suppliers, two firms (A and B), and one mer Suppliers provide the raw materials necessary to make a good, firmstransform them into a finished product, and consumers benefit from theuse of the finished product Imagine further that each supplier, firm, andconsumer provides for, manufactures, and uses at most one unit of thegood Each supplier will sell to at most one firm, and each firm to one con-sumer; each consumer will buy from at most one firm, and each firm fromone supplier Imagine that the opportunity cost to suppliers of selling tofirm A or B is $1 In other words, the most they could get by selling theirraw materials elsewhere is $1 Furthermore, firm A makes a lower qualitygood which the consumer values at $10, while firm B makes a higher qual-ity good which the consumer values at $15

consu-In this example, how many units of good are made? What suppliers,firms, or consumers participate? And how does available value get divided?There is only one consumer, who can make use of only one unit ofgood, so only one unit will be manufactured Only one supplier can beemployed, and so the two suppliers will bid down the price at which theyoffer to sell raw materials in an effort to be the chosen supplier Of course,they will not bid lower than their opportunity cost, $1, so this will be theprice at which one of them is chosen to supply raw materials

Now, if firm A purchases the raw materials for $1 and creates a goodworth $10, they generate $9 of value to split between themselves and theconsumers Firm B, on the other hand, would create a good worth $15 andhave $14 of value to split Firms A and B will bid down their prices in aneffort to be chosen by consumers Of course, firm B has an advantagebecause its good is valued higher; when it offers a price any lower than $6,firm A must offer a price less than $1 to offer consumers the same amount

of value Doing so, however, would cause the firm to lose money, and sofirm A would choose instead to leave the market

5The Business Model: Nature and Benefits

Because firm B purchases raw materials for $1, it would sooner leave themarket and net $0 than sell goods at less than $1 and net a loss Becausefirm B must compete on price with firm A to attract the consumer, it mustsell its good at less than $6 What is unclear is what price in between $1and $6 the goods wind up being sold at If either firm B or the consumer isdissatisfied with the price, then the transaction will fall through firm Bwill make nothing and the consumer will be forced to transact with the lessdesirable firm A According to Brandenburger and Stuart, prices are setarbitrarily within this range according to the bargaining ability of eachparty.

Ambivalent value refers to value falling in this price range of $1 $6: sofirm B and the consumer must split this $5 of ambivalent value betweenthemselves They must agree on how much each party gets they cannotrely on bargaining and the forces of competition to encourage the otherparty to cede value Notice that ambivalent value is only a subset of thetotal appropriable value the consumer in the above example, forinstance, captures $9 in addition to some portion of ambivalent value

Fig 1depicts this example and helps explain the nature of “ambivalentvalue.” As the solid black arrow shows, firm B has moved the triangledenoting the sale price from $15 to less than $6 in order to compete withfirm A As the double-headed dashed gray arrow shows, firm B and theconsumer may locate this triangle anywhere between $1 and $6 the range

of ambivalent value

Purchase Price = $1 Sale Price < $6

Firm B is assured no more than $5 because it must bargain down the sale price by $9

to no more than $6 to compete with Firm A; the remaining $5 is split between Firm B and the consumer, depending on the determination of the sale price.

Fig 1 The Nature of Ambivalent Value

WHAT IS A BUSINESS MODEL?

“Business” is human activity in a competitive market setting, usually acterized by the exchange of goods and services for money “A business”refers to a real collection of people, decisions, resources, buildings, pro-ducts, values, actions, and any other ingredients necessary to conduct andsustain this particular human activity If we accept these notions, what do

char-we mean by a “business model”?

