Origins of the Term “Business Model”

Chapter I. Business models

Origins of the term “business model”

There isn’t a general accepted definition of the term ‘‘business model’’. There is a certain diversity in the available definitions which poses substantial challenges for delimiting the nature and components of a model and determining what exactly constitutes a good business pattern. There is also confusion in the terminology, as business model, strategy, business concept, revenue model, and economic model are often used interchangeably. Moreover, the business model has been referred to as architecture, design, pattern, plan, method, assumption, and statement.

According to Morris, M. et al. (2005) there are three general categories of definitions based on their principal emphasis. These categories can be labeled economic, operational and strategic, each having comprised a unique set of variables. They can be seen as a hierarchy, from the perspective that the model becomes more comprehensive moving from the economic to the operational and further to the strategic levels.

The concept of business model is becoming a popular topic among business people today as it could be seen in various industries. There is an attempt of introducing new business models that can threaten or even replace established companies and conventional ways of doing business. Relevant examples can be the music or airline industry. (KLM airplane apartments)

Therefore, the interest in business models comes from two opposing sides:

•“Established companies have to find new and innovative business models to compete against growing competition and to fend off their adversaries;

•Entrepreneurs want to find new and innovative business models to carve out their space in the marketplace.” (Ankaraju, S. 2009)

Following this context, a business model can be considered a helpful unit of strategic analysis tailored to today’s competitive business environment. It helps executives and entrepreneurs to increase their capacity to manage transitions and adapt to rapidly changing business environments by implementing new ideas into their business models. (ibid.)

But what is actually a business model?

The question of what a business model is often remains relatively vague. The main reason for this is because business people have an intuitive understanding of business models. This is normal, since the business model is about how an organization makes money, which is a manager’s job after all. However, there is often a lack of a more precise and shared understanding of what a business model is. Yet, such a common understanding is required if we want to have high quality discussions of one’s business model and make important business model decisions.

Alexander Osterwalder has come up with the 9 building blocks approach to describe business models. This approach has the characteristics of any other type of model (e.g. in architecture or engineering).

It is a simplified description and representation of a complex real world object. It describes the original in a way that we understand its essence without having to deal with all its characteristics and complexities. A business model reflects how a company does business and makes money without detailing its strategy, processes, units, rules, hierarchies, workflows, and systems. (Osterwalder, A., 2005)

So, Osterwalder defines a business model as consisting of 9 building blocks that constitute the business model canvas:

“1.The value proposition of what is offered to the market;

2.The segment(s) of clients that are addressed by the value proposition;

3.The communication and distribution channels to reach clients and offer them the value proposition;

4.The relationships established with clients;

5.The key resources needed to make the business model possible;

6.The key activities necessary to implement the business model;

7.The key partners and their motivations to participate in the business model;

8.The revenue streams generated by the business model (constituting the revenue model);

9.The cost structure resulting from the business model.” (ibid.)

According to Osterwalder, the popularity of the business model concept increased in the late 90s as a relation to the rapid decrease of prices in the IT and telecom industry. It became very cheap to process, store and share information across businesses and other companies and all the way to the customer, which is why many new ways of doing business became possible: value chains were reconfigured, innovative products and services appeared, new distribution channels emerged and more customers could be reached.

Ultimately this lead to globalization and high competition, but, as described above, it also led to new ways of doing business. Therefore, nowadays there are various ways on how companies can make money: this means new in terms of what they do, how they do it and for whom they do it.

Managers and executives have a whole new range of possibilities to design and redesign their businesses. This results in innovative and competing business models in the same industries. Before, it used to be sufficient to say in what industry you where, for somebody to understand what your company was doing. All players had more or less the same business model. Today it is not sufficient to choose a lucrative industry, but you must also design a competitive business model. In addition, increased competition and rapid copying of successful business models forces all players to continuously innovate and adapt their business model to gain and sustain a competitive edge. (Osterwalder, A., 2005)

Companies that thoroughly understand their business model and know how the building blocks relate to each other will be able to constantly rethink and redesign these blocks and their relationship to innovate before their business model is copied or becomes outdated.

