Westland GIM_Business Models

8/3/2019 Westland GIM_Business Models

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LFARNINC OBJECTI\'ES

~ he .Ih le to lie ll lle.1 buvincvv model .Il ld kllow whcr« Iht'

l.tJll(Cpt i\ .tpplin.l ill .l\\c\\ing;\n innov.rrion

~ U lit ie r".llld \I h .I(.1 ',c ien rih c met hod' I;) r bu,il le" .m.ilvvi-,

n(inno\ .irio n mc.m-; ;llld rh .ir th i- , i- , dil1~Tl'llt (rolll "rrate~y

Beam me up

~ IIiH ic r'l. lll ll rh.u hu ,i n 'e" ll""le l, ~~li Ihcc.ur«: (he l C lil e ithe r

to tel! .1((lIl\iJ1l.:illg \r()r~' or to \upporr rh.ir \tory with

(oIlY llL"ing j-ill.1I1L'i.lllllllllhcr\

tnucprcncur l"Y W alkc l inv ent ed Pll ce line .co m , a

reve rs e a uc tion fo r .nrlm c ti cke ts, yO ll1 y on 10 ex tend

Il lS co nce pt 10 ho te ls. qroc cncs and petro l. Th e 's io rv '

a 5 W alke r to l d II wa s Iha l consume rs wo uld 11.'11im

how much Ihey wanted 10 pay lo r, S JY ,a fliyh l 10

80 11.Co nsume rs co uld spec ify the pncc bU I no t th e

au line . Pflcc lin e .c om w an ted 10 be ,1powe r broker lo r

md lv idua l consume rs , By r cprcs cnu nq th e de ma nd of

mil lio n s 0 1 c on sumer s , II w o ul d n cq o uatc disco unts

an d th e n p us s 0 1 1th e S JV IIlYS10 us cus tomers, Idk lfl g

a fe e m t he p ro ce ss .

l hr ou qh m os t o f th e dot-cum years, PI ICCIIllC 'S

o l hu o l s p ok e sp e rs o n w as Stnt trek': Wi ll iam Sh a tnc r,

w ho a qrccd to do the sp OIS l o r f ree m e xr ha nq c fo r

s tock rn the company . He W,IS l a le l 'rep laced ' b y h is

S ta r r rc k co-s tai, teo na rd N llno y (a lthouqh Shatner

511 11ppea red I f l s POIS ,ru nr un q i nto Nrr no v a s Ill S

re p la c ement). Th e a f f anyeme n llU ined out to be quuc

lu cra nv e f or ShJln er , who so ld m ost of h is P ri cc line

s to c k s h o rtly b efore 11 5va lu e p lu mme ted m the do t-

co m bust

~ un dcr -r. uu ! the componcnt\ u r v.ilu« lIl.tpping .\111..1ho\\'

they .i rc lI\ed tu \Uppnrt.l \tory .. lnd gl'lll'Lltc fin.lllL-i.d

projcc rion- . O(C(ht\ .111drevenu e- t~H-.lI1 in uov .iriou.

/\ttcr re;ldin~ the i}JJ/(}~,{li()J1 ""i.!wrl'()/[I. you w ill be

.Ih le [() uvc morph o log ica l boxes [() ex pl o re .111he

pc nn ur.ir io n -, o f.1 produc t. m ark er or vcrvicc .

{\fie r re., d ing rhc rhc :-tL ld C lr L (.IS,. stur lv you will be .ib lc W idenr i f) rhc

ro le, rh. u di ffe ren r C <lll lp onen rs p l.!y in ge ne ra rin g cos ts and rev enue s,

Note: l-urr hcr int o rm a rion. cl.i« ,Iide" tc- r qu cv rion - and other

'l Ipl '(H ring 1ll.l re ri.11 .I re .1I 'o liL1bl e on our cO IllI '.lI1 ion web-ire onww w ,p,l lg l, lVc .con l/bu 5lness /wcSIIJ nu

\

So Wh ,1 1IS w ron g wuh 'the siorv'> Ihc biqqcs t

pi oblcm W, lSw , llk er 's ass um ption that co mp ani es

such as Ameri ca n A lrl in cs - wh ich had made hu ye

i nvcsuuc n ts in it s ow n pr o pric ta rv Sa bre pr ic ing ,

rese rva ti on an d sc.it invcntorv system - would

actua llv be int eres ted in p laY lf lg uy P ri ce line's lul l 'S,

and los lfly huqc sums o f money Ifl the process.

Aulincs rcta ha tcd b y c o llabo ra tin t) on th e pi Ice s

Ih e y sent P flCc lin e , o tt cc uvc lv un dcrrnuunq us prices e a rc h m o de l. wa lkc l's 's torv' wa s myo pic. n Ia ilcd

10 s e e b ey ond th e c on sume rs ' prob lem ; II spcC ll lca lly

la llc d 1 0 a cc ou nt for the c omplex ol invcs t rncnt s and

d vn .u ru cs o n t he v en d or s i de . w olkc rs s lO lY w as

mcornp lctc . a nd utur natclv Pr ice ll f le w as (erred 10

move 10 a I ra di li on d l s ale s m o de l wh e re travelle rs arc

presen ted w rth pnc cs w hich Ihe y c an ta ke o r re jec t.

Pf lCcll f le 's otlcnnqs m g roc e ries and pe tro l (th rouqh

pa r lla lly owned a lf il lil lc WebHo us e) w ere even less

successful. In oc tober 2000, WcbH ouse ran oul of ca sh

a t th e s am e ume th at t t ra n ou t 01 in ve s tors who w ere

w ililny 10 pU I a n y m o re money int o 'the s tor y '.

What's in a name?

MO lo ro la's Iri dium sa te lln c svstcm was O IIQI fl,l ll y 10

ha ve 77 ac tive sa tc tli tcs . ,1nd as such wa s nam ed fo r

th e c lem en t iridium , W ith a nucleus sur rounded by 77

c lcc uo ns. Bu t 10 re du ce co s t, tha t num ber o f ac tive

sa tclti tcs wa s redu ce d 10 6 6 c ,lr ly III p ! dnn in y . Th e

c lemen t w ith atom ic numbe r 66 is ca lled dvs prosrum.

wh ich in Grce k mea ns 'hard to ge l in co n tac t w ith '.

Und ctstan dabl v , th e company was les s Ih 'lI I cn lflu se d

w ith e ithe r the name dy spro s ium or 11 5u.in s l.uron.

and stuck with it s o flYlfldl name .



76 GLOIJAllNNQVATION ,\IANA(l,\1 ~T

In cas e anyone thi nk s int ernet enrr epr eneur s have a m onopoly on A aw ed bu s iness

m odels, think again. \'i 'c ten d ro forget abour idea s that don 't work our , bur bus ines s

hi s tory is aw ash with 's tories' th at on deeper in spect ion m ade little sense . M otorola

inves ted USS3·) b illion in the Iri dium sy s tem ( the com pan y incurred m ore than $6

bi ll ion in loss es in its short li f~). M otor ola' s 's rorv' was that cus tom ers wo uld pay a pr e-

m ium ro be ab le ro m ak e ph one co nn ec tions anyw here at any tim e. To the delig ht of

Motorola's en g ineers, Ir idi um m ore or les s pulled off that technolog ica l feat, beg inning

ope ra tions in late 1998 .oth ing about the Iridium sys tem wa s particul arly inn ovative. T Ile m ain patenr s

on the sy s tem were in the area of m as s pr odu ction of sate llites, des ig ned by the sa m e

eng inee r who set up the aut om ate d fac rory for A pple's M ac int osh. eac h conta ined a

clus ter of seven of th e M ac int os h's PowciPC 603E 200M Hz CPU chip s . Bur w ith a

$1,00 0 pri ce for a m ass ive Iridium phone, plu s int ernational ca ll ing rate s of up ro $,+

a m inute, the company br oug ht in only 1) ,00 0 cus tom er s bef ore declaring Chapt er II

ba nk rup tcy on 13 Augus t '3 '99 9.

In lat e 200 0, a group led by ex-airline executive D an Coluss y pa id $2) m illion for the

ent ir e network (nbour 0.+ per cent of its orig ina l COSt) whi ch now prim arily serves the

US Depar tment of D efen se . Af ter Iridium fi led fo r bankrup tcy it cited its 'difficulty in

ga ini ng sub s cri bers' . These 'diffic ult ies' we re elaborated by CNN w riter Da vid Rohd e

when he det ailed how he app lie d for the Ir id ium se rvice and w as s cnr inf orm ation k its,

bur wa s ne ve r con rac tcd by a sa les rcprcsc nrativc, en countered pr ogr am m ing pr oblem s

on Iridium 's we bs ite and a 'run -a round ' from the company's rcprcscnrative s . App arentl ythe eng inee rs felt that p urring their sa tellites i n o rb it was all that wa s required for a

succe s sf ul bus ines s - end of 's rory '. U ltim ately , bu s iness m odels lik e thes e fail beca use

they are built on fa ult y ass ump t ions about cus tom er behav iour . TI ley arc solutions in

search of a problem .