A firm is an authority structure capable of production and transactionand responsible for creating and capturing value from these business activ-ities Authority structures rely on sources of power and a source of legiti-macy A firm’s power may lie in its ability to fire an employee; a firm canexercise this power without question because it can appeal to a higher voice

of authority the laws of its national state, perhaps Authority structuresare capable of imposing their decisions on the people who are subject tothem they can offer no resistance The business model of a firm detailsthe decisions that a firm imposes on the agents who work for it.1

A firm’s business model has two aspects: its internal constitution and itsexternal alignment The power the firm has over its employees gives it theability to coordinate their productive activity When interacting with otheragents in the free market, a firm does not have this kind of power, and somust buy and sell resources and products by appealing to the self-interest

of other parties In a free market, however, it does retain the authority todetermine the parties with which it will not transact

Internal ConstitutionFirms make choices about how to organize their employees’ activities sothat the manipulation of their material and other resources produces value

in the form of a marketable product or service The activity system describesthe actions taken by various firm employees as they acquire the necessaryinputs for production, transform them into products or services, and distri-bute them as goods to other members of the economy A simple representa-tion of the activity system includes the actions responsible for inboundlogistics, operations, outbound logistics, marketing and sales, and service,

as well as support activities These activities create value as each is appliedsuccessively to some material good, and when the activities are re-enforcing.The activity system is a useful way to think about how actions producevalue, but it is an oversimplification of the relationship between firms and

7The Business Model: Nature and Benefits

their employees’ activities A firm does not create value simply by ing the actions of its employees to do so precisely in time and spacewould be a very costly if not impossible endeavor Employees facevarying circumstances, and must sometimes deviate from what is expected

determin-to actually produce the greatest possible value Moreover, even if a firmwere capable of determining the actions of one employee, strictly coordi-nating the actions of others would cause significant additional expense If abusiness model is the set of determinations enforced by the firm’s authority,

it is more than just a collection of activities

Rather than dictate the exact activities of their employees, firms mine procedural norms On an assembly line, for instance, the firm is notresponsible for determining that worker X actually spray-paints a particu-lar car door Instead, the firm is responsible for the common knowledgethat when the door reaches the paint station, it will be spray-painted Thus,while firms determine procedural norms, workers can adapt their behavior

deter-to changes in their environment if the door doesn’t arrive, or if they runout of spray paint Common knowledge can be shared by several parties,including the other workers on the assembly line, who are better able tocoordinate their behaviors with those of worker X, knowing what they arecollectively responsible for Another advantage of procedural norms is that

a firm may borrow behavioral norms from other relevant professions(accounting, for instance), and so avoid having to invent them itself.While they deviate in important ways, procedural norms do correspond

in general terms to actions taken by members of the firm But businessmodels do not consist solely of procedural norms; they also specify bureau-cratic structures, which determine employees’ rights and responsibilities Ateam leader who is responsible for the success or failure of a productlaunch may be given wide latitude in terms of what they may ask of theirsubordinates Notice that by tying responsibility to end results rather than

to specific actions, the business model departs significantly from ing the actions of employees in detail, although bureaucratic structureshelp organize actions When employees know who is in charge of a particu-lar project, they can approach that person with information relevant tothat project’s outcome

determin-Finally, business models can also specify incentive structures howmuch an employee stands to gain for their actions Firms have many incen-tive structures to choose from they may pay employees on a wage or sal-ary basis, they may reward specific actions or measurable outcomes, orindividual or group performance, and may increase or decrease the levels

of remuneration of employees working at different organizational levels

Incentive structures also include details about how employees earn tion, or move up to different pay scales Note that, as employees maychoose how to spend their time according to incentives, incentive structuresprovide a framework that helps, indirectly, to organize activity.

promo-External AlignmentFirms make choices about which external parties they will negotiate withand which transactions they will participate in The supply chain describesthe parties responsible for bringing a firm good to market, so that consu-mers may purchase and use it A simplified representation of the supplychain includes firms that are responsible for sequential activities, organized

in the order in which they are performed: for instance, it might includemanufacturers, distributors, retailers, and finally individual consumers.Goods flow from manufacturers toward consumers; cash flows in the oppo-site direction as each party pays for the goods it receives from the previouselement of the chain

