When talking about business models with someone who is experienced in strategic management and especially familiar with the theories of Michal Porter, I often hear the following questions:
- Is a business model the same as strategy?
- How do business models relate to the domain of strategic management?
- If we already have the well-defined and thoroughly researched field of strategic management, do we need business models at all?
- Aren’t business models just another view in strategic management, such as the resource- or market-based-view?
And also very often I hear that business models are just “toys”, lacking profound theory and scientific resarch.
As you might guess, I strongly disagree with this statement. To make a long story short: In my opinion business models are a necessary extension to the field of strategic management, which alone is incapable of dealing with the massive market disruptions we see today. These disruptions are very often triggered by the digital economy. It’s true that business models slightly overlap with some aspects of strategic management, but all in all there are much more differences than similarities. So where does this confusion come from? Well, although the term business model is used very often today, and often interchangeably with strategy, it is not really well defined. Have a look at these statements:
Business models describe, as a system, how the pieces of a business fit together
(Magretta, Joan: Why Business Models Matter. In: Harvard Business Review on Business Model Innovation. Harvard Business Press, 2002, p. 1–17)
Strategy defines how all the elements of what a company does fit together.
(Porter, Michael E.: How Competitive Forces Shape Strategy. In: Business Strategy Review 57 (1979), Nr. 2, p. 137–145)
Quite similar, aren’t they?
But Magretta also noted:
“[...] But a business model isn’t the same thing as a strategy, even though many people use the terms interchangeably today”.
(Magretta, Joan: Why Business Models Matter. In: Harvard Business Review on Business Model Innovation. Harvard Business Press, 2002, p. 11 and 17)
I agree with Magretta that the most important job of a businesss model is describing the core logic of a company. What it doesn’t describe is the execution context of the business model. This is the job of strategic management.
Let’s examine this statement a little further: Business models are static in nature and describe what value proposition a company offers, which key resources and key processes it needs to build this value proposition and how revenue and profit is generated. It says nothing about the context or environment in which the business model is executed. A business model is agnostic to that. In particular, says nothing about:
Markets and competition
This is the domain of the market-based- and competitor-based view of strategic management. The market based view concentrates on the market a company operates in and the competetive landscape. It therefore sets the focus solely on external aspects. This view was popularized by Porter, along with his Five-Forces model. Though Porter’s views and statements will be discussed in a separate article, I want to say that I’m not a big fan of Porter and his theories. For one, the market based view does not focus enough on one of the most critical aspects of a business, and that’s the customer. Analyzing competition and markets is important, but the customer comes first. I agree more with Peter Drucker in this aspect (you can find literature by Drucker in the library).
So, if you have a great business model, how do you get started? In particular, where do you get the money from? And how do you use it? What is your cash burn rate, your time-to-cash and your time-to-out-of-cash? How much money do you bring in, and how much do you need from outside. What interest rate would you accept, and how many shares are you willing to give for initial funding. These are all questions the finance-based-view tries to answer. It’s aim is to achieve a superior capital structure through financial engineering. Business models only care about what costs are involved in creating the value proposition and what revenue streams can be achieved. Thus, they only cover a small fraction of what the finance-based-view looks at. But, in my opinion, optimizing finances is the second step, after having implemented a working business model.
Environment and Institutions
In a globalized world, the importance of environment and institutions is ever increasing. The term institutional-based view was popularized by Peng et. al. (Peng, Mike W.;Wang, Denis Y.; Jiang,Yi: An institution-based view of international business strategy: a focus on emerging economies.In: Journal of international business studies 2008(2008), Nr.39, p.920-936). For the authors, institutions govern societial transactions in the fields of politics, law and society. In that sense, the institutional-based view analyzes aspects of the execution context of a business model. A business model that works well in Spain might fail completely when executed in, say, China. This can be due to different laws, or different societal or cultural aspects. If you’re interested in this topic, check out the works of Gert Hofsteede who studied the “cultural distance” between countries (Hofstede, Geert: Culture’s Consequences: Comparing Values, Behaviors, Institutions and Organizations Across Nations. Sage Publications, Inc, 2001).
So why do business models exclude all these things, from which some might say that they are critical for success or failure of a business? Two reasons: First it would clutter the pure view on the core logic of a business. Second, and more important, the mentioned aspects are not as relevant today as they were, say, 15 years back.
How do you define a market? There are still many traditional markets, but especially in the digital domain market categories seem to vanish. In which market would you put Amazon?
- Sales platform?
- Datacenter / cloud operator?
Is YouTube just a platform for watching funny videos, or does it compete directly with TV-stations? What about TVs with built-in internet access where you can watch YouTube in your living room instead ?
Patrick Stähler states that since markets are changing so rapidly today and market boundaries become blurred, the market-based-view is not a tool anymore, but a hindrance to (disruptive) innovation. Disruptive innovation more often than not creates brand new markets, and the market-based-view is no longer able to detect those opportunities (see Stähler, Patrick: Geschäftsmodelle in der digitalen Ökonomie. Merkmale, Strategien und Auswirkungen. Josef Eul Verlag, 2002).
Raising a lot of cash also does not play a major role in starting your business anymore. You sure need cash when you want to scale your tried-and-proven business model very fast, but that’s just the second step. In the digital domain, you don’t need to buy costly inventory or do any other massive up-front invest. You need brainpower, good coders and a bright idea. Server capacity can be rented in the cloud. Offices are virtual today. Accounting services can be bought. And so on.
Environment and institutions: Well, this has some effect in the sense that not every business model works in all countries. Society, ethics and specific values of society come into play. But on the other hand, it was never been easier to implement a business and then roll it out to different environments.
I could add some more examples, but you get the idea: Business models are a representation of a firms underlying core logic, which is executed in a specific environment. Strategic management analyzese whether a business model can be executed in a specific environment or context, and may suggest changes to the model which then need to be validated.