Wha t's in a name? (pa rt 2)

Auctionw eb was found ed in San Jose , Californi a

on 4 Septem ber 1995 by compu ter prog ram m er

Pierre Om idy ar, as part of a large r personal s ite

that belo ng ed to hi s consu lt in g f ir m, th e Echo Bay

Techn olo gy Gr oup . Th e c ompany officially change d its

nam e to eBa y in Sept em ber 1997. Omidyar had tried

to regi s ter th e dom ain nam e Echo Bay .co m but foun d

it alread y taken by Echo Bay M ines , a g ol d m i ni ng

company , so he shortened it to h is se cond choic e,

eBay.com.

TI 1C irony of a careless em ploym ent of bu s iness m odels is that when us ed co rrec tly, they

force m an agers [Q th ink rig orous ly abour their bus in ess . Bu s iness m odels arc benefici al

im plem ent s th at articulate the activitie s, play er s and resour ces required of a bus iness

propos al, and desc rib e how they w ork rog ether as a valu e-creati ng sy s tem . Even dur -

ing the internet boo m , ex ecut ives who und ers tood the language of bu s ine ss m odels

outpe rform ed the naive. '

1 \ k g W hitm an w as candid in her reasons ror joining eBa y in its ea rly day s - she was

s tru ck by what she describ ed as 'the em otional conn ec tion betw ee n eB ay user s and the

s ite: and rea lized that that the communi t ies and services eBay had orig inated s imp ly

CI-IAPTER .•. UU!'>INL•.•S,\IOIHI." 77

'couldn 't be done off-lin e. ' \X 1hitm an s aw these two charac teris tics ly ing at the core of

the eBay bu s iness m odel, one that co uld be trans late d into an eng ine of valu e. Ever

s ince, \'i 'hi tm an has enshr ined 'th e em otional conn ect ion betwe en (Ba y use rs and the

s ite ' as a ke y com petence in eBay's bu s in ess , tak ing full adva m ag e of the psy cholog y

and th e eco nom ics that draw co llec tors , barg ain hunt ers, cornmunirv seek ers and sm al l-

bus in ess peopl e [Q eBa y .lll is help s eBa y to m ake decis ions about the sco pe of it s ac tivi -

ties that res ult in a pr ofitable CO St s tru ctur e. Com pare thi s w ith the pr etex t of Pricc lin c,

whi ch naively ass um es that co nsum ers are onl y co nce rned w ith p rice and that sell ers arcun conce rned about los s of reve nu e. In fac t, the reve rse is the ac tual case.

STRATEGY A D BU SI ESS M ODELS

Sound bus iness m od els, w heth er articulated or not, underlie ev ery corpo rate suc cess

s ror y . Nonethe le s s , a bus iness m odel is n ot the sam e thin g as a s trat eg y (although the

ter m s arc s om etim es us ed w irhour dis tinction). Bus in es s m odels de scrib e the sy s tem s

view of a b us ine ss - it s operat ions an d its relation ships w ith the wo rld of consum ers

and ve ndors . S trategies, in con tras t, deri ve from a m il itary perspect ive which ex pec ts

an action plan For w inn ing in the rivalry wi th c ompetito rs, ei th e r c urr ent or foreseen.'

Busin e ss s tra te gy

As overu se d as the word s trateg y is today , it s

pr ov enance as a bu s iness term is rem ark ably recent .

Pe rhaps the fir s t w idely rea d trea ti se that incorporated

st rategy as a bu s ines s concept was hi s torian A lfred

DuPo nt Ch andl er's 1962 book S trategy and S t r uct u re ,

which prof iled the relatio ns hip betw ee n the s trategy

and co rpo rate depar tm ent s at General M otor s and

Sears. A scion of th e Du Pont family , Ch an dl er use d his

pedig ree and access to determine how the departm ent

and orga niz ational s tru ctur e of a firm relate t o i ts

m iss ion - its 's trat egy '. Ch andl er pr esc iently devo ted

chapt ers to t echnolog ical and m ark et in no vation and to

th e rol es o f f un ct io nal departm ents . (T he latter had a

defining influenc e on the curriculum and depar tmental

s tru ctur e o f t od a y's bu s ines s school s. )

H is t or ia n and econom is t Peter Dr uck er also b eg an

hi s s tudies o f b us in ess s tr ategy at General Motors

as a c on sult ant . Dr uck er's 1964 bo ok M an ag in g for

Res uit sswas orig inally called Busin ess St rategi es .

Both D ruck er and his pu blisher rejected this title after

inform al tes t m ark eting . Drucker ex pl ained in the

pr eface to a later ed itio n th at he was repea tedly told

that 's tr ategy belong s to mil i tary or p erhaps to political

cam paign s , but not to bu s iness '.

The work of b oth Chand ler and D ruck er was s trong ly

influenced by both m en's personal ties to General

D w ig ht E ise nh ow er. Dr uck er w ork ed closel y w ith

Ei se nh owe r at C olumb ia Univers ity to se t up the

bu s ines s school there, an d C ha nd ler was Eise nho we r's

b iog raph er. It see m s apt th at h is torians , w ith their

fo cu s o n g overnm ent s and power, int roduced s trategy

to busin e s s .

Co m petit ive s trategy ultim ately requires yo u to do so m ething bet ter than you r

opponents; it req uire s yo u ro dift~ renr iat e you rse lf in som e way , w ith products, ser -

vice, cos t, or wh atever else reg is ters on yo ur cus tomers ' radar.' Bu s ines ses can only

outperform others w hen they arc unique; when compe tito rs are forced [Q inn ova te in

ord er to ent er their com petitive spa ce . An y bar rie r ro m arke t enrr y is at m os t tem po-

rar y . To erect new barriers ag ain s t com petit ors, produ cts and services nee d continual



78

difl crcnriar ion an d red ifl-cre nti:Hion. ontinuallv ev oking the b as is for diftcrcnriation

can only be done through innova tion.

STORYTELLING

At hearr , business mo dels arc stories - s rories rhar ex plain how enterprises work. A

go od business m odel illus trates the inrricac ies of an enterprise by pain ring a m ental

picture, It m ay be clabo rare, or s im ple and abs tract. it m ay be st il l l ife, land scape,

portraiture, or combinations of s eve ral on a sing le canvas ," Ir should answer funda-

m ental questions about how money is m ade i n r his business , and what the undcrlving

I. b

eco nom ic ogi c is that will attrac t custom ers and revenu e comm ensurate with the

C0l11pctCnccs and resource usag e."

The prophet of post-industrialism

Socio lo gi st Daniel Bell is b es t known f or t hree

particu larly influential boo k s: The E nd of Ideo logy

(1960), Th e Cu ltura l Co ntr adi ctions o f C a pitalism (1976)

and Th e C o mi ng o f P osHn dustr ia l S oc iety (1 973)' In

Th e End of Ideo logy , Bell arg ued that the influence

of b oth his tory and ideology had been sub sum edby m ark et forces (fores ha do wi ng t he inf luence of

the story telling of 'p op c ultur e' and 'spin politics')

and that ge nuin e political debate wo ul d g ive wa y

to technoc ratic guidan ce f ro m soci al and cultural

elites (fores hadow i ng p ol it ic al dec is ion m aking

guided by the story telling of consult ant s , lob byis ts

and think t an k s), substitut ing cons ensus fo r m oral

di sco urs e. In The C o mi ng o f P osHndu str ial So cie ty ,

he outl ined a new k in d o f society - the post-industrial

soc iety - argu ing that pos t-indu strialism would be

information- led and se rvice -oriented, an d woul d

replace the industrial soc iety as the dominant sy s tem .Th e post-industrial soc iety wo uld be m arke d by a shift

f ro m m anuf ac turing to s ervi ces , the centr ality of new

science-bas ed industries , the ris e of new techn ica l

elit es an d the advent of a new p rincip le of social

s tratifica tion.

Srory telling used ro be sim ple; in facr until the I96 0s a bu s ine ss s chool educa tion wa s

usually little m ore than rim e spen r lis tenin g ro retired executi ves tell s tories (wh ich

they ca lled case stud ies) , Th e firs t half of the z orh ce nrury wa s dom ina ted by busines ses

that were easy ro u nderstand - they we re retailers, utilities , bank s or whate ver, with

straighrforward bus iness m odels and go als uni que ro e ach indu stry . B ur t he zrowrh of

ser vices and espec ially inf orm nrion industri es char popu late the post-indu srria] soc ietyspaw ned an ecolog ica l ex plosion of new spec ies of bu s iness , ohcn sen ing up bar ri e rs ro

com petition ba se d simply on the com plexity of their bu sines s models." Globalization

and oursourcing Ran ened comp etitive environm ent s, and short ened life-cycles, m ak-

Ing bu s iness m odels even m ore dynam ic and varied. Te lling a srory - at leas t one rhar

conve ys an accurat e portrait of rhe firm 's operat ions and com petitive land sc ape - is no

longe r s im ple. It ra kes technical ski ll as w ell as an is try ro porrra y a rea lis tic srory of a

m odern business's valu e propos iti on. In com pariso n with go od bu siness s toryt elling

today , the sto ries we rold a deca de ago com e oft' as s ti lted, Rat and drab as hicrog lyph-

ICSon an ancient tom b. 0 wonder this crude sroryrdling go t us into troub le dlll'ing

those hcady doc-corn days .