While the supply chain is useful as an orienting device, the real world isdifferent from this representation in several important ways all of whichgive firms choices regarding the transactions they participate in A simpli-fied supply chain may depict one firm per niche (e.g., distribution) but,

in fact, many firms may compete to distribute the goods a single firm ufactures Similarly, a simplified representation may depict each firm asresponsible for a single activity (e.g., the firm responsible for distribution isdifferent from the one responsible for retail) but, in fact, firms maychoose to organize themselves so as to offer more than one such activity.Again, a simplified supply chain may not distinguish between a supplierfirm’s activities (e.g., delivery of print media) and functional roles (e.g.,distributor), but a firm’s supply chain partners may be involved in multipleactivities and roles Finally, a simplified supply chain may depict onlytransactions between two parties (e.g., cash for goods), but more than twoparties may come together to agree to supply chain transactions

man-Both when purchasing raw materials and when selling finished products,

a firm has many options of parties with whom it can do business.Sometimes, when a firm does not have explicit control over the distribution

of its goods, it will choose its transaction partners implicitly, based on thecharacteristics of its products For instance, making smooth rather thancrunchy peanut butter may appeal to the tastes of some consumers ratherthan others Other times, firms may choose their transaction partners more

9The Business Model: Nature and Benefits

directly different people will visit a retail store depending on whether it islocated in a beach town or in a sprawling metropolis.

Firms can choose to be involved in a variety of the activities in their ply chains; manufacturing firms may look forward to integrate into distri-bution, or firms may merge with others to sell related products Integratingnew activities will make firms responsible for new and different transac-tions For example, deciding to integrate into distribution means a firm willlikely no longer be responsible for transacting with distributors, but ratherdirectly with end consumers, while firms that offer related or competingproducts now become responsible for selling them if they don’t want tolose money on their purchases

sup-Firms may find that several qualitatively different parties are interested

in what they have to offer Thus, newspapers are organized to distribute information: in the print media supply chain, this capabilityserves to distribute journalistic output stories and opinions However,they have also long distributed advertising information as well: so whilethey are responsible for the same activities as in the print supply chain inthe consumer goods supply chain, they serve the function of supplying avaluable resource to advertisers Because their single set of activities mayserve different functions, newspaper publishers may have more options ofpartners with whom they can transact across these two different supplychains to serve readers of both news stories and adverts

mass-Finally, more than two firms may come together at once to facilitate atransaction For instance, firms that participate in joint ventures likeSouth West and Delta may negotiate prices together from supplierssuch as Boeing Additionally, rather than purchase goods from producersand sell them on later to consumers in two separate transactions, a distribu-tor may instead act to match the relevant parties, and take a cut of thetransaction price, so that one transaction accomplishes the interests of allthree parties at once

Summary

We have described a business model as a constellation of decisions that areenforced by the authority of the firm Although business is a chaotichuman activity, the procedural norms, bureaucratic structures, and incen-tive structures a firm enforces can lead its employees to coordinate theiractivities, producing order Firms do not have unrestricted authority overtheir interactions with other market agents; they must appeal to the

self-interest of others to facilitate those transactions However, the externalalignment of a firm is still the composition of several decisions that a firmmay to some extent enforce unilaterally (in that it chooses whichtransactions it participates in) In this sense, a business model is an act ofwill rather than simply the product of its environmental circumstances.There are several benefits to rendering the “business model” in this way.First, by describing the business model without denying that the firm is anauthority structure or that business itself is chaotic human activity, it seemsplausible that they are actually essential components of the makeup of aparticular business Second, decomposing a business model into a constella-tion of choices makes it possible to begin analyzing it, piece by piece.Finally, because this definition considers the business model as an expres-sion of will, it may prove useful to managers interested in implementingcorporate changes.

