Technology and Business

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The more of talk; the more of confusion

An example is worth half-a-thousand words

Looking into two directions

Bridging the two worlds

(Author’s note: The term product is used in a generic sense; it refers to a usable entity.)

"Confusion” is the word that comes to my mind whenever I think of the term “Business Model”. It is one of the most loudly discussed topics, especially since 1990s. Most (or should I say almost all) of the research literature over this topic contain two arguments without fault,

The first argument is somewhat like –

And the second argument is somewhat like -

The more of talk; the more of confusion!

There are loads of research papers and published resources that talk about the concept of business model as well as the confusion over the topic; and sometimes cause more confusion as different authors take different views.

A scenario reflecting first argument above is well illustrated in a paper from Osterwalder et al [3]. In a survey conducted to know how different people understand the term business model, from 62 participants they received 54 different definitions! Moreover, the paper mentions two very important facts about divergent understanding of the term –

1. Technology-oriented and business-oriented people tend to define the term differently.
2. Most of the definitions can be categorized into two broad groups as value/customer oriented (outward looking approach) and activity/role oriented (inward looking approach).

Business model is often confused with another important concept called strategy. This confusion is mainly because strategy closely follows business model; but business model is not strategy per se. Another misconception about business model is that it is considered as an attribute associated with a company e.g. Dell business model. Business model makes more sense when it is associated with a product than company as a whole. A company can have different business models for its different products.

(Source: Osterwalder et al May 2005)

A literature survey had been done by Osterwalder et al [3] to find out occurrences of the term “Business Model” in scholarly reviewed journals. The above graph depicts those findings; it looks like the term has got more and more attention towards the end of last century. Anyways, the first argument above is not the focus of our discussion here. What we are more concerned about is precisely the second argument above.

An example is worth half-a-thousand words!

In the simplest form, business model is nothing but seeking answers to two extremely important questions –

[1]. Who all are involved in making a product successful?

[2]. Do they have enough motivation to do so?

I think these are the questions that decide fate of a product more than anything else. As Joan Magretta perfectly points it out in the HBR article [1], one needs to have insight into human motivations in order to have a fairly convincing answer to these questions. A business is basically a collaborative activity and its success depends on how effective the collaboration works out. A product essentially shares the same culture. Its success depends on effective actions and interactions among different actors involved in that collaboration like producers, distributors, consumers etc. If there is no attractive incentive present to any of the actors involved, we can’t expect effective contribution from that actor.

Let’s consider a simple fictional example to make the explanation more concrete.

Alright, so we have a product idea and associated technology with us. What we need is a business model to create a business around this product. Let’s say we decided a business model something like the one below –

VirtualCorporateWorld.com will allow individuals as well as companies to participate. These web-users can register and become virtual citizens and can also start virtual companies. They will have to pay a reasonable registration fees during registration; and a small annual/monthly subscription charges as they continue to use the product. In return, individual users will have a place where they can enjoy, learn and more importantly test their intuitions about business related activities. Companies have even better returns; they can test their strategies before implementing those in real corporate world. Companies can try launching different products and get a feel about response from people. It will help individual users and companies to try out different things that they would not have in real corporate world due to fear of failure or uncertainty of success. Though it is a virtual world, as participating entities are real, it will simulate fairly realistic experience. Once they see their strategy works well, they can be more confident to implement it in real world. This product will not only serve as an enjoyable and learning resource but will also prove as a test-bed to check important strategic actions. (#words = 191)

Hmm … looks like a win-win game for everyone. Will the above business model work? Obviously no! There are some major flaws. First, the product needs a larger user-base in order become really useful. But before reaching that step, why would a user bother to register by paying hard money. Same is applicable to companies; unless the platform is crowded by millions of users and at least hundreds of other companies, it can’t really become useful to them. This will pose a long known chicken-and-egg problem. Another flaw comes even before asking the question whether users will register or not; how will they know about this platform in the first place. Advertising and marketing aspect was missing. Just advertising won’t be much helpful too as today it has become a lot difficult to get recognized through advertisement alone. If there is some attractive incentive for people who bring more participants then it can trigger a network effect. Third flaw is related to pricing strategy. In above business model, every user is charged same amount irrespective of how useful the product to a users is. Companies have better returns than individual users; also users involved in business activities have more benefits than average user. Fourth one is there is no thought about avoiding somebody else replacing this product with similar idea i.e. strategy to differentiate.

If we note, we have simply identified different actors involved into making this product successful and argued if they have enough motivation to do so. First actor is MakeLifeEasy Inc. itself. They do have enough motivation to implement the product. Second actor is advertiser. Advertisers may have monetary motivation but we can certainly think of some additional attraction e.g. Top 5 advertisers driving maximum users to the product will get an opportunity to advertise themselves in the virtual corporate world free of charge. Third actor is marketer. Web-users could be best marketers for this product. A MLM (Multi Level Marketing) concept can be used to motivate them (e.g. agloco.com). Fourth actor is consumer. There is a motivation i.e. usefulness of the product per se but if we think deeper, its usefulness depends on its usage. More the number of users and more the number of hours those users spend inside, more useful the product becomes; and there is no strong motivation to cause that. Of course interest of user in business activities can be an internal motivation but there is no external motivation as such. Fifth actor is competitor. I know it sounds a little weird but competitor is an actor on whose actions success of the product depends. A negative motivation needs to be posed to this particular actor.