CHAI)TER 4- IiUSINE~S "10IHL~ 79

11K s to ry be hind a succe ss ful business m odel repr esents a better way ro crea te value

than ex is ting alternarive s . Ir m ay offer m ore va lue to a di scre te g roup of custom ers . O r

it may com pletely replace the old wa y of doing thing s and becom e the standard for the

next g enera rion of enrr cp rcncur s to bea t. Ir m ay sub tly fine- run e the internal opera-

tions of a bu sine ss to such a deg ree that comp etitors find it hard to duplica te, as is the

case wi th \X/al-l'-.arr . Ir m ay consis tentl y crea te cus tom er ex periences that arc so trendy

and exc iting rhar com petitors fin d them hard to duplica te, as in rh c c as e of A pp le, And

all the whi le it le av es c omp etitors to sc ratc h their heads wo nd ering what exactly is the

business m odel be hind this m ag ic.

Numbers guys

spr eadshee ts. Pr ior to this tim e, bonds sales peop le

received all of the analys is for dea ling in securities on

doc um ents prepared by their N ew Y ork-bas ed rese arc h

departm en t. Securities inventories , prices , cus tom ers,

prof it m argi ns and so forth m ig ht at best be upda ted

da ily , or m ore like ly weekly or m on th ly. With PCs,

spreadshee ts and data on inve ntories , m arke t pri ces

and cus tom ers at their finge rtips , bond sa lespeop le

were no long er reliant on the static repo rts of a dis tant

research department . Inst antly tyi ng num bers to their

telephone narrativ e, salesp eop le coul d b uy and se ll,res tru ctur e dea ls an d p ro cess new m ark et information

while they we re speakin g w it h c ustom ers, or across

the X-shaped des k wh en talk in g w ith D rexe l traders .

Mil ke n's pay off was a rapid expansion of the us e

of j unk bond s in corpor ate fin ance and m er gers and

acquisitions, which fuelled the 1980s leverag ed bu yout

boom . Dr exe l went from $1 .2 m ill io n i n fees to over $4

b il li on i n 1 986 , m ak in g it t he m os t p rofitabl e firm on

Wall Stree t. A single transa c tio n in 1 989 sold $5 billion

of hig h-yi eld bond s to help f i nance Kohlberg Kr avis

Roberts & Co .'s pur chas e o f RJRNabisco Inc. Because

the perceived risk o f default m ade inv es tors skittis h,

the f ir m s t hat c ou ld fin d b uye rs fo r j un k bond s had

the power to d i ct a te their ow n term s to participate in

the larg es t dea ls. Hostile takeov ers often h in ged onwh ether Mi lken issued a lett er s a yi ng he w as 'highly

co nfident' of being able to provide the financing. With

Brick lin's spreadshee t, he co uld usu ally ass ure him se lf

of being on the winn ing side of even the risk ies t

trades .

Michae l Mi lken w as the undisput ed cham pio n o f t he

jun k b on d, and a p on y t aile d c om p uter prog ram me r

m ade it all possib le. Milken head ed the New

York- ba s ed n o n-inve stm ent -g rade bo nd (junk bond )

depa rtm ent when Drexel m erg ed wi th Burnham

and Com pany in 1973, an o peration that ear ned a

remarkable 100 pe r c ent return on inve stm ent . By

1976, M ilk en's incom e wa s es tim ated at US$5 m illion

a ye ar, giving him the influence to m ove hi s operation

to his hom e town, Los An geles , where he ha d swan k y

offices o n Beverly H ills ' Rodeo Drive.

Dan B ri cklin 's ex perienc es analys ing case studies

at Harvard B usiness Schoo l w ith h is primitive Texas

In strum ents calculator convinced him that there had

to be a better wa y. Workin g with som e o f h is o ld M I T

professors , he adapt ed an old tabl e- driven chalk-and-

black boar d a pp roach to prod uction sc hed u li ng wh ic h

had been in use since the 1930S to wo rk on one of the

new personal c om pu ters. Tes ts on the Pepsi-C ola case

study co nvinc ed him that he had a w i nn in g bu si ness

ana ly sis tool, w hic h he s oon parlayed in to a company:

softwa re Arts , se lling Vi s iCalc (Vi sibl e Calculator) . If

V is iC al cw a s t he 'killer application' fo r t he new PC ,

then M ilken certainly m ust have to be con sid ered the

killer appl icant.

M icha el Mi lken once comm ented that Bri ck lin 's

inven ti on had s in g le-hand edly paved the way for

the 19 80s corpor ate m egadeals . It certain ly did the

job for M ilke n, wh o rem odelled his Beverly Hills

off ice s in the early 198 0s around a larg e x-shap ed

desk lined w ith personal com puters loaded with



80 (;LOII,\] INNOVATION } !ANM;I",,\ ENT CH\I'TEIt ..•.

At some level, business models, just like stories, are variations on a Few archetypes

giving voice to universal themes underlying al l human experience. Business models

arc variations on the economics of supply and production underlying all businesses

(which in turn are just reflections ofhuman behaviour). On the one side arc stories

about the activities associated wi th making something - designing it, purchasing

raw materials, manufacturing - the costs and resource usage narrative. 'The other side

is associated with selling something - finding and reaching customers, transacting

a sale, distributing the product or delivering the service - the revenue generation

narrative. A new business model's plot may turn on designing a new product For

an unmcr need, or it may turn on a process innovation. There is one big difFcrence

between stories and business models: business models tell investors where they make

their money. II

1I1iSNESS ~lOIH.L.s 8]

Coca -C ola fin ds that com petitors can be devious

Coca-Co la fa iled bo th its s tory a nd num be rs te s ts

when it co ncoc ted a swee te r drin k, unof f icia lly

dub bed New Coke. New Coke was for mul at ed

in res po nse to Pep s i's h igh ly succ ess ful 'Peps i

Cha lleng e ' ad ve rti sing campaign which t oo k place in

ma lls, shopping ce ntr es and oth er public lo ca tion s.

A Peps i repr esen ta tive would se t up a table w ith

two un mark ed cups , one co n tai nin g Pep s i a n d on e

(o ld) C oke. Sho ppers we re enco ur ag ed to s ip bo th

co las, an d then se le c t wh ic h drink th ey pr e fe rr ed.

Peps i regu la rly won the 'Ch a llenge ' s imp ly beca use

parched, wea ry shopp e rs prefe rred th e sw ee te r

dr ink . If cus tome rs we re asked w ithin a mi nut e o f

co mp a r ing dr in ks, th ey wo uld usua lly res pon d tha t

they pre fe rred th e illu s ion o f g luc ose jo lt from S ipping

th e swe e te r one . If they we re a llow ed a few more

TY I G N AR RA TIVE TO NUMBERS

Before PC spreadsheet programs became widespread, business planning usually meant

producing a single, base-case Forecast. At best, people did a lirrlc sensitivity analysis

around the projection. 11,e spreadsheet ushered in a much more analytical approach

ro planning, because every major line item could be pulled apart, its components

and subcomponents analyscd and tested. People could ask what-if questions about

the critical assumptions on which their business depended. 111ey could model thebehaviour of a business.

111is was something new. Before the personal computer changed the nature of bus i-

ncss planning, most successful business models were created more by accident than by

design and Forethought. 111ebusiness model became clear only afi:er the Fact. By enabling

companies to tic their marketplace insights much more tightly to the resulting eco-

nomics - ro link their assumptions about how people would behave to the numbers of

a pro Forma profit and loss (P&L) projection - spreadsheets made it possible to model

businesses before they were launched.

OF course, a spreadsheet is only as good as its underlying assumptions or its model.

It is easy to get lazy and assume that the business model or whatever can be modelled

on a spreadsheet - nothing more or less. But this is an increasingly tenuous assumption

as businesses grow more convoluted, complex and intangible. What exactly is Coogle's

business model; or eBay's? Both are profitable companies. Value creation in both busi-

ness models is driven by social networks and customer experience: try plugging thoseinto a spreadsheet."

To generate reliable and mean ingFul numbers, business modelling needs a rich

and dynamic language ro model how the entire business system works, and com-

pare that with real outcomes as they develop. 111e success of decisions, strategic

initiatives, income and financials provides Feedback on whether the model is work-

ing. Business modelling is, in this sense, the managerial equivalent of the scientific

method - you start with a hypothesis, which you then test in action and revise

when necessary.

minu tes , co ntr o lle d labo ra tor y tes ts re vea led tha t

th ey com pla ined the s we ete r dr in k le ft them queas y ,

w ith a b ad tas te in th e ir mouth . Add itiona lly, som e

pa rtic ipa nts reca lled th at th e Peps i was se rved ch illed

wh ile the Cok e was a t room tempe ra tu re. Bu t the

Co ca- Col a Comp any didn 't know th a t, a t lea s t not

be fo re it rep lac ed its flagsh ip so da with a swee te r

Peps i-b ash in g 'New' Co ke in 19 85·

Public reac tion to th e change was d e va stating. New

C oke quick ly ent e red th e panth eon of ma jo r ma rke ting

flops . Th e sub seq uent re in tro du ction of C ok e's ori g in a l

for mul a led to a signi f icant ga in in sa les , w ith Co ca -

Co la lea rn ing a pa infu l lesso n a lon g the way : tha t it

should do it s ow n marke ting resear ch in the futu re

ra the r than re ly in g o n the adve rti sin g cam paigns of it s

co mpe tit o rs .