STRATEGY AND STRUCTURAL CHANGE

Markets that have persistent features (no technological developments,stable consumer preferences, stable resource barriers) offer firms the oppor-tunity to secure value not only from present transactions but also fromfuture transactions of the same kind Careful design of activity systems anddeployment of resources are strategies the literature has proposed to createand then capture value in the long run As markets are subject to forces ofchange over time, without the assurance that structural features will persist,firms may be better off seeking opportunities for value capture that persist

in spite of structural change Dynamic capabilities are the tools managerscan use to take advantage of opportunities which arise due to imperfectcompetition, while business models are tools that they can use to takeadvantage of opportunities associated with ambivalent value Both appro-aches to strategy enable firms to secure superior returns from sequences ofdissimilar transactions

Strategy and Stable Market Structure Activity Systems and ResourcesThe field of strategy is concerned with answering the question: How can afirm ensure and sustain superior returns? For business managers, theanswer promises profitability: for scholars, the answer is a curiosity,

11The Business Model: Nature and Benefits

because it stands in contrast to equilibrium, a founding concept ineconomics.

Consider a handful of firms that have identical cost and revenue tures, competing for consumers on the basis of the price of identical pro-ducts, and assume that there are unlimited firms “waiting in the wings”that may join the competitive marketplace at any time At first, the forces

struc-of supply and demand may set a price that is above the costs struc-of any givenfirm, so that all the firms in the market turn a profit However, theory sug-gests that the promise of turning a profit incentivizes more firms to enterand compete, increasing supply and driving down prices until there is nolonger any profit to be made This is the idea of equilibrium that theprofits a firm turns in the short run are the incentives for competition andtherefore precisely the reason that the firm will not be able to turn a profit

in the long run

Of course, an important assumption in the equilibrium model is thatfirms have identical cost and revenue structures In real life, while the costsand revenues of several firms in the same industry may approximate eachother, they will certainly not be identical The entry of new firms mayincrease supply and drive down prices, but the firm that is capable of offer-ing a quality product at a lower cost will still turn a profit from its sales.The problem facing any strategist embarking on the creative endeavor ofimproving their firm relative to the competition is that many of their strate-gic decisions could, presumably, be replicated The way to sustain superiorreturns, then, is to find ways of ensuring that competitors cannot imitateone’s business operations

One approach to strategy is to consider the firm as a cluster of activitiesresponsible for bringing a product to market These “activity systems” can

be designed well or poorly; well-designed systems include activities that arecomplementary, those that perform better together than they do alone Forinstance, Urban Outfitter’s high product turnover rates go well with itsvariable store layout, in that both contribute to a bazaar-like shoppingexperience (Porter & Siggelkow, 2008) Of course, complementary decisionscould be imitated by competitors, but there are several reasons why deci-sions that are interdependent tend to obstruct such imitation Some firmdecisions are not observable simply by looking at a firm’s manufacturing orstore operations, making them hard to imitate And some may not beworthwhile, or may even be harmful unless made in conjunction with otherdecisions (Porter & Siggelkow, 2008;Rivkin, 2000) Designing activity sys-tems that are complex may be a suitable way to fend off the threat of imita-tion and thereby ensure competitive advantage

A firm may also be viewed as a bundle of resources over which ment has limited control, rather than a series of activities over which man-agement has a great deal of control At any point in time, different firmswill have access to and control over different levels of resources: usingthem effectively enables firms to ensure superior returns because accessbarriers will hinder other firms from employing the same kinds ofoperations so preventing imitation For instance, a firm’s R&D teammay have established a real rapport over years of working together anddeveloped a knack for dreaming up stylish, new products In this case, afirm has an advantage in competing on quality and trendsetting in a mar-ket, rather than, say, just trying to sell lower quality items cheaply(Wernerfelt, 1984) Other firms may want to compete, but they will nothave access to this important cultural resource for success Unlike Porter,the resource-based view argues that imitation can be deterred not by theobscurity of recipes for success, but by differential access to the ingredients.The careful design of activity systems and the leveraging of privilegedresources are solutions to the same managerial problem Both approachesrecognize that, if a competitor is capable of offering the same product inthe market, a focal firm will be forced to negotiate prices down until there

manage-is no opportunity to turn a profit We call these “long-run” approaches tostrategy for two reasons For one, they address threats to profitability thatcome from imitative competition, a “long-run” feature in the equilibriumeconomic model Second, to sustain superior profits, management mustidentify and exploit persistent features of the market (e.g., consumer prefer-ences) or of other firms (e.g., resource disparities) In other words, a firmdistinguishes itself by achieving repeated success in facilitating the sametransactions despite the presence of competition

