Survival of the fittest in business

The brutal reality of competitive markets means that for most companies the chances of long-term survival are slim. The Darwinian process of corporate evolution leaves few firms standing. Only four from the original 1935 FT 30 index remain in today’s FTSE 100: GKN, Imperial Tobacco, Rolls-Royce Group and Tate & Lyle.

Although many firms fail to adjust their businesses to meet changing consumer expectations, some move with the times and even adapt to disruption in their market. Take Nokia, one-time rubber boots and paper products manufacturer turned smartphones giant. Or IBM, which has embraced the electric tabulating machine, electronic typewriter, mainframe computer, personal computing revolution and the advent of the internet in its long history. Or once niche PC firm Apple, now morphed into a producer of iPods, iPhones and iPads and the biggest company by value in the world.

What differentiates these companies from those that fall by the wayside is the willingness to critically examine the way they do business and the ability to undergo successful business model innovation (BMI).

The concept of the business model has been with us for a long time, although the phrase was popularised more recently. “The term first appears in academic articles around the mid-1950s and then disappears. When we have the dot com boom in the 1990s, it reappears in the context of organisational structure and new ways of creating networks,” says Dr Katy Mason, senior lecturer at Lancaster University Management School (LUMS) and co-author of Using Business Models to Shape Business Success. “At the time, people were talking about virtual companies and virtual networks, and the term business model is used increasingly as people try to find a language to talk about these new ways of operating and structuring businesses.”

Despite the term’s common usage there is no single agreed definition. “Most simply it is a way of turning capabilities into money, whether you make things, deliver services or sell things, need things, or do it all yourself or in collaboration with someone else,” says Mason.

Business models provide an effective way for business leaders to understand and shape an organisation’s activities, capture elements of organisational strategy, bring them together in a coherent and cohesive manner and create and capture value for the firm, says Mason.

Together with co-author Martin Spring, Mason offers a framework for thinking about business models focused around three central elements: technology, network architecture and market offering.

One useful way of thinking about business models is through the lens of innovation. Business models change as people find better ways of leveraging the capabilities of the organisation, usually via advances in technology. Typically, BMI is incremental. But occasionally radical BMI is required, often in response to external market threats such as the introduction of the internet.

In the early 1900s, for example, audiences watched films in a cinema. Later, television allowed people to watch them in their own home. Videotape technology led to the video rental market. DVDs replaced videotapes, but the business model was the same, and the video rental store business model remained successful. Automated DVD kiosks followed. Then the internet helped to establish a business model to send and return DVDs by post. Now businesses are piping video on demand (VoD) to homes via the internet.

Thus the movie-viewing market has seen periods of business model evolution and revolution. Market players have changed. Some have adapted, others have vanished. Today major Hollywood studios vie with cinema operators, supermarkets and online retailers to capture value from the VoD market.

A good example of how BMI changes business and industries is the so-called servitisation of product makers and suppliers, whereby manufacturers evolve from traditional business models to adding a service element. Some corporations may transform themselves to become a provider of complex services.

It is phenomenon explored in the white paper 'From Processes to Promise – How complex service providers use business model innovation to deliver sustainable growth' by Andy Neely, director of the Cambridge Services Alliance (CSA) at Cambridge University, and Ivanka Visnjic, business models research lead at the CSA and assistant professor at ESADE Business School in Spain. Visnjic and Neely argue that for complex service providers at least, BMI (a non-linear process) consists of essential elements that managers need to understand thoroughly before beginning to innovate their business model.

Business models, in the BMI framework they describe, have two components – the value proposition (the offer to the end customer and what the service provider is accountable for) and value delivery (how that value proposition is delivered).

In addition, becoming accountable for the value proposition creates additional levels of risk for the service provider – the accountability spread – which must be managed appropriately.

The move to accountability reflects the direction in which the business models of many organisations are heading. There is a shift from transaction (providing a product) to relationship (becoming accountable to a customer for a promise to do something).

Take Rolls-Royce’s business model shift from selling aircraft engines to charging a fee for its engines on an hourly basis, accompanied by a promise to maintain and replace it in the event of breakdown.

Moving to a model of accountability for promises also enables the company to turn to other members of its ecosystem to help fulfil that promise more efficiently and effectively. (The ecosystem is the environment within which the service is provided, consisting of those organisations that have an impact on the service provider’s ability to create value – whether they be customers, partners or even market regulators.) Mason says, “The shift in the business model is that it has to focus on the business network, so it’s looking at the network from the outset. That’s a key difference.”

The finance function plays an important role in BMI and the growth of outcome-based contracting has implications for it. “You end up changing the nature of contracts, of payment terms, of the risk the organisation faces because there is often more at risk in the contract if you do not deliver the desired outcomes,” says Neely. “So finance has to engage in some fairly careful design and understanding of the contracting mechanisms and the potential cashflow implications for the business and the risk profile that emerges.”

Another key area for the finance team is encouraging innovation in the value delivery system. “If you accept that part of business model innovation is about doing things differently and looking for new and more efficient ways of working, finance has a really important role to play in enabling the right strategic investments to allow innovation to take place,” says Neely.

Tensions can arise between functions and units as a result of BMI. There may be concerns about cannibalising existing business. Improvements in servicing products and extending their life mean there is less need for consumers to buy new products. So it’s important to encourage and promote collaboration between different parts of the organisation.

There is also a question around BMI of the finance function and how to make it more useful to the organisation and its decision-makers. Smart organisations collect increasing amounts of data and build sophisticated systems to analyse that data in productive ways.

“There is a key challenge around information and analytics. Finance has a big role to play in ensuring the right data is captured, ensuring the quality of that data is adequate and building the organisational capability to make use of that data to inform real operational decisions,” says Neely.

It may be a powerful route to sustained success, but BMI is rarely a straightforward option. Generating ideas is the easy part. Implementation is likely to cause problems, says Costas Markides, strategy and entrepreneurship professor at London Business School, author of books and papers on strategic change and an expert on BMI.

“The established competitors have been operating with a certain business model for years. Then all of a sudden all these major changes happen around you. At the rational level the company will recognise the need to re-evaluate its business model and the way it operates and maybe change it. The problem is going beyond thinking about it and actually implementing anything. It is very difficult to change,” he says.

A company may develop a fundamentally different business model to the existing one but not abandon it, according to Markides. It ends up with both existing at the same time. But the new business model tends to conflict with the old one.

“The organisational environment – the culture, incentives, metrics, structures and process – all those may change as result of changing your business model. You have to think about all those things,” says Markides. “And there is no single right answer. Whatever you decide has its inherent problems and difficulties,” he adds.

What does improve the prospects of successful implementation, adds Markides, is senior management buy-in and involvement and the flexibility and agility to respond and change tack as required during implementation, depending on the information available at the time.

BMI, certainly on a radical scale, may be a daunting prospect for many organisations. But failing to innovate the business model could be even less palatable – as many thousands of organisations have discovered to their cost.

• From Processes to Promise – How Complex Service Providers use Business Model Innovation to Deliver Sustainable Growth; Ivanka Visnjic, Andy Neely; Cambridge Service Alliance, September 2011
• Reinventing your Business Model; Mark W Johnson, Clayton M Christensen, Henning Kagermann; Harvard Business Review, December 2008
• What to Do Against Disruptive Business Models (When and How to Play Two Games at Once); Costas Markides, Daniel Oyon; MIT Sloan Management Review, July 2010
• Using Business Models to Shape Business Success; Katy Mason and Martin Spring; Advanced Institute of Management Research, 2011

• Survival of the fittest in business
  Finance & Management Magazine, March 2012

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