Alright so here is another version of business model. Here we support our arguments with related statistics. We try to pose enough motivation to consumers here; similarly, MakeLifeEasy Inc. can do other required data analysis and think of motivations for the other actors involved.

This product is mainly useful to students, faculties and professionals with interest in business management and investment areas. Considering internet users statistics, about 65% web-users fall into these category. Given existing similar products and their limitations, we are targeting around 15% of those web-users initially i.e. about 20 million users as approximately this percentage of users are interested in investments and corporate strategies both. Users can register and become virtual citizens and maintain their citizenship as long as they want free of charge i.e. they don’t have to pay any registration and subscription charges. Additionally, every registered user will be initially provided with virtual money of $1000 that can be used to enjoy buying/selling of stocks and products; once this amount is exhausted user needs to buy virtual money to continue virtual transactions (Real $1 = Virtual $1000). In order to avoid users registering multiple times to enjoy free virtual money, depending on (number of hours spent), (number of activities) and (virtual citizenship period) they will be granted certain privileges like starting a company etc. Another way to have the privilege to start a company is through premium registration (a paid option). Once some thousands of users start using this product, those statistics can lure managers and owners of real world companies to participate. With their participation, virtual corporate world will start getting more realistic and more useful. In turn, it will attract more users and the exponential growth stage will soon be reached.

Given the data from various resources and pessimistic assumptions for first year as –

1. Approximately 10% of target users start using the product.
2. Approximately 1% users will opt for paid membership.
3. Approximately 20% of users will buy virtual money 3 times, 27% for 2 times, and 35% for 1 time.
4. …

Note: Numbers and statistics used are totally random and just for the sake of conveying the point.

Now, this is by no means a full-proof business model but at the least it clarifies the point that “A good business model is an essential ingredient of business success.” On the other hand, it shows how a bad business model can hamper chances of success irrespective of how good the technology alone is. Point worth to mention here is that these answers have to be fairly convincing. Of course, fairly is a subjective measure but the answers need not with accurate numbers and statistics at this stage. More than those numbers, what is to be focused here is the insight into human behavior and ability to make right judgment. Elements of business model have been extensively discussed in research literature. I found the elements described by Klaus Gaarder in the research paper [2] pretty much convincing and concise.

Looking into two directions

So far we have discussed application of business model concept in single direction; there are two directions in which it could be applied. I would name them as – Forward and Reverse directions. Companies can come up with or adapt an existing or revise their already implemented business model to make their product more successful; this is precisely what I mean by the forward direction application. In forward direction business model is treated as live entity that needs to be revised consistently. There are different measures of success for a product; those measures, in a way, give feedback about how good the business model is working in the field. Over time the company may need to tweak or redefine their business models as situations demand. Now let’s do about turn and see into another direction. This application of business model is to analyze and understand success or failure of products of a company; it’s similar to reverse engineering methodology. In this view, business models have also been pursued as a simplified view and common language for analysis of businesses. Categorization of business models has been one of the hot areas of interest, in this direction.

Again, there exist too many schemes and views towards business model categorization. The one that, as authors claim, looks “intuitively sensible” and “mutually exclusive and collectively exhaustive” categorization scheme is from a MIT research paper by Thomas Malone et al [4]. They categorize business models into 16 different categories using a 4*4 matrix. The matrix below shows those 16 categories with an example product for each business model category. Row and column attributes together form a business model category e.g. Physical-Creator is a business model category and so is Intangible-Distributor. Row attributes indicate asset rights being sold

• Creator: Product manufacturers who sell product ownership rights to buyers; buyers can then do whatever they want to do with that product.
• Distributor: Wholesalers-retailers who buy products from manufacturers and without modifying much of it, they sell ownership rights to buyers.
• Landlord: Product owners who grant limited period and limited usage right of a product to buyer.
• Broker: Intermediate entities involved in connecting buyers and sellers; once committed sellers can’t sell the product bypassing brokers.

Column attributes indicate type of asset involved. Categories are pretty much intuitive from their names; still for further clarifications please refer [4].

(Source: Malone et al May 2006)

I would reiterate here, to stress upon, the point that business models make more sense when associated with a product and not with company as a whole. The examples given here are of products and not of companies as whole. For example, Bank of America (BOFA) provides “loan services” product which fall into financial-landlord business model; but it’s not the only product offered by them. BOFA offers “investment services for individual investors” product as well and that product would fall into financial-broker business model.

Business model categorization has helped to answer questions like “does specific type of business models perform better than others financially?” In a sense, categorization helps to focus on important characteristics of a business model per se keeping product specific details (with which the model is associated) abstract. It gives us an important ability – the ability to compare business models.

Bridging the two worlds

[1] Joan Magretta – “Why business models matter?” (May 2002)

[2] Klaus Gaarder – “Business Models – What are they and How do we design them?” (October 2003)

[3] Alexander Osterwalder, Yves Pigneur, Christopher Tucci – “Clarifying business models: Origins, present and future of the concept” (May 2005)

[4] Thomas Malone, Peter Weill, Richard Lai, Victoria D’Urso, George Herman Thomas Apel, and Stephanie Woerner – “Do some business models perform better than others?” (May 2006)