When Should You Innovate Your Business Model?

In my book Seizing the White Space: Business Model Innovation for Growth and Renewal, I tried to distill the question of when to innovate your business model into a specific set of circumstances. But it can never be a cookie-cutter exercise. It's always going to come down to judgment and perspective, thinking through the specific situation of your company. There are just too many moving parts to say in perfect confidence, "OK, well, we're in this situation, so we're going to fundamentally change our business model, and we need to set up a separate business unit." It doesn't work that way.

What I suggest in the book is that strategists need to think first about the external circumstances and then about what you may or may not need to change in your company. This thought process will help you decide if what you're talking about is fundamental business model change.

So, what are the external circumstances that might suggest it's time to innovate your business model? They can be grouped into threats and opportunities.

External Circumstances: Threats

First, there are two basic threats to the incumbent business that require the business model to be changed. Or, as Peter Drucker would say, times when "the theory of the business is no longer working."

One of those threats is the process of commoditization. Generally speaking, industries go through a fairly predictable progression, in which the basis of competition moves from performance—making the better widget—to reliability—that is, making that widget more reliable, longer-lasting, and more durable— to customization and convenience—making multiple different widgets and making them more convenient and customized for individual tastes—to, eventually when all of that's said and done, pure commoditization, when everyone's competing only on price and cost.

In the evolution of that lifecycle, business model innovation starts to play a role at the point when you get to customization and convenience, and is fairly imperative as a way to escape commoditization. A great example of the convenience play is Dell Computer (DELL), which came into the personal computer market and said, "We're going to make a play for convenience and customization" and introduced a fundamentally different direct-to-customer, manufacture-just-what-the-customer wants business model to the personal computer industry.

Xiameter is a good example of escaping the profit-killing effects of commoditization. Dow Corning, longtime maker of high-end silicon products sold through a high-margin, high-touch business model, created a whole new business called Xiameter to address decreasing demand for technical support among some segments of its customer base. Rather than cede those customers away to a competitor, it created a radically different business model in which it lowered costs, not only by stripping away support (which would just lower its margins) but by sourcing its product on the spot market, thus dynamically lowering its costs.

The point is two-fold; Xiameter didn't try to address this new customer need by shoehorning it into its existing model, which would never have worked. And it didn't put its head in the sand and say, "Well, we can't serve those customers profitably, so we won't, and we hope no other competitor does either."

Classic disruption is the second threat to the business that would require a new business model. Take the classic case of the old integrated steel mills when they confronted a disruptive threat from small minimills, which had worked out a way to produce lesser-grade steel at far lower cost. The big, integrated mills had two choices. They could either have passed along all that low-cost business to the minimills (which is, in fact, what they did), or they could have said, "Well, we're being disrupted, so let's come up with a whole new business model to address that." If they had gone with option two, they might have survived when the minimills improved their quality and ate up the entire customer base from the bottom up.

Those are the two clear-cut threats that require new business models, and they are circumstances in which incumbents find themselves in a reactive mode.

But companies can employ business model innovation proactively as well, not to counter threats but to create or capitalize on opportunities. In that case there are two particularly fruitful circumstances as well in which a new business model can enable a business to take advantage of opportunities.

External Circumstances: Opportunities

The first opportunity is the chance to "democratize" a market—that is, to open it up to people who have previously been entirely shut out— because all current alternatives are either too expensive, time-consuming, complicated, or inaccessible for them. To use the computing world as an example, we went from mainframe computers to minicomputers, to personal computers, to laptop computers, to netbooks and handhelds. And each of those democratizing moves, where computing became more ubiquitous and accessible to more people, required a different business model. There's a lot more to it than that, but that's a fairly simple example.

The final circumstance in which business model innovation is needed is to capitalize on an internal innovation that doesn't mesh well with your current business model. Xerox PARC (XRX) is the classic sad example—scientists there famously came up with the graphical user interface and the mouse. But those technologies would have required Xerox to take a different approach than just saying, "How does this apply to copiers and the copier business model?" So those technologies ended up in the Apple (AAPL) computing business model. The Ethernet technology went into 3Com, and Adobe (ADBE) used the PostScript technology when it started up.

Really, those technologies required three different business models. Xerox wasn't willing to come up with new business models and therefore didn't end up with any part in commercializing any of those technologies.

Internal: Look at Your Current Business Model

The only way an individual company can determine for sure whether aparticular threat or opportunity requires an entirely new business model is to work up an initial estimate of the business model that could capture the new opportunity (or address the threat) and compare it with its current model. The Swiffer, for instance, although it was highly disruptive to the traditional mop makers, fit squarely within Procter & Gamble's (PG) established model for making and distributing household consumables in high volume.

That's why it's imperative that companies judge opportunities and threats first according to their own capacity to meet them—that is according to how they fit with their own business models—rather than according to how near or far the opportunity might be to competitors. Going after a seemingly lucrative opportunity with the wrong business model is the reason so many companies fail in their efforts at transformational growth. Failing to respond to a disruptor in your market because it requires you to develop a new business model can be suicidal, as the big integrated steel companies found out.

Conversely, though, failing to grasp opportunities like P&G had with Swiffer to disrupt other markets using your current business model is just throwing money away—something companies can ill afford in the current economy. That said, if the opportunity requires a business model that features smaller margins, a much smaller overhead structure, or a dramatically changed resource velocity (that is, a dramatic change in the speed with which assets need to move through the business system), it's a good bet that it can only be addressed by setting up a separate unit to run this separate business model.

The same goes for models that need to run under different metrics, norms, or business rules (different gross margins, unit pricing, unit margins, quality measures, time to break-even, individual rewards and incentives, etc.). That's a lot to take in, but the bottom line is that when addressing that big, big question of when business model innovation is called for, here's how best to think about it: Match the four external circumstances to the internal capabilities of your current business model. If responses to those circumstances require changing any of the things I've mentioned above, then you're probably not just looking at a tweak of the business model, but something fundamentally different.

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