Business model concepts: a review with case illustration

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1 Business model concepts: a review with case illustration M. Seppänen, S. Mäkinen Center for Innovation and Technology Research Institute of Industrial Management Tampere University of Technology P.O. Box 541 FI-3301 Finland Abstract The paper reviews what kinds of business models exists in literature and what kinds of consequences has been received when utilizing the best-of-breed business model in practice. The applicability of current business model concepts is illustrated with a case study. The future research should strive to build business model conceptualizations that are capable in aiding selection between alternative configurations of resources and capabilities. Keywords Business models, resource-based view, capabilities I. INTRODUCTION Technological evolution has driven products, services, companies and even industries into a trajectory of ever increasing convergence. In the last decades companies have recognized increasing need to partner with one another in order to build their competitive strengths in effective and efficient manner. These developments have resulted in increasing amount of alternative business models that companies can use in order to organize their business activities and increase value appropriation from their capabilities. However, existing research on the business model concept itself is not holistic, systematic and rigorous. Usually business models are built to a certain purpose in a certain context without comparative testing of differing concepts. The aim of this paper is to review the literature of business models and illustrate shortcomings of existing business models by a single case example. We present the state-of-the-art of business models based on literature review and compare how the selected business model suits to practical case. The aim of case was to build joint offering for one MNC and two small companies targeted to global markets. The research method was participant observing with extensive written documentation of the meetings and workshops. II LITERATURE REVIEW A business model should articulate the value proposition, identify a market segment, define the structure of the value chain within the firm required to create and distribute the offering, and determine the complementary assets needed to support the firm s position in this chain, estimate the cost structure and profit potential of producing the offering, give the value proposition and value chain structure chosen, describe the position of the firm within the value network linking suppliers and customers, including identification of potential complementors and competitors, and formulate the competitive strategy by which the innovating firm will gain and hold advantage over rivals. [1] In the literature the term business model is often used to describe the key components of a given business. Hedman and Kalling [2] pointed out that e-business model research could be organized around two complimentary streams. The first stream describes and defines the components of an e-business model [3-11]. The other stream develops descriptions of specific e-business models. [3, 7-11]. However, these streams seem to be overlapped to some extent. Another point of view in organizing business model research into streams is an architectural view i.e. how the model is constructed [See 9, 12, 13]. In this stream it is stated that the business model is an architecture that includes 1) a description of various business actors and their roles; and 2) a description of potential benefits for the various business actors; and 3) a description of the sources of revenues [9]. Information systems planning frameworks is utilized to classify e-business models using three dimensions: timeliness, community, and integration [13]. The authors aspired for identifying the key factors that would determine the information requirements of e-business. Similarly, a business model is defined as a coordinated plan to design strategy along three vectors: customer interaction, asset configuration, and knowledge leverage [14]. Furthermore, e-business model is also defined as a description of the roles and relationships among a firm s consumers, customers, allies, and suppliers that identifies the major flows of product, information, and money, and the major benefits to participants. [11] These streams and models, however, are in many cases constrained by their e-business origin. This creates contextual limitations that inhibit generalization of models to other lines of businesses. These limitations are less prominent in the highlevel explication in which a business model requires four choices that include the specification of [15]: A value proposition or cluster for targeted customers, A market space offering product, service and information, A unique, defendable system, and A financial model to generate revenue. As can be seen from the above review, the concepts of business models are in many cases heavily based on their originating stream of business or discipline. This creates a need for an unambiguous definition of basic constructs in order for the research on business models to advance the body of scientific knowledge. Recently, the definitions and problems associated with business models are suggested to be due to flawed assumptions concerning either the underlying core logic or the value X/05/$ IEEE. 376