Business Models & Innovation

The term business model is also closely related to innovation. The business model concept is related to a whole new range of business design opportunities. There are examples of business model innovations in each of the 9 building blocks described. The most obvious is innovating in the value proposition. When mobile phones appeared in the market they offered a different value proposition than fixed line phones. In the early days of the Internet popular indexes like Yahoo! helped people find information on the Web. Regarding target customer segments, low-cost airlines like EasyJet have brought flying to the masses. Dell became really successful by exploring the web as a distribution channel. Gillette has made a fortune by establishing a continuous relationship with customers based on its disposable razors. Apple resurged based on its core capacity of bringing design to computers and electronic gadgets. Cisco became famous for its capacity of configuring activities in new and innovative supply chains. Intel thrived for its capacity to get partners to build on its processing platform. Google tapped in an innovative revenue streams by linking highly specific search results and content with text ads. Wal-Mart became dominant by its ability to slash cost throughout its business model. (Osterwalder, A., 2005)

Business model definitions

At a general level, the business model has been referred to as a statement (Stewart & Zhao, 2000), a description (Applegate, 2000; Weill & Vitale, 2001), a representation (Morris, Schindehutte, & Allen, 2005; Shafer, Smith, & Linder, 2005), an architecture (Dubosson-Torbay, Osterwalder, & Pigneur, 2002; Timmers, 1998), a conceptual tool or model (George & Bock, 2009; Osterwalder, 2004; Osterwalder, Pigneur, & Tucci, 2005), a structural template (Amit & Zott, 2001), a method (Afuah & Tucci, 2001), a framework (Afuah, 2004), a pattern (Brousseau & Penard, 2006), and a set (Seelos & Mair, 2007). Still, the business model is often studied without an accurate definition of the concept. There are over one hundred business model publications reviewed, more than one third (37%) do not define the concept at all, taking its meaning more or less for granted. Fewer than half explicitly define or conceptualize the business model, for example, by enumerating its main components. The remaining publications refer to the work of other scholars in defining the concept. Moreover, existing definitions only partially overlap, giving rise to a multitude of possible interpretations. (Zott et al., 2011)

The business model concept has gained increasing importance in the management science literature as well as in business practice. In particular, within the current discussion on novel forms of corporate renewal, dealing with the search for approaches that go beyond innovating new products or services, the business model has emerged as the core for innovation for a firm’s mechanisms of value creation and value appropriation. Nevertheless, the emergent literature on the business model concept is full of inconsistencies and overlapping or contradicting definitions, triggering up debates about the ambiguity of the concept and thus making it difficult to apply correctly.

Business models are “stories that explain how enterprises work”. A good business model answers Peter Drucker’s age old questions: Who is the customer? And what does the customer value? It also answers the fundamental questions every manager must ask: How do we make money in this business? What is the underlying economic logic that explains how we can deliver value to customers at an appropriate cost?” (Magretta, 2002, p. 4). A business model is a “concise representation of how an interrelated set of decision variables in the areas of venture strategy, architecture, and economics are addressed to create sustainable competitive advantage in defined markets” (p. 727). It has six fundamental components: Value proposition, customer, internal processes/competencies, external positioning, economic model, and personal/investor factors. (Morris et al., 2005). Business models “consist of four interlocking elements that taken together, create and deliver value”. These are customer value proposition, profit formula, key resources, and key processes. (Johnson, Christensen & Kagermann, 2008, p. 52). As per Casadesus-Masanell & Ricart, 2010, “A business model is… a reflection of the firm’s realized strategy” (p. 195). An ultimately, Teece (2010, p. 179) defines a business model as “the logic, the data and other evidence that support a value proposition for the customer, and a viable structure of revenues and costs for the enterprise delivering that value”.

Probably, the simplest definition found is given by the University of St. Gallen. A business model provides answers to 4 questions:

1. Who is your target customer?
2. What do you offer to the customer?
3. How do you create the value proposition?
4. How do you generate revenue? (University of St.Gallen)

Fig. 1.1 Business model

Source: University of St. Gallen [1]

Business models in renewable energy (need to research more)

What is the basic business model of a renewable energy power plant or project? According to Green Rhino Energy (2013), the key elements of business models for electricity generators from renewable sources are the revenue streams, cost structure and the way it is financed. With the exception of biomass and biofuels, working capital considerations are not as important (once in operation) due to low fuel and maintenance requirements.

The revenue model. The most significant revenue stream comes from selling electricity to the grid, either at a fixed price (guaranteed feed-in tariff) or a market price. If the installation is not grid-connected, the savings from not having to purchase electricity from other sources improve net income in the same way. The project may also be able to generate and sell renewable energy certificates or carbon emission reduction certificates, depending on the country.

The operating model. There are few operational expenses, as maintenance fees tend to be low, although some technologies may require major maintenance half way through the lifetime of the plant – for instance inverters in solar plants may need to be replaced well before the modules. Tax only needs to be paid after the investment has been fully depreciated. All other flows are dependent on the way the project has been financed.

The investment model. Renewable energy generators require an up-front investment, which may be spread over the duration of the construction. Once operating, no further injections of capital are required unless a major incidence happens, which can be avoided if cash is kept in a major incidence account, funded from current cash flows. The most common financing structures and how to choose between them are outlined on the following pages.

[1] Source: Website: University of St.Gallen – Business Model Innovation (https://www.youtube.com/watch?v=B4ZSGQW0UMI&feature=youtu.be😉