Markets and Structural ChangeMarkets’ structural features change over the long run Government policiesmay change, and cause tariffs or quotas that operate as barriers to marketentry to disappear The inevitable, though discontinuous, march of techno-logical innovation may erase resource barriers: so, for instance, experience

in manufacturing cassettes will have little bearing on the ability to facture CDs Shifting cultural values may change consumer tastes, so awave of concern about the environment may make consumers more willing

manu-to pay for products that are manufactured in responsible ways

13The Business Model: Nature and Benefits

What is more, individual firms’ innovative capacities may make tural features that are relevant today irrelevant in the future A firm with

struc-an effectively structured but obscure activity system may not be threatened

by the forces of imitation but over time, other firms may discover newand interesting ways to structure their own activity systems to achieve simi-lar ends more cheaply or effectively, giving them a competitive edge A firmthat has accumulated a valuable resource (such as experience in buildingmotorcycles) may not be threatened by competition from an upstart firmbut, over time, the newcomer may enter related industries and develop theexperience needed to overcome the original resource barrier

To the extent that structural features of a market change over time,firms may be unable to sustain their superior returns simply by conductingsimilar sequences of transactions (selling the same kind of good to the samekind of customer) Instead, they may have to rely on developing the ability

to arrange dissimilar transaction sequences (offering fundamentally ent goods to new sets of customers) to achieve superior returns Of course,the realization that market structures change does not negate the impor-tance of product and resource positioning rather, it highlights thefact that a firm’s strategy must be updated from time to time However,careful consideration of the value capture process identifies two kinds ofopportunities to capture value that exist independently of structural marketfeatures: imperfect competition and ambivalent value Because these oppor-tunities do not depend on market structures, approaches to capturing valuefrom them have the advantage of not needing to be updated in line withstructural change

differ-Developments in the literature on value capture distinguish between twofundamentally different processes (Brandenburger & Stuart, 1996;

MacDonald & Ryall, 2004) On the one hand, firms have “bargainingpower” that assures them some cut of the pie this has to do with howmuch bigger they make the pie and how easily they can be replaced On theother hand, there is a margin of value that goes uncaptured, even after var-ious slices have been allocated to various players Because creating value is

a cooperative process and everyone has a claim to what’s left firmscannot rely on their “bargaining power” to secure a share of these “left-overs”: instead, they must exercise their “bargaining ability” (Grennan,

2013)

Understanding that value is divided on the basis of both “bargainingpower” and “bargaining ability” yields an important insight for strategy Itdistinguishes between two different kinds of short-run profits There areprofits due to a firm’s “bargaining power” the fact that its goods are

necessary for everyone to create value together: traditionally, strategistshave divided this category into profits that are due to imperfect competi-tion and those that are caused by a firm’s competitive advantage, with theformer being “competed away” over time.2As well as these, there are alsoprofits that flow from a firm’s “bargaining ability” which is based on thefact that a firm is a necessary but insufficient player to produce some of thetotal value Of course, if the firm has a competitor that provides exactlythe same kind of product for exactly the same price, it will have no oppor-tunity to exercise bargaining ability at all, but any kind of differentiationneeds to be capitalized on and translated into profits.

There are also two kinds of opportunities for a firm to capture valuewhich are time sensitive: markets that have not yet become perfectly com-petitive and the arbitrary determination of prices in transactions whereboth parties benefit from transacting specifically with the other Changingmarket conditions (new technologies, shifting consumer preferences) do notundermine these opportunities in fact, the development of new technolo-gies continues to create new markets that are imperfectly competitive.Meanwhile, wherever coordination between optimal groups of players cre-ates superior results, there is room for the division of ambivalent value, aform of value that survives changing market conditions.3