2 network [16]. Moreover, misunderstandings about value creation and capture may take place sometimes and limitations of strategic choices are not always easy to recognize. Regarding the purpose of business models, we can easily share these thoughts and agree the view that business model can provide a powerful way for executives to analyze and communicate their strategic choices. An overview of the selected models All models presented and analyzed below have one thing in common: the logical reasoning [17]. We have considered logical coherence and consistency in relation to theoretical foundations of all the above-mentioned business model concepts [18]. Based on our assessment, we selected four business models for our study: 1) Amit and Zott, 2) Hedman and Kalling, 3) Gordijn et al. and 4) Osterwalder and Pigneur. Amit and Zott [5, 19] have outlined the sources of value creation in e-business (Fig. 1). Based on their analysis of 59 e- businesses, they proposed the business model as a unit of analysis. They described a business model as the architectural configuration of the components of transactions designed to exploit business opportunities. Amit and Zott [5] emphasized the importance of distinguishing a business model from a mode of generating revenues. The business model and the revenue model are complementary yet distinct concepts. A business model refers primarily to value creation, whereas a revenue model is primarily concerned with value appropriation. Subsequently, Zott and Amit [19] tested their modeling with 50 indicators. They found empirical support for suggestions that the design of a firm s business model is an important determinant of a firm s performance. The authors mentioned that models should embody two important features. The model must have causal inter-relations between the above-mentioned elements, a characteristic vital to any real model. However, it remained somewhat unclear how this causality should work. The second feature concerns time. The model has to be managed and developed over time as it evolves over time. Thus, the model must also include the process perspective, a longitudinal dimension. Fig. 2. The components of a business model. [2] With several co-authors, Gordijn [e.g. see 12, 22, 23-26] has developed ontology for e-business models. The registered trademark, e 3 -value TM, ontology contains concepts, relations, and constraints, describes actors and alliances between them, the exchange of objects of value, the value-adding activities and the value interface between them. Ontology is based on the analysis of economic value creation, distribution, and consumption in a multi-actor network. It is founded on requirements engineering and underlying conceptual modeling techniques, borrowed from the information systems community. Fig. 3 illustrates the basic concepts and relations of ontology. Recently, a modeling notation is presented that resembles quite much Gordijn s et al. business modeling technique [27]. This notation may offer alternatives for comparing different scenarios of that business model enables. Fig. 1. Sources of value creation in e-business [5]. Hedman and Kalling [2, 20, 21] proposed a generic business model that includes the following causally related components, starting at the product market level: customers (1), competitors (2), offering (3), activities and organization (4), resources (5), and supply of factor and production inputs (6). To complete their model, they also included a longitudinal process component (7), to cover the dynamics of the business model over time and the cognitive and cultural constraints that managers have to cope with (Fig. 2). Fig. 3. Concepts and relations of the e 3 -value ontology [12] X/05/$ IEEE. 377

3 Osterwalder and Pigneur (O&P) pointed out that the ability to create a big, transparent picture of a business and to externalize the relationships and dependences of business elements seems to interest executives and consultants. [See e.g. 28, 29-32] This is intelligible. The latest version of the continuum of these studies is presented in Fig. 4. It should be noted that the aim of authors was to enable the business model concept to be implemented into a computer-based tool, requiring a rigorous, ontological approach. Infrastructure Capability Resource Partnership Agreement Configuration Activity Cost Account Actor Product Innovation Proposition Offering Financial aspects Relationship Mechanism Channel Link Revenue Pricing Fig. 4. The O&P s business model framework [33]. Customer relationship Customer Criterion This business model consists of nine elements which are divided into four pillars. A business model has to address [28]: The Product: What business the company is in, the products and the value propositions offered to the market? The Customer interface: Who the company's target customers are, how it delivers products and services to these customers, and how it builds a strong relationship with them? Infrastructure management: How the company efficiently performs infrastructural or logistical issues, with whom, and as what kind of network enterprise? Financial aspects: What is the revenue model, the cost structure and the business model s sustainability? These four areas can be compared to the four perspectives of Kaplan and Norton s works [34, 35] on Balanced Scorecard and, more recently, the Strategy Map. Each pillar includes interrelated business model blocks (that is, the elements). III CASE DESCRIPTION In order to test business model concept in the real-life environment, we had an opportunity partake to a joint development project. The project aimed to create a new product and service concept for global markets in a network formed by three companies, a large multinational company (MNC) and two small companies. Participating firms locate in the same geographical area and they have quite long history in project co-operation. The project coordinator and activator was a local publicly funded science park. The project was, as earlier development projects oftentimes also, accelerated by public funding. During these