Thursday, October 12, 2006

Business Model Innovation

Business model innovation has captured the attention of executives tasked with achieving growth in the face of increasing competitive pressure. Business model innovation suggests that if you took an existing product and repackaged how you sold it, you can hold off competitive pressures and even capture entirely new market segments. For obvious reasons this is attractive to companies, but when a company’s brightest are tasked with finding ways to innovate their business model, they’re often forced to make it up as they go along.

What’s needed is a how-to manual for business model innovation.

Below I explain what a business model is and how it can be differentiated by comparing Netflix with Blockbuster. After giving a high-level overview of business model innovation, I’ve provided a list of steps to go through to arrive at business model transformation.

Netflix vs. Blockbuster, a comparison of business models
Suppose you’re over at a friend’s house for dinner on a Saturday evening. After dinner, you settle down in the living room to watch a movie. The movie, however, turns out to be a real bore and as your mind wanders, you begin to wonder…did my friend rent this from Netflix or Blockbuster?

From just watching the movie, you wouldn’t know where it came from. Both companies sell exactly the same product. So what makes these companies different? The answer: their business models.

What makes up a business model? Let’s answer that by reasoning through why anyone would buy from Netflix when practically every town in America, big or small, has a Blockbuster. The first person to rent from Netflix must have done so for a reason. Netflix offered some advantage over Blockbuster; it solved some deeply-rooted, unmet need among Blockbuster consumers.

A business model can be thought of as the way that a seller transacts with a customer. Some business models are less consumer-friendly than others. Netflix picked up on the discontent Blockbuster customers felt about late fees and they offered a business model that got rid of them. There are now many happy Netflix customers, and I am among them.

But is the Netflix model the be-all end-all of business models for DVD rental? To answer that question, we simply need to ask whether or not consumers have any unmet needs with regard to the way they do business with Netflix.

There are indeed many Netflix customers who are very unsatisfied because of a problem they are calling “throttling.” In fact there is a whole blog out there called www.hackingnetflix.com that has helped expose how Netflix becomes gradually less responsive to its most avid users, a problem that has become known as “throttling.”

In addition, many customers complain about discs arriving scratched. Now with the Blockbuster business model, a customer can just go back to the store to get another copy and finish watching the movie that night. With Netflix, if it’s a Friday night, you’re not going to get to see the rest of that movie until Wednesday. Bummer.

As illustrated, the definition of a business model is the way a supplier transacts with its customers. Business model innovation focuses on addressing unmet needs on the part of consumers who dislike some aspect of an existing business model for an existing category.

As with so many other types of innovation, business model innovation comes down to what my dear old professor Eric von Hippel taught me at MIT: market needs drive innovation.

Business Model Innovation: How-To
How then, can companies go about innovating their business model? I would like to invite my fellow innovation bloggers to share their ideas, but I think business model innovation consists of the following steps:

  1. Identify the market category
  2. Gain insight into what the market dislikes about incumbent business models for that category
  3. Scout for business models that address those problems in adjacent industrie
  4. Take action

There are different ways of obtaining the information needed for each of these steps. The market category in question would be your own market category if you’re seeking to innovate on your own business model. But if you’re an entrepreneur that’s not tied down to any existing product or market, you could pick any market category where you’d like to investigate opportunities for business model innovation.

The second step involves gathering insights about unmet needs. Ethnography is one way of doing it, if you have the time and resources. But more and more, people are turning to the Internet for those types of insights.

The third step is very much like technology scouting. That is to say, a business model is just another form of intellectual property, or I-Stuff, as Suzanne Harrison describes it in her new book, Einstein in the Boardroom.

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