Strategy and Structural ChangeEconomic equilibrium is a powerful idea, but it may or may not be appro-priate to certain industries, especially those in which the innovation andintegration of new technologies causes continual change and upheaval.Consider, for instance, the transition from portable cassette players toportable CD players to rudimentary mp3 players to more advanced mp3players, like the iPod When a new technology is introduced, firms that donot take advantage of it become obsolete, while those that integrate thetechnology successfully enjoy high prices because of the limited supply Ofcourse, as discussed in the summary of the equilibrium notion above, theseprofits incentivize other firms to follow their example and integrate the newtechnology When innovation in an industry is rapid enough, though,another new technology is likely to be released before the firm everbecomes fully competitive: so, again, the current technology becomes obso-lete and the market is once more characterized by a short-term lack ofcompetition.4

15The Business Model: Nature and Benefits

The problems of firms participating in industries characterized by continuous change differ from those in industries marked by equilibriumand perfect competition Those in the latter face the threat of imitation andthe need to provide cost-effective delivery: but imitation is a less significantthreat for the former because, once established in the market, the new tech-nology is disrupted by the introduction of even newer technology wellbefore imitative competition drives revenues down toward costs Instead,such firms are under the constant threat that the products they offer maybecome irrelevant at any point in time because of the unexpected dawn of anew technology.

dis-To address the problem of relevance, scholars have identified a subset of

a firm’s resources as its “dynamic capabilities.” By definition, these are thecapabilities that are responsible for helping a firm to adjust to changingeconomic conditions, such as new technologies and shifting consumer pre-ferences Some examples include (1) restructuring ownership of physicalassets, (2) learning new business practices via investment in humanresources, and (3) understanding changes in the firm’s reputation Eventhough a firm may never be able to predict or begin planning for thechanges that follow from technological advances, cultivating its dynamiccapabilities can enable it to detect and respond to changes quickly Theresult is that the firm has an edge when new technologies make old onesobsolete; adaptiveness enables firms to capture profits due to imperfectcompetition in the short run (Teece, Pisano, & Shuen, 1997) The fact that

an industry may contain a series of markets with imperfect competitionmeans that a firm may need to deploy its dynamic capabilities repeatedly toensure sustained superior returns

The promise of dynamic capabilities is that they help a firm to adapt

to changing market conditions Firms that make good use of them mayenjoy sustained superior returns by facilitating a successful series of dif-ferent transactions (e.g., selling a series of different music playingdevices) Firms do not need to worry quite so much about persistent fea-tures of the market (like consumer preferences), because discontinuousinnovation promises that there will always be markets characterized byimperfect competition for those savvy enough to seek them Finally, thedynamic capabilities approach is not concerned with imitation, a feature

of long-run markets for all these reasons, we consider it a “short-run”approach to strategy

There are other time-sensitive but recurring opportunities to capturevalue during market changes The introduction of new technologiesgives firms opportunities to take advantage of imperfect competition

Whenever a combination of players is guaranteed more value by workingtogether than the total of what they could make by working separately,some amount of ambivalent value will exist Changing market structures

do not eliminate this ambivalent value, so there are other opportunities

to turn a profit by exercising bargaining abilities: as we discuss in thenext section, firms may use their business models to exercise these bar-gaining abilities For now, we summarize the above discussion in Fig 2,which categorizes the different opportunities available to firms to achievesuperior returns The following different sources of firm profit can benoted:

• Competitive advantage enables a firm to sustain superior returns by tating similar transactions in markets with stable structural features inspite of equilibrium pressures Product and resource positioning helpfirms establish competitive advantage;

facili-• Imperfect competition exists in new markets that form as a result of tural change A firm’s dynamic capabilities may help it take advantage ofthis phenomenon and sustain superior returns by entering markets andfacilitating new kinds of transactions;

• Ambivalent value persists in market transactions despite changing tural features of the market Those aspects of the business model that arerelevant for capturing ambivalent value are elaborated later in this essay.The purpose of this categorization is to specify the source of profit dis-cussed in the remainder of this paper the exercise of bargaining ability

struc-Bargaining Power:

Competitive Advantage

Bargaining Power: Imperfect Competition

Dynamic Capabilities

Fig 2 Parsing the Sources of Firm Profit Source: Created by authors

17The Business Model: Nature and Benefits