projects, the participating companies were recognized an attempting opportunity for more profitable business which could be attained by collaboration. The first objective for this project was to find and define a joint value proposition. The actual joint offering for the particular target market could be based on this proposition of value. On the basis of earlier collaboration, it was in prospect that all participants actually do have capabilities and skills that would have a suitable fit together. A unique opportunity for the joint offering that is not able to achieve by operating separately, could have been built up. Even MNC was not able to achieve that kind of business mainly because of historical reasons. The main objective of the project was to build a business model for joint offering for the particular customer industry. Why companies were willing to expose themselves to risks of vulnerable collaborative actions? Companies earlier experiments, their in-house development and selling activities made evident that there would be demand. Of course, one alternative was to act as an individual supplier. However, especially small firms witnessed that there is an opportunity to notably faster growth than their internal resources would enable. Observations were made and they recognized the possibility that cooperation with local MNC would offer a selling channel and power for marketing and development. Moreover, combining resources was assessed as an imperative if they will pursue global markets. Their internal resources may be enough for sales and production operations in close markets and near close markets but for instance Asia is too far away. A globally operating MNC seemed to be an alluring alternative as a partner. In addition, the targeted customers are typically very large companies generating billions euros revenues. Even one that size Goliath will require enormous share of small company s resources and regardless of that co-operation may not be successful. Historically, MNC was mostly a product manufacturing company but nowadays it has encountered pressures for transforming toward more service-oriented company. A common belief has been that services selling will enable better profitability. On the other side, an intense competition has forced to search for new business opportunities. Being able to cope with tight price competition with existing physical products it became a necessity to find ways to differentiate their offering. Therefore, steps to this direction have been intimidated to some extent. In practice, there have naturally been other alternatives. The MNC could have carried out (at least MNC representatives are willing to believe this alternative) similar offering by its internal development. Actually, some years ago a part of the joint offering was already been developed by MNC s R&D department but time was not ripe then. Later on this product line was run down which, in turn, creates still some internal inertia at MNC. The project was launched to figure out how to organize collaboration and especially, how to organize production of joint offering. Confiding relationships between key persons involved in this project have been a pre-requisite to start with. The process begun by observations regarding each participant s offering and processes. Every participant has to have an understanding detailed enough what kind operations the triad was planning and developing. Especially important was that all do understand, what could be possible alternatives for dif X/05/$ IEEE. 378

4 ferent roles and combinations between participants. Also, what kind alternatives could exist to organize collaboration with three companies? Based on company-specific offerings, the first version of joint offering was formulated in writing. Later on, this version was updated to find better fit with refined thoughts. These refinements did not actually change the content of the joint offering but clarified its essence communicatively. Actual business model building was implemented by utilizing O&P s business model. This model was selected because it shares our view of the purposes of business model [1]. Amit and Zott [5] focused only on value creation, not to value capturing. Hedman and Kalling s model [2] is more abstraction construction and it does not suit joint offering of several companies. Gordijn s et al. model [12] could be possible one, because it has many similar elements with O&P model. However, O&P model was selected because it could be adapted more easily from the praxis point of view. Gordijn s et al. approach does explain how to model business but at the same time it utilizes fluid concepts (i.e., value model, value activity) which have many connotations. This might lead to difficulties in communicating between participants. During the development process observations were made how well the model selected suits for this purpose. In addition, it was also observed how the working process itself was going and what kind difficulties or obstacles were encountered. Thus, research method utilized was participant observing because researchers in a fact become change agents as Gummesson [36] portrays it. The working process was a typical roller-coaster of a project. Interests of the participants keep changing during the project. When the consensus of the joint offering was reached, workshops were started with each participant company concerning other elements of the business model. Customer side was screened by different segmentation criteria, keeping in the mind the context of the offering. Regarding infrastructure, one of the main questions were capabilities needed to fulfill offering. A one small company was mature enough with its production process that it could offer distinct procedure what activities