\'\Ihen a business model Fails, it is because the story doesn't make sense, or the numbers

don't make sense. Stories fail to make sense when they nuke unrealistic assertions

about technology, production capabilities or consumer behaviour. Rough tests of thestory can be made fairly quickly using coustonption chain dlld~ysiJ and .utrilnit« IIIllpS

(see Chapter 3).

The ntoubcrs 11'51 is more difficult, because of the risk inherent in the new, on both

the demand and supply sides. On the demand side, it is likely that whatever is new in

an innovation will not be appreciated by customers.

Finding an innovation's value proposition

111e context of the business model For an innovation is established by the firm's

vllille proposition, which ultimately drives its business model aswell as its strategy and

technology choice."

111e value proposition is the business' raison d'ctrc - the justification For commirring

people and resources to the operations. 111eecology of the market may allow diflcrcnr

business models to fi nd their own niche within the competitive environment. Swatch

value propos itio n Bus in es s model Str a teg y and

(type an d am oun t o ff--

(p roc ess b y w h ic h stra tegy andI-- tec hnolog y

value gene rate d) te ch nolo gy gene ra te va fue ) (m anagemen t cho ice )

Fi gur e 4.1 Th e v a lu e proposition f or the i nn o va tio n

I

••



82 CLonAl INNOVATION .\lANAGIMINT

makes low-cost watches whose s tyles are updated weekly; Patek Philippe makes expen-

sive watches which t he company claims are 'timeless'. Each can be considered difFerent

solutions to the generating of retail profit in the consumer watch market. Each demands

different technology and strategy to generate value. Yet the direction of inAucnce is

the same in both businesses: only once the idea or objective of the business - that is,

the value proposition - has been articulated can management go about designing the

business processes.

Once business processes have been settled upon, management can make strategic

or technology choices, although sometimes the proces se s will be selected ro rake

advantage of a firm's particular strategic or rechnological advantages. The approach

is Platonic: the value proposition Ius a pumanency rhar is wanting in rhe ephemeral

worlds of business processes , srraregy and technology.

VALUE MAPS

One of the earliest comprehensive value map methods to enter rhe business mainstream

was a conceptual model of the value transformation in firms which was introduced by

Michael Porter in his 1985 book Competitive IJdvdll/flge. ; Porrcrs idea derived from

rhe economic inruirion of production, that every f irm is a collecrion of activities that

a rc performed to design, produce, marker, deliver and suppOrt irs product. All these

activities can be mapped using a value map. A firm's value map and the IVay that it

performs value-adding acriviries reAect its history, its srraregy and rhe underlying

economics i n rhc market.

Th ema tic m aps

Edmond Halley, patron of Newton, student of

magnetism, Latin poet and cartographer, is best

remembered today as the rzth-centurv astronomer

who predicted the periodic return of Halley's comet.

But his greatest contribution to science was the

introduction of the first 'thematic map' - a map that

illustrates a set of facts and figures in a geographic

format. Halley's map was the culmination of his two-

yea r voyage as captain of the Param our, mapping the

variations in the magnetic compass from true north. It

ushered inthe very modern notion that anything that

can be measured - abstract or not - can be mapped.

In POITer's v iew there were cight SOrtSof activities in a typical value map. There were

four types of primary activities - logistics, operations, delivery and marketing - and four

types of supporting activities - procurement, R&D, human resources and inhastrucrurc.

Co mp eti tioc ,-/rlVrlntflge was written in the early 1980S; the PC had JUStbeen introduced,

and information technology was limited mainly ro back-office accounting systems. 111e

modern pantheon of corporatc activities - especially knowledge-intensive ones - has

evolved substantially since then. Today' s value map must map a rich, complex and inher-

enrly knowledge-based set of primary and supporting activities. 1111'rate at which new

technology adds competitive niches means that any dcfinition must be open-ended,

creating an entirely difTcrent environment from the one Porter faced rwo decades ago.

CI-IAI'TER -l 83

In knowledge-intensive businesses, an updated perspective may be more suir.iblc. In

this perspective rrnnsacrion Aows circulate around the core proccsses in the firm's value

map. C or" proc ess es directly involve the creation and delivery of a product or service,

and arc tho se e ssential to value creation. Supportillg pmcesses add cost, and osrcnsibly

nuke core processes more efficienr. There arc usually many dift""erent options for sup-

paning core activities - make or bu y, vertical integration. outsourcing and so forth.

As a consequence, the inherent cost of the supporting activities is often be difficult ro

assess. Generally though, they nuy be considered to Fall into tour categories:

~ transporrarion, coordination and communication activities

~ administrative activities: administrative systems are suppOrt activi ti es tha t improve

rhe effic iency ofcore activities

~ quality control activities

~ activities that promote process efficiency.

Porter's value map perspective has proved popular, and consultants and academics have

over the years incorporated it inro varying formal mcrhodologics - from extensions

ro XML called Value Chain Markup Language to extensions of Michael Hammer's

Semantic Modelling, which were the basis of the r(engineering vogue a decade ago.

Value-generating processes on the value map transform the transactions to generate

value for the firm. 111is value is assessed by rhe ulrimatc consumer of the product or

service, and - from the firm's point of view - can be assumed to be the aggn:gate of

revenues, COStS(both capita l a ss ets and expenses), and adjustments ro risk (for exam-

ple, hedges such as arc common in conunodiry-inrcnsive businesses such as chocolate

and grains).

111is approach makes the relationships between events and the value thcy generate

much more transparenr. Consider the tactics used by telecommunications com-

pany Qwest to inAatc income rhrough accounting for ofFserring sales and purchases

of bandwidth. In the first six months of 2001, Qwest sold US$857 million wOITh of

bandwidth ro other rclccom companies which was accounted For as revenue; at the

same time it also bought $+50 million from some of those same companies, which was

accounted For as an asset. 111is accounting fiddle pushed Qwcsrs revenue growth for

the six months from 7-5 per cent ro I!.O pCI'cent, at a time when insiders were selling

oft""substantial stakes in the company at in flated stock prices."

THE lECHANICS OF VALUE GE ERATIO 1

'One picture is worth a thousand words' goes one incarnation of an advertisement cre-

ated by Fred R. Barnard for the trade journal Printers' Ink in 1921.". where he suggestcd

that advertisements with images arc more efTcctive than those without. Our minds

seem to be able ro take in more information at a glance with pictures, and here we use

that bct to advanragc by showing how to depict business models graphically.

Figure +2 presents rhc components ofa graphic business model (value map) - the

environment box, the straregy-owner bubble and the value Aow. At the centre of a value

map is the network of business processes that are owned by a firm, and arc the focus of

its stratcgy. These arc processes over which the f irm has a high degree of control. 111at



84 GLOUAI INN()\ATO~ \1,,"';"(;( ,\\1 ~n

Environm ent

In contras t, the Phill ips head em erg ed as the choic e

of the int ernational com m unity. Henry F . Phi llip s, a

Portl and , Orego n bu siness m an and form er travelling

sa les m an, hit on the id ea of an X- shaped so ck et head.

Phillip s ' des ign wa s initially rejected, bu t eventu ally

acc epted by the Am erican Screw Co ., which persuaded

General Mo tors in 1936 to use the Phill ip s- hea d

sc rew in m anuf ac turing Cadil lac cars . Th e ca r indu s tryso on em br ace d it, se tt ing the s tag e for even w ider

acceptance by the military during the Second W or ld

War. Carm ak ers lik ed the fact that there is a deg ree

Str ategy -ow ner

11 1e va lue-How , s trateg) '-ow ncr and environm ent cons tructs arc borrow ed tror n the

form al di ag ramm ing m ethods of da taflow diag ram s ." 111e rigo rous m ethodolog y of

dataflow diagram s ofF ers a form al lang uag e to ca pture the s tructure of the va lue m ap,

and of the com petitive and s trateg ic environm ent in which it fun ctions . DataAow

diag ram s have bee n shown to prov id e a com plete and un am bigu ous language for the

desc ription ofinrerrclatcd processes. B ecam e of thi s, daraflow di agr.lm s can pr ov id e us

w ith an unequi vocal language to desc ribe innov ation s trategy , firm ope rations and the

com petit ive environm en t. Such rig our is useful i n a s su ri ng that dec is ions an d forec.l s ts

are u nique and un am biguous - in other wo rd s, tha t they prov ide a s cient if ic bas is for

dec is ions and forecasts invo lving inn ov ations .

