A successful business model will achieve better results, will be more difficult to copy and outperform the competition. In this blog post, we present two approaches that you can use to evaluate an existing or new business model.
Decisions as a groundbreaking evaluation criterion
Companies make decisions when they develop or reinvent a business model. The impact of these decisions determines the success or failure of a business model. In particular, three types of decisions are relevant for the development of a successful business model:
- Company policy (policies): Decisions that have cross-company effects (employee air travel in economy class only)
- Property, plant and equipment (assets): Decisions relating to tangible assets of the company (e. g. production facilities)
- Governance: Decisions that determine how a company's decision-making structures are organized in terms of policies and assets (e. g. purchase of machinery or leasing).
What can you use to determine whether the decisions in your company lead to a successful business model? Essentially, four factors can be mentioned here:
1. The business model is geared to the company's goals
Decisions should have consequences that enable the company to achieve its goals. This may seem obvious, but practice shows that this is not a matter of course. For example, the Xerox PARC research center established in the 1970s developed technological innovations such as laser printing, Ethernet and graphical user interfaces. However, due to a lack of focus on the parent company's goals, Xerox PARC was unable to translate these innovations into new business models for Xerox.
2. The business model is self-reinforcing
Decisions taken by management in developing a business model should be complementary (internal consistency). For example, if a low-cost airline decides to raise the service to the level of an Austrian Airlines, this would have consequences for catering and the number of seats in the aircraft. This decision would undermine the airline's low-cost structure and leave profits in the basement. If decisions do not lead to positive reinforcement, the business model should be further developed by making new decisions.
3. The business model is robust
A successful business model should be able to maintain its effectiveness in the long term and avert danger. Pankaj Ghemawat identifies four risk factors that should be kept away from the company through appropriate decisions:
- Imitation: When a business model is copied or replicated, it decreases the value of the original (e. g. products made in China).
- Holdup: delays by customers, suppliers or other players in the value chain (negotiating power).
- Slack: Lack of employee commitment, inefficient use of resources, theft, high sickness figures, etc.
- Substitution: When other, new products reduce the demand for your own product (e. g. the old dial-up modem)
Although the periods of effectiveness are shorter today, robustness is still a critical parameter.
4. The business model generates positive growth cycles
A successful business model generates feedback loops that have a self-enhancing effect. This means: Decisions lead to consequences, which in turn enable new decisions, etc. This process creates growth cycles that strengthen the business model and develop a dynamic that resembles network effects. For example, Ryanair's business model creates success cycles by deciding on low prices and costs:
- Cycle 1: Low price high volume higher volume greater bargaining power with respect to suppliers lower fixed costs even lower prices
- Cycle 2: Low price high volume high capacity utilization low fixed costs/passenger even lower prices
- Cycle 3: Low price low expectations of service no food supply lower variable costs even lower prices
Another example is the Spanish producer Irizar. The company transformed the business model by making decisions that led to three consequences: a high degree of responsibility, satisfaction and trust among employees. In its decisions, the company focused above all on increasing employee loyalty and empowerment - by eliminating hierarchies, decentralized decision-making, strengthening teams and employee participation in the company. These decisions set in motion a growth cycle that produced an annual growth rate of 24 percent.
Comprehensive criteria for a successful business model
Another approach to evaluating your business model is Alexander Osterwalder's holistic approach. The focus of the evaluation is shifted from a pure product/service approach to a more holistic business model approach. Below are seven questions to help you evaluate your business model in detail. Scale the performance of your business model from 0 (bad) to 10 (excellent).
1. What is the effort for your customers to switch to another company?
The more time, effort or money it takes a customer to switch to another company's product or service, the more likely it is that the customer will remain loyal to a company. A good example of how switching costs were consciously implemented in the design of a business model is Apple's i-Pod launch in 2001, when the company advertised the i-Pod with the slogan "thousand sounds in a pocket". However, the product launch was not only about the product innovation "ipod". Apple pursued a business model strategy to encourage customers to copy all their music on itunes and the ipod to make switching to another music platform more difficult. This decision ultimately laid the foundation for Apple's strong position in the music sector and numerous other innovations.
2. How scalable is your business model?
Scalability describes how a business model can be expanded without increasing costs to the same extent. Software and web-based business models are naturally easier to scale than those based on physical values. But there are also major differences in digital business models. An impressive example of scalability is Facebook. With only a few thousand employees, an attractive product was created for millions of users. Only few other companies were able to achieve such a high rate of users per employee.
3. Does your business model produce recurring revenues?
When a magazine is sold in a kiosk, every sale involves an effort. A magazine subscription, on the other hand, generates recurring, virtually guaranteed revenues. Recurring revenues have two main advantages: the "sales costs" are generated only once and the company has a better orientation on how much it will earn in the future.
A nice example of recurring revenue is the software provider Redhat. The company provides open source software on a subscription basis. In this business model, customers do not pay for new software as it is constantly updated. Microsoft and other software service providers also use this business model. Other examples include printers and generating recurring revenues from the sale of printer cartridges. Similarly, Apple's sales of content and apps, which generate ongoing revenue compared to hardware sales, are growing.
4. Do you make sales with your business model before investing?
The more sales you make before you spend money, the better. For example, by changing its business model, Dell was able to escape the problem of depreciation costs by producing computers only after ordering and paying for them.
5. How much does your business model encourage customers and other players to create free added value for your company?
While others do the work for you, you earn money. IKEA has implemented this approach with its home-made furniture. Customers assemble their own furniture and IKEA saves a lot of money. Facebook is based on a similar basis, in that it merely provides the platform and leaves content production to the users.
6. How well does your business model protect you from the competition?
A good business model not only produces great products, it also offers long-term protection from competitors. Strong business models are difficult to compete. Apple's competitive advantage is based not only on its innovative products, but above all on its strong business model. For Samsung, for example, it is easier to copy the iPhone than to build an ecosystem such as Apple's App Store, which manages thousands of applications.
7. is your cost model substantially better than that of your competitors?
Saving costs is a common practice in cost management. Some business models go beyond this and place their cost structure on a different basis. Skype, for example, offers communication solutions that are comparable to those offered by a conventional telecommunications company - but free of charge or at a low price. Skype's business model is based on a cost structure that primarily includes personnel costs, while the telecoms company has huge spending on infrastructure.
Precisely for this reason, mobile communications provider Bharti Airtel also changed its cost structure significantly. The network structures are no longer operated by Ericsson and IBM themselves, but purchased on a variable cost basis. Adaptation of the business model makes Bharti Airtel one of the cheapest mobile operators worldwide.
Conclusion: How successful is your business model?
A successful business model must constantly create value for its customers and for itself. Therefore, even established companies have to constantly review their business models and further develop or reinvent them. The evaluation of a business model on the basis of entrepreneurial decisions and their effects provides a good basis for this. The detailed examination of individual company divisions on the basis of the Osterwalder questions provides additional insight into a company's competitiveness and reveals potential for improvement.