and capabilities are needed to fulfill their part of the joint offering. Two other companies, a small one and MNC, have to carry out more internal process development to find out internal processes and right persons in charge. It became evident that to be able to discuss in a proper, very concrete level of their roles and responsibilities in the joint offering, participating companies must have their internal processes clear enough. Financial aspects were excluded from this project. It was considered as a contractual issue and before the contractual negotiations the participants should have common agreement about all the activities, responsibilities and roles of each one. Discussion about costs and revenues may easily lead to conflicts and as a one conflict resolutions method was seen a strong consensus regarding the whole of the business model. Possible revenue and costs sharing could be based on the roles and responsibilities at a later time. The common business model and operations plans with natural and distinct roles for each participant were reached in the end of project. The business model developed offers a good growth potential for future business if the participants are able to reach an agreement. IV DISCUSSION Quite soon when the development process started, it became obvious that most of the problems concern configuration of activities and resources between the participants. Because capabilities of them naturally have some overlapping, it is not obvious who should be responsible for what activities. However, using different illustrations communicating about participants needs and wants become easier and it enabled that discussion proceeded. Existing business models do not offered aid how to overcome these difficulties in role and responsibility issues. Moreover, it would be helpful if there could be reasonable definitions what elements or capabilities (i.e., resources) should be taken into account, and what kind of consequences will be certain decisions made in defining capabilities. Another lack in existing conceptualizations of business models was the intertwined nature of the elements and missing these links in the concepts. The business model conceptualizations, e.g. O&P model, do outline some links but these concepts do not give systemic picture on what decisions will lead to what outcomes and more specifically, the dynamical nature of changes between different elements in the models. For example, in the case description the definitions of alternative roles, responsibilities and capability configurations necessarily influence one another at the element level. In practice these relationships between elements must to be resolved and understood but current business model literature gives little or no guidance on the issues. In the case the O&P business model concept gives little guidance on building the value proposition and reaching agreement between participants in a partnership. As a part of value proposition the link between customer and partners was resolved and therefore presented no additional challenges. However, relationship between markets and customers was under a lot of debate since partners had differing alternative roles and possibilities to form these relationships. When considering differing roles and possibilities partners have with customers the logical next step was to consider responsibilities, activities, tasks and capabilities needed in order to fulfill the value proposition. The O&P business model concept gives reasonable guidance on the activities configuration but the links between activity and capability selections and responsibilities defined in contractual agreements are missing. This evidently is one of the weak points in business model concepts since practical resolution of building offering needs to consider the systemic nature of the whole operation, not just the elemental level of components that are needed in order to produce the value proposition X/05/$ IEEE. 379

5 V CONCLUSION The case example illustrates that existing business models do not consider enough how resource- or capability-based business model development should be carried out. Many of them are capable for illustrative modeling purposes but they cannot aid in implementation phase when company representatives try to negotiate roles and responsibilities of each participant. However, in practice the business model concepts do give guidelines and some items that need to be considered when configuring new business opportunities. Therefore, the existing concepts can be used as starting points in building new offering. Further research should be targeted to find out reasonable ways to define what are capabilities needed and especially, how configuration of these capabilities should be carried out. The ultimate aim should be developing a business model which can consider what causalities between different elements are and how these elements could be configured to achieve a particular outcome. The future research should strive to build business model conceptualizations that are capable in aiding selection between alternative configurations of resources and capabilities. Similarly research should be targeted in building rigorous elemental and causality links between elemental levels in customer side of the business model. REFERENCES [1] H. Chesbrough and R. S. Rosenbloom, "The role of the business model in capturing value from innovation: evidence from Xerox Corporation's technology spin-off companies," Industrial and Corporate Change, vol. 11, pp , [2] J. Hedman and T. Kalling, "The business model concept: theoretical underpinnings and empirical illustrations," European Journal of Informations Systems, vol. 12, pp , [3] A. Afuah and C. L. 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