Va lue n1 .lps show the Ao w of va lue of m ajor par ries that ow n, or have cla im s to

or in fluence ove r, the va lue crea ted in a firm - what are com m onl y te rm ed the

's tak eholders' in an inn ova tion . 111 ..: se are the 'pr inc ip alities ' of the m ap, where 'value

How s' are the river s tra ve rs ing the m 'lp and co nn ectin g the principalities, 111e m ajor

s tak ehold ers w ith claim s to value are oumcrs (co nce rned w ith m ax im izing wealth),

customers and ue ndor s (co nce rned w ith price and tim ing) , creditors (co ncerned w ith

dow ns ide risk), JIJ,zlll1gers (co nce rned w ith their jobs) and competitors (c oncern ed

w ith m arke t share).

111c va lue of an ide a or innov ati on is se ldom loca lized to one se tting or ow ner. In a

com petitive m ark et, it i s the cus tom ers rhar are like ly to benefit m os t fro m an inn ova-

tion; other s take holders wi ll share whateve r is Ieti : ove r. Additiona lly , the w ealth g mcr-

ared by an inn ov ati on is se ldom sto rable lik e go ld or other comm odities ; va lue in theinn ova tion eco nom y arises from 'id eas in ac tion'. Kn owledg e as sets in th em selves are

little m ore dun cur ios itie s un til they arc pur to wo rk. In the traditiona l 's toc ks and

How s ' perspec tive ofcorpornre sys tem s, inven tories and ass et s have playe d a central role

in corporate sy s tem s . Bu t wi th innovat ions , as sets, if they exis t at all, are ju s t another

cos t of c10ing bus iness . Often less is m ore, leadin g to dec is ions [0out so urcc wh.ircve r

activities lie out s ide the firm 's core compe tences .

In add ition there arc inrluctioc processes, which consum e reso urces and modu late the

operation o f k ey proces se, in one way or another. These m ay sup pO rt I. 'e.yprocc.ues, as is

the case w ith the trad irion.il 'cos t ce ntr es ' of the fin n - info rm at ion process ing, lega l,

accounting , ndr nin is rrarion and so forth. 11 1c y m ay be i nt er nal o r e xt er nal to the firm ,

Fi gur e 4.2 Va lue m ap c omponent s f o r d i ag r amming a bu si n e ss m od el

control com es at the CO~t of own ership of the pro ces s, and the risk s that com e w ith it.

1 11 c\ e a rc co nnected to on e an other through value Aow s w hich represent transferred

cos ts and reve nu es . 111e environ m ent boxes def ine the com peti tive environm en t

wit h whi ch the firm int erac ts . These boxes repr es en t things lik e cus tom ers , vendors ,

com petitors, g ove rnm ent reg ulato rs, and other g roup s or entities that can only be

controlled indirec tly by the fi rm .

How st and a rds h e lp o r h urt a busines s m ode l

The py thago rean philos oph er Ar chyt as of Tarentum

(5 th ce ntury BC) is the alleged inve nt or of the sc rew .

Screw s cam e int o com m on use around the 1s t ce ntury

Be. These were the wooden sc rew s that were use d

in w ine pres se s, olive oil pres ses and for pre s s ing

clothes . Metal s cre ws and nu ts only app eared i n t he

15 th ce ntury.

Sixtee nt h-ce nt ury sc rew -m aki ng was a co ttag e

indu s try. Th e threa ds, filed by hand , were im perfect

and shallow, and screws were so expens ive that

they were so ld indi vidually . In the 1Bth century ,

indus trializa tion brought consum ers m as s -produc ed

sc rew s at cheaper pri ces , but they s till had one

draw back : the m achin ery of the da y coul dn't file

a screw to a point. Workers had to drill a ho le into

m aterial to ge t the blun t screw -end s tarted. The

fam iliar m achine-m ade, po int ed sel f-s tarting sc rew

didn 't app ea r unt il the rnid-roth centu ry .

In 1906, Canadian Peter Robertson hit on a head

des ig n w ith a sq uare rece s s that is s till a favouri te

am ong m any wo odw ork ers . Robertson patent ed hi s

square-headed driver and sc rew sy s tem in 190 B, and

not long after, the Fisher B od y C om pany (fam ous

for cons tru cting the Ford Mo del T) decid ed to use

Rob ertson head screw s i n i ts prod uction line. Tod ay ,

around B S per ce nt of the screws sold in Ca nada use

th e R ob ertso n hea d as oppo sed to about 10 per cent

of those sold in the Un ited States.

nu ...Ic ' •.••••~101ll1 ••• 85

of cam -out or s lipp ag e inherent in the Phi lli ps d e si gn

wh ich allow s aut om ated screw -d riving m achines to

pop out once the sc rew is tigh t.

Th e a cc eptance of the Phillips head over the

Ro bertso n head in the Un ited States cam e about

beca use the too l indu s try or ig inally stand ardi zed

around the des ign w ith the lowes t roy alti es - the

Phillips hea d. Th is lea d to adopt ion by the aut oind us try , and subse qu ently the US m ili tary . Th e relative

m er its of on e des ign ove r the other were pe ripheral to

the influ ence of i nd us try s tandard s ."



86 (,IOHAI lr-:NOVATI(lN i\IA\AGI·.1\1I NTCHAITER ..•.

and arc o trcn the subject of outsourcing decisions because of their non-central char-

acrcr . Historically, rules of thumb have suggested tha t inductive proc~ss~s consume

between So and 90 per cent ofa firm's operating budget.

87

1884: The measurement crisis in geographical mapmaking

Dur ing the las t two dec ades of the 19th ce n tur y ,

co lon ia lism cause d ca rto g ra ph e rs to re f lec t o n

the sh ortcom i n gs o f t he ir disc ip lin e in its a bility

to ge ne ra te a wo rld map. By la te 1884 , les s th a n

o ne- ni n th o f the la nd surface o f th e g lob e h ad bee n

surve yed o r w as be ing sur veyed . Th is pa tchw ork

o f sur ve y in g h ad been co nf ound ed by a var ie ty o f

s ta nda rds o f m ea sur em ent . Ea ch co un try h ad go ne

its ow n wa y , dev e loping it s o wn tra di tio ns fr om a

chauv ini s tic pe rspec ti v e .

Wi thout s ta ndardiza tio n , m ap makin g cou ld ne ver

p rov id e an un amb igu ous lan guage . Eng lan d had a

semb lan ce o f s ta nd ard s: Hen ry I dec re ed th a t th e ya rd

wa s th e di stan ce fr om th e ti p o f hi s no se to th e e nd

o f h is th um b; the leng th o f a fu rlo ng (fur row -lo ng)

wa s es ta blis he d by th e Tu do rs a s 220 yard s, a nd

E liza be th I dec la red a mi le to be 8 fur lo ng s (inc re as ing

the Roman m ile o f 500 0 fee t to th e mode rn m ile o f

52 80 fee t). F ra nc e w a s in m uch wo rse sh ape, ha vi ng

differ ent s ta nd ar ds fro m pr ov ince to p rov in ce . Th e

mos t co mm on ly use d mea sur e on map s wa s th e toise,

Vallie 'qua nra'

Our fundamental d~fini tion of innovation = invention + commercialization makes

the implicit assumption that we are interested in innovations that generate value,

and are profitable (this is the commercialization part of the equation). Valuation is a

problem in even the simplest of business models. We address it in the more complex

models required For analysing innov:lt~ons by scgm~nting value into its components,

and analysing each subcomponent individually. (For an example, see the innovation

workout on attribute segmentation in Chapter 2)

COStS and revenues arc both lumpy - computer scientists refer to this as 'granu-

larity' - and usually they come in lumps of significlnrly diflcrcnt size. For example,

consider the fundamental unit by which xottwarc is measured, as perceived from

either the supply side or rhc demand side. On the supply side, the unit of work is the

packaged software product. 111is will take many person-years of eltort to produce,

but once produced, the firm can make an unlimited number of copies to sell. 111us

the value is the Full cost o f production, less rhc projected life-cycle revenues, less the

projected life-cycle support for each software package produced. From the demand

side, the logical unit is a single copy, the unit used Fo r measuring sales. From a value-

modelling srandpoinr, adopting the 'quantum' to be the packaged software product

makes more sense than to treat it as a single copy of the software. bn,lg~ment's

stra te gy and policy are applied uniformly across all sales, but arc unique to the project.

Thus the appropriate level of granularity for 'quanta' or 'transactions' is at the software

project level. AJI measurements throughout the value map should be expressed in

terms of unique software products (whether they arc versions of a given product, or

customized installations or whatever).

Value Aows in the value map arc pipelines carrying packets of value called 'trans-

actions' Transactions originate as discrete economic events arising either outside or

within the finn, which either consume or generate value. In traditional accounting,

journal entries capture the transactions specified on the chart of accounts, and all

value is measured in the cash equivalents exchanged in ann's length transactions. 11K

value map, in turn, consists of the key valu~-gcn~rating process~s in which thc firm has

invested and the transactions running through them.

One key problem with ascertaining 'value' is chat the units ofvalue - dollars, cures

and so forth - arc priced through markers themselves. 111CI"(s no 'absolute' global val-

ue metric. Any particular business operaees in a specific region, purchasing particular

commodities, selling its products in exchange for specific currencies. 11K knowledge

economy clearly exacerbates problems with monetary dcnominarion.Mnny knowledge

products have no market, nor is there a clear way to value them (for example, consider

a patent or copyrighe).

whic h equ a lled six Fre nch fee t (w hich we re slig ht ly

lon ge r tha n En g lis h fee t), and w as de rive d fro m ha lf

th e w idth o f th e ma in g a te o f t he Lo uvre.

Ye t it was ult im a te ly th e Fr en c h Aca demy of

Sc ie nc es th a t deve lop ed th e 'm e tric ' s tand a rd ( from

th e Gr ee k metron = 'a m ea sur e' ), and it wa s th is

th a t pr eva ile d. A me tr e w as o ne te n -m ill ion th o f th e

me ridia n distanc e be tw ee n th e po le an d th e equa to r;

a g ram wa s th e mass o f a cub ic ce ntim etr e o f wa te r; a

litre was th e vo lum e o f a cub ic deci m etr e .

Th e imm edi a te e ff ec t o f th e me tri c syst em on map

making wa s to int ro du ce a s imp le, un ive rsa l la nguag e

fo r expr ess in g map sc a le . In O c to ber 188 4 th e US

go ve rnmen t inv it ed 25 na tio ns to th e fi rs t Int e rn a tio na l

M erid ian C on fe re nce , in wh ich Fr an ce and Eng land

agr e ed th a t th e prim e meridian wo u ld ru n th rough

th e Ob serva to ry a t G re enw ich , En g lan d, in ex ch an ge

fo r the Briti s h adopt in g Fra nc e 's me tric sy s tem.

On ly th en d id map maki ng emb rac e a un ive rsa l a nd

un amb iguous s ta nd ard o f m eas ur ement s n ece ssary fo r

m ap p in g the wo rl d."

In the environment of the knowledge economy, then, how can we distinguish good

management, good business models and good accounting from simple good luck?

111is w as a major problem in the 1990S dot-com bubble. Ir was difficult to know

what a 'good' business model was, because so many o f the models were novel and

unr es red.K loncy and efFort chased aher business models that didn't make sense, but

were - for a while - very lucky. And when their luck ran out, managers in some firms

(read: Enron and \XloridCom) augmented the gap in their revenues with creative

accounting (read: Fraud). These sores of problems will only grow more widespread

and common as the knowledge economy grows, and business becomes even more

complex.

To deal with these uncertainties, it is probably best to take a non-denominational

and opportunistic approach. Value Aow units (ehat is, the fundamental 'quantum')

may be either mon~eary or non-monceary 'transactions' At least For our purpos~s, this

will sidestep problems with moneeary units which arise in four areas:

• inflarion/dcflario»: they arc unstable over time

•• erratic exchange rates: rhcv are unstable across global operations

• marker Failures: they i:1i1to capture value where there is a ready market for goods

that arc e ither thinly traded or non-existent

, rapid depreciation: historical COStfOliisto properly assess value where there is rapid

depreciation of goods, an especial problem where technology is accelerating rapidly.



88CtlA[ITER - + 89

Non-monetary bases for valuation, as well a; graphic Illaps of proce;,es, hav e b een used

in several valuation approaches over the past half-cenrurv, The cost accounting tech-

niques that arose around Tivlor's flCtory accounting and dficiency movcrncnrs alter

the First \X!orld \X /ar provided an 'equivalent units of production' (EUP) technique for

putting ,III processes throughout the factory on a common metric - essentially units of

finished and saleable product.'

Activity based costing (ABC), which was popular in the '9905, extended cost

accounting concepts to a broader base, including a broader scope of non-monetarybases (that is , ' activity bases') than cost accounting's 'finished goods'. ABC laid our the

organizational ownership and control structure in a value map, similar to the value

map prescribed in this chapter." On a much grander scale, the Soviet Union's Soviet

State Planning Committee (Gosplan) ran national economic policy for nearly seven

decades on a non-monetary basis. Russian production quotas were Set by the state

through a series of five-year plans. By design, supply and demand gener:lily adjusted

to meet these quotas. Money became redundant, and all accounting up and down the

supply map was done in units comparable to the COSt accounr.mrs' EU P. 11", Russian

experiment would, no doubt, be a disaster for consumers and producers wherever

supply and demand arc volatile (in fact, it was a disaster in Russia, resulting in waste,

obsolete inventories and massive queues). B ur under free markers, such a system is still

useful to the planners and managers, even if it docs do a terrible job of defining the

schedules and preferences of consumers and producers."

111e legacy of Gosplan has been a modern Russian industrial complex that conducts

from +0 ro 70 per cent of its internal trade via barter. A barter economy must base

value on ad hoc a ss es sments for each exchange, which potentially require an enormous

amount of information processing (and thus create enormous overhead costs) when

transaction volumes become large. 111e modern solution is ro set rctcrencc prices which

can be used to determine transaction ratios. Gosplan's databases (now on computer)

evolved into the reference prices for Russia's free markets. These arc the de facro mar-

ket economics imposed on any society when price controls are enacted. For example,

consider the United Scares in the 19605 and '970S under Richard Nixon's price controls.

Earlier in the chapter, we showed how something that can be defined as unluc can be

delivered in discrete containers called transactions. Transaction price measures the value

delivered; transaction uoluntc measures the qu anrirv of number of transactions processed

in a given time period (the default accounting rim e unit is one year); ualu« j / O l l l is total

value generated in a given time period. In practice, the distributions of business 's account

balances tend to be highly kur roric (fat-tailed) and right-skewed (because negative

values are prohibited). These tendencies arc the result of commingling different value-

generating processes in the same account.

More importantly, particular management strategies may tend to aA-ecr one

component differently from the other. Let's assume that management is assessing the

merits (in this context, the impact on future value Aows) of a high volume/low margin

product (think Saturn automobile) or of a low volume/high margin product (think

Ferrari). 111e first strategy raises volume while lowering unit value; the second strat-

egy raises unit value while lowering volume. If only value, and not its componems, is

considered, the two might well be seen as equivalent. Bur if instead we think in terms

of volume and value components, the comparative impact of different strategies on

potential losses, risk and error become explicit."

Very little research has been conducted into asset market volumes. \V'here it has

been done, the inrlucncc of volume and l iq ui di ty on price volatility is most often

addressed. 111l1s there tends to be a significant asymmetry in the amount of research

done on marker prices and on trading volumes, and we cannot necessarily look to that

research for guidance in our current task. Fortunately, within a firlll or project context,we know a good deal more about transaction volumes because they arc so central to

capacity planning, utilization and discretionary budget. rV\anagerial strategy and

policy are most important in ascertaining transaction volumes; market forces arc most

important in ascertaining transaction prices.':'

GROWTH, CHA GE AND RISK

VALUE FLOWS

Traditional discounted cash Aow financial analysis commonly assumes an ad hoc two-

stage growth model for forecasting future cash Aows (the so-called Gordon growth

model, introduced in a popular finance text back in the 1960s -). 111is assumes that

there is an initial stage of rapid growth in a firm, some constant rate of growth which

applies up to the forecasting horizon, which is typically set 10 to 15 years in the fururc.

Past that horizon, convention uses two approaches to calculate a so-called 'terminalvalue' - first, perpetuity, and second, price/earnings multiple approaches. The pCljielll-

it)l approach assumes that the cash Aows beyond the forecast horizon act like an annu-

ity payable indefinitelyThis approach assumes - primarily for sake of argument - rhnr

the firm reaches a steady state of operations. Alternatively, if the firm's business model

is stable (a big 'if' in the knowledge economy) the pritcje,/l"rJillgs 111lI/Lip/e approach

assumes that the market will ultimately value the finn at some multiple of earnings.

Industry averages may be used, or for lack of better numbers, it is common practice to

use a multiple in the range from 5 to 15.

Lacking information to the contrary, it seems reasonable to assume constant growth

(or shrinkage, although this seems suspiciously rare in practice) based on prior trends

111e interaction between the details of transactions, cost and revenues in a single

transaction Aow can actually be quite complex, but it is at the core of Illany successful

models of i~lnovation. 111us any useful value Illapping needs to be able to incorporate

methods of capturing this added complexity to:

allow f"r the creation of independent models of value as well as modelling volumes

of transactions

• incorporate specific strategy and technology models: that is, the explicit or implicit

models underlying management's strategic choice and the consequent future value

creation

• incorporate growth models implicit in the life-cycle of the technology underlying

the business model.



90 C LOlA INNOVATON 1\1ANH I,.\I I,NT CHA TER 4- I LSNESS 1 10111.1 • • 91

. Channels

ship of real ond tangible properties. Int ellec tu al assets how only recently received the

arrcnrion they deserve. \\lithout 0 clear judgemem on ownership, soles arc difficult.

Unit sales of pirated media, for example, arc estimated to be double legitimate sales.

Since there is a significam price difFeremial between pirated and legitimate copies

of intellectua l property (for instance, a movie that sells for US$IO on the legitimate

marker may sell at a tenth that price on the black marker), it is difficult for legitimate

channels to maintain any sort of comperirivc advantage.

\X!here ownership of property is ambiguous, legitimate channels may be able to

maximize their revenues by dealing with pirates. For example, a British textbook pub-

lisher found that, for a variety of reasons, it was impossible for it to publish legitimately

in Turkey's market. Yet pirates were able to obta in Xeroxed copies of ncorly any British

text on short notice, including the publisher's own. Publishers rvpically distribute

textbooks at marginol cost in many developing economics to thwart pirates. in the

COSeof Tur key, this publisher simply agreed nor to prosecute the pirates in return

tor the pirates rnaintaining the quolity of their copies. The pirates essentially acted as

local printers. The pirates mode a profit; the publisher found the pirates to be faster

and more efficient than its legitimate channels in tha t area; and the publisher's text

maintained a presence in the Turkish market, which opened up future opportunities

for expansion in the market.

Particularly where items arc large and unique, specific channel intermediaries have

arisen to facilitate ownership and title transfer of goods. For very unique transactions,

this may require the services of a skilled lawyer. For less unique products - say, houses

- title transfer has been routinized and become considerably less expensive as a result.

Promotion of a product often demands specific talents, in addition to a wide range

of customer contacts. The use of the World \\lide \X /cb for electronic commerce has

spawned a hi-tech cottage industry of graphic artists, multimedia and communica-

tions experts, and advertising types to construct online web pages which project the

producer's corporate image, promote the producer's products, and provide feedback

on customer needs.

Negoli,lIion is required tor many big-ticker products, where price, options,

cusrornization and arrer-nurket service can be tailored to the needs of each indi-

vidual customer. Automobile and home purchases are the most prominent examples of

products in which negotiation is a central function in the channel.

The ordering function has seen the most dramatic applications of intorrn at ion tech-

nology over the past two decades. Electronic data interchange, electronic commerce,

web order forms, telephone direct orders, and numerous other applications of com-

puter and communications technology make it possible to place orders conveniently,

with costs savings passed on to consumers.

!Ilnrkct injimJlflti(1II is essential for production planning, and minimizing srockours

and other forms of risk which must be borne by channel members. Although exist-

ing applications in electronic commerce arc only beginning to realize the potential

for accumulation of market information, this has been an important application for

computers over the past two decades. For example, Wal-l'vlart has dedicated a world-

wide telecommunications network and powerful Teradara supercomputers to provide

the company and its suppliers with statistical synopses of demand parrerns on a near

real-rime basis.

in the objective historical data. \Vith additional information - seasonal cycles, market

trends and so forth - a wide r:lngc of econometric and time-series statistical tools have

been developed in economics to improve forecast accuracy.

Henri Pages'· suggests that Gordon's growth mode! is inherently incompatible

\\'ith non-stationary growth of firm or project value. A more glaring problem arose

during the dot-com bubble - there is little justification for the 'kink' that occurs in

growth between the first and second stages. Thi« kink often rook extreme values in

financial plans that appeared during the late-1990s dot-com bubble, where it was not

uncommon [() see XO-120 per cent of the firm value i n t he terminal valuation.

A more transparent and defensible approach to growth involves discarding the plan-

ning horizon altogether. Growth is Seen as resulting from two sources: first, growrh

induced by managerial strategy, and second, growth induced by the external supply

and product market factors - what we call the business environment.

Marketing and supply channels coordinate the succession oHunctions that arc requ ired

to bring a product from factory to customer. \Vhne a service is being sold. the channel

controls contracting and settlement.

Marketing channels emnge as a parr of the natural evolution of hierarchies and

markets in an industry. Although producers may provide many of the channel func-

tions required to stimulate and satisfy demand for their goods and services, economics

of scale and access to multiple competing products may make some channel functions

better suited to third parties. Channel intermediaries provide a link between buyers

and sellers, lowering the costs of transactions and making most goods and services

cheaper. They may consolidate particular channel operations from a variety of produc-

ers, rhus achieving economics of s cale. For example, few magazine publishers actually

distribure their own products or handle their own subscription services - these services

arc provided by one or two large subscription processors.

Channel intermediaries smooth the Aowof goods and services, help ing the producer

[() better plan and control production, by creating possession, place and time utilities.

llley do this by representing a large number of producers supplying complementary

goods and services. Four benefits arc realized by working through intermediaries -

breflking bull; crellting assortments, reutiliz.uion oJtmnSl1ctions and efficiCllI search,

At least seven generic functions must succeed for a channel to work, regardless of

who, or what, is performing that function - p/)),sic,z/ possession, oumcrslii p, promotion,

negotifltioll, pro v ision oJlllflrket il1/01'll/fltion.jnfll1(illg. JhI)17IIclil. and risk bell/ing.

Pbvsic.tl possession of inventory in a warehouse or on consignment is required

at one or more points in the channel. How much of this inventory is stockpiled

depends on the cycle times required to produce, replenish, distribute and sell a

particular product. The warehousing and distribution management functions arc

dedicated to transferring physical possession between channel members, and finally

to the consumer.

Oioncrsliip is distinct fro IIIphysical POssession in t hat it is a legal concept. Ownership

is a contentious issue in the information age. Laws have more or less focused on owner-



92 GIonAI INNOVATION MANA(;EiIoIE;o..:TCH\I~TER4 nUSIN[S~ MODELS 93

Filh11lcillg is also r equired For expensive products, and is likely to be a significant

factor in negotiation. Automobile and home purchases demand specialized financing.

Sales of less expensive products, especially impulse sales, may be faci li ta ted through

routine transactions financed with credit cards. Credit cards make the transfer offunds

straightforward. They can also smooth individuals' cash inAow from income with t he

cash ourAow from purchases.

Payment must be collected if producers and channel intermediaries are to stay in

business. Payment presents an increasing problem as developed economics move

away from cash t ransactions. Credit and debit cards have grearly facilitated this move,

and have standardized and routinized transaction payments. Unfortunately, their

use on open networks such as the internet is still suspect. A considerable portion of

the expense passed on to consumers and producers using credit cards ror payment is

needed to cover criminal abuse of credit cards. It may be difficult to protect against

this abuse because of restrictions on consumer credit monitoring,

Risk uedl"illg and insurance are important when products have a long production

cycle (as do houses), where there is significant investment in inventories (as with

jew cllcr y), or where there are significant responsibilities incurred through warranties

and for alter-market servicing. Sales contracts typically state who bears the risk for

performance of a product. This inAuCl1ces both price and marketability. For example,

an au tomobile sold 'As is' will be worth less than one sold with a ',-year 50,000 mile

warranty'.

- i~Morpho logica l bo xes

z The morphologi ca l re sea rch me thod - o r m ore ch a rac te rist ics , se le ct ing one o r m ore f rom ea ch

s imp ly the graph ica l pe rspec tiv e tha t we ca ll co lum n an d then c om bi nin g them in to entire ly new :-.

z morphologica l bo xes - is an o rde rly way of making formulations fo r the innov ation . Y ou may fin d it

comp lex d ec is io ns i nvo l vi ng l ar ge numbe rs of he lp fu l to random ly ex amine th e e ntire bo x, and

0 fea tu re s and b us iness mo de l c om po nents . It s a im

t he n g radu a lly res t r ic t y ou r self to p ort ions tha t "'.l

is to ac hi e ve a s chema tic o f a ll o f the poss ible ap pear pa rt icu lar ly fruit fu l.

<

so lu ti on s o f a g iv en lar ge- sc ale p ro gramm e . Th is Co nsi d er t he fol low in g cha lleng e th at m ig ht f ac e

in nov a tio n w o rk ou t d ra w s o n th e b ra in child o f M ad C atz, th e c om pa ny i n thi s chap te r's c as e s tu dy : ~Fr itz Zw ick y , a form er prof e s so r o f as tr op hys ics to design a v ideo game conso le w ith mo rph o log ica l

»a t C altec h . In 1933, Zwick y employed th e boxes , th en writ e it s busi nes s mod e l a nd e stim a te

mo rphologi ca l me th od to di sc e rn tha t a th e va lue fr om co mmerc ia liz ing yo ur v ideo g am eti~ 'co nsi de rabl e fra cti on o f th e mas s had be en mi ss ed' co nso le inn ov a tion . Co ns ide r th e fea tur es th at yo ur

in mea suri ng th e ve loc iti es o f ce rt a in ga lax ies . This ca pab ilit ies a llow you to pr odu ce . Th e se c ould be

- wa s th e fi rs t kn ow n obse rva tion o f th e 'mi ss in g e ith er pa rt icul a r com ponent s (c ho se n from th e

mass ' of th e un ive rse - what la te r bec ame kn own co lum ns in Tabl e 4.1) or a g iven fea tur e se t (chos en ~

0 as 'da rk ma tte r'. fr om th e row s in Tabl e 4.1).

Morpho logi ca l bo xe s o ffe r a w ay to co mbin e Eac h cha rac te ri stic of a co mpo nent add s s ome

z th e pa rame te rs o f a challenge in to new idea s mar ke t va lue (a co nsumer will in gnes s to payor

- (pa rame te r here m ea ni ng charac te ri s tic, fac to r, W -to-P in T ab le 4.2) an d s om e p rodu c tion co s t (a lso

var iable o r as pec t). Y ou choose the nu mb e r and show n in T able 4.2).

na tur e o f th e paramete rs with an o bjec tive o f Wi th th is in fo rma tion , F ri t z Zw i c ky's

selec t in g th e co mb in ati on t ha t bes t repre sent s y ou r mo rpho log ica l bo xe s can be used to build p r od u ct s

innov ation - young , edgy , co nse rvative , ico noc las t ic f or d iff eren t ma rk e ts , to d if fe rent pri c e p o in ts. We

a nd s o for th . shal l loo k a t t hi s f ur ther in t he Mad Ca ll ca se s tudy

below .

Blueprint Des c ri b in g y o u r i n no va tion in a s et of

Sp ec if y the object ives you have set fo r y ou r morpho lo gic al b oxes s impli fies a nd co ndens es

inn ovat ion. a c om plex pro blem, makin g p os sib le i n fo rmed

Se lec t th e components: th e cr ite ri on for decis ions where the re a r e s im ply too many

se l ec ti ng a p aram e te r is wh ether tha t pa rt icul ar c omponents fo r the human m in d to tra ck . The

pa ra m et er a ffe c ts y ou r o bje ct ives. my riad o f unr ealized o p po r tu nitie s and

Lis t charac te ris tics, val ues, or states des ig n s p oss ib le fo r re s tr uc tu r ing the bus in es s

that each component ca n take : th es e c oul d represe n t the 'da rk m atter ' o f a n y i nn o va tion .

b e c olou rs , shapes, ma te ria ls or an yth ing e lse F irm s that fa il to explore th is un se en m ass o f

t ha t m ight in flu enc e th e ultim a te goa ls o f yo ur oppor tunit ies may v e ry

in nov a tio n . we ll be surprise d when they show up in a

Tr y d iff ere nt combina tions. Ma ke rand om competit or 's p ro du ct - o r w o rse, in th e angr y

ru ns through your 2X2 ma tr ix of co mp onent s and rev iews o f disg ru n tled cus tomers .



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In 1987 a sma ll g roup o f e ng ine e rs sa w the 40 pe r c ent an nu a l g row th o f th e g lob a l v ide o

ga m rng ind us try as a un rque oppor tun i ty to inve st rn wha t th ey pre d ic ted wa s des tine d to

be come th e wo rld 's pre mi e r e n te rt a in men t industr y. B y 1989 th ey h ad foun ded Ma d ca tz.

w it h p ro duct ion fac il it ies in Sh en zh en , P R o Ch in a managed from th e ir Hong Kong o ffi c e , a nd

des ig n a nd ma rke ting in Sout he rn C a lifo rn ia, bring ing th em c los e r to th e ir ta rge t ga mi ng

aud ien ce .

For se ve ra l yea rs, M ad C a tz ope ra tio ns revo lve d aro un d a ha lf -doz e n emp lo ye e s , ge ne ra tin g

a ft e rm ark e t pe riphe ra ls a nd a cce ss ori es w it h in nov a ti ve s ty lis ti c tw ists fo r N in tend o , So n y,

Sega Dr e am ca s t a nd xbo x g ame co ns o le s.

By th e la te 1990S Mad C atz had gr ow n to ov er 100 employ ee s making co n tr o lle rs an d

o th e r v id e o g ame ac ces sories un der th e Mad C atz and GameSha rk b rand names , and se ll ing

th rough ab ou t 12,000 re ta ile rs g lob a lly . The Un ited s ta tes acc oun ted fo r m ore th an 80 pe r

ce n t o f sa les , w ith much o f th a t be ing sa les a t to vs 'c 'us . whe re Mad C a tz a lso OE Me d" it s

'TRU H igh Frequ ency ' s to re brand o f v ideo g ame ac ce ssori es . tov s' eus wa s impres sed enough

w ith the quality a n d i nn ova ti v en ess o f M ad C a tz co nt ro lle rs th a t In 1997 Ma d Ca tz wa s It s

Vend or of the Yea r (re ce iv ing , fo r its e f fo r ts , an e ff igy o f th e Iov s'R 'Us mascot, Geo ffrey th e

gi ra f fe ).

To ta l indus tr y re ve nu e fo r th e game co n so le a ft e rm a rke t was about US$I\OOmill ion in

2006, w ith Mad C a tz ac cou ntin g fo r a bout o ne- qu a rte r o f th e marke t. Three comp et ito rs

mad e u p t he rema in de r: Ta ke Two In te ra c tive w ith a round 20 pe r ce n t, th e pn va tc lv h e ld

NYKOT echn o log ies wi th 50 pe r ce nt , a nd th e p riv a te ly he ld B ig be n Int e rac tive a t 5 pe r ce n t.

C om petition was in ten se , a nd a ll o f th e compan ies were los in g money in 2006. On e o f Mi ld

C a tl's pri o riti es was to rev ise its busin es s mod e l in a fas hi on th a t wo uld u ltim a te ly as sur e

p ro fita bi lity .

Th e Mad C atz va lu e m ap (Fi gur e 4. 3 ) c on sis ts o f th ree re la tiv e ly ind epend en t ph a se s th a t

add to va lue m th e frn a l g ame co nt ro lle r pr oduc t - th e e lec tro n ics , th e pl as tic cas in g wi th

butt on s a nd jo ysti ck s, a nd th e pack ag ing . M ad C atz vi sua lize s th es e in te rm s o f th e ir demands

o n plann in g (in o th e r w or ds, the ir lea d tim e), th e deg ree 01 rn fl ue nce on th e cus tomer's

pur ch as e deci s io n (th a t is, va lue add ed in te rm s o f w illi n gn es s to pa y and impu lse to bu y ),

a nd th e co s t co n tribut ed to pro du cti o n , in c lu d ing a lloc a tion o f fi xe d and disc re tion a ry co s ts.

A g lan ce a t Tab le 4 .3 m ight co n v in ce you th a t th e re is l ittl e jus tice in bu si n es s, s in c e c ost

a nd va lu e ge ne ra t io n by c om p onent a re in ve rse ly co rr e la ted . Th e mos t ex pe ns ive co mponen t

o f M ad ca tz 's co nt ro lle rs, th e e lec tr o ni c a sse mb ly , has the lea s t in flu e nce o n th e bu y ing

dec is ion of cus tome rs; th e le a st ex pe ns ive comp onent , the pa cka g ing a rou nd th e con trolle r,

has th e g rea tes t in f lu en ce, be ing a big mo tiv a to r o f imp ul se buyi n g .

Th is ca n bes t be unders too d in th e cont e xt o f th e fea tu re map (disc uss ed in C hapt e r 3 : se e

Tabl e 4. 4) .

Game con tro lle rs a re 'e xpe rie nce go od s ' - you n eed to use th em be for e yo u rea ll y know

whethe r you like them, even whe re ga mers may have str on g prec o nce ption s ab out wha t

th e y are buying . El ec tro n ics a re a bas ic fe a tur e o f co nt ro lle rs -love 'em o r ha te 'e m . Th e

plas tiC ca se s, w ith the ir un ique loca tio n , look a nd fe e l 01 butt on s, jo y sti c ks and th e wa y the y

fit in t he h and , a re di f fe re n tia to rs, a nd if we ll (o r poo r ly) rec e ived by th e gam in g co mm unit y

ma y even be e xc ite rs . Pa cka gi ng , th o ug h , is the firs t t hi ng a con sum e r s e es , a nd in mos t

ca se s is th e onl y thin g h e o r sh e is ab le to 'e xperi en ce ' prio r to pu rch as rn g. For re la tive ly

in expen siv e cont ro lle rs such as Mad ta tzs , th e pac ka g ing is th e 'dea l c lose r ' .

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va lue add ed O f . Co s t added O f . Lea d time

Elec tr oni cs 0-20 60 4-6 mo nths

Cas e 30-40 20 3 mon th s

Pac kag ing 40-70 10 2 we eks

Table 4 .4 : teotore mop o f game conttoller

Bas ic Diffe renti a to r Exc iter

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Repea t p urcha se s a re dif fe rent. A fte r game rs have had a chance to use th e co nt rolle rs lo r

a few days , they are like ly to fo rm a stro ng o pin ion about the case o f t he cont ro lle r - th ey

are eith e r exc ited o r enr aged. You ca n 't pl eas e eve ryo ne, and every co ntro lle r wi ll hav e so me

use rs in ea ch ca tegory. In th e shor t r un (before th e o ri g in a l purc has e) th e energ iz in g features

are th ose o f the package - often th e a r t o n the bo x th e con tr o lle r co mes in. In th e long er run

(be fo re a repu rchas e o f th e Mad C atz br and co ntr o lle rs ) th e c as e wil l bec ome th e ene rgi ze r.El e c tro n ic s, on th e o ther hand, are o ften out sourc ed, and Mad C atz e lec tr on ics may end up

bei ng th e sa m e as thos e use d by it s c om petit ors. El ec tr oni cs are ne ith er dif ferenti a to rs no r

ene rg iz er s; b ec ause th ey are ex pens iv e, th ey a re th e ant e th a t firms mu st pay upf ron t to ge t

in to th e ga me.

Pa c ka g e and case fea tur es a re enti re ly di rec ted tow a rds manip ul a tin g the hum an in te rface

- v isua lly , tac ti le ly and p sy cholog ica lly . Ad va nce s i n plas tics mould in g and dig ita l pho tog rap hy

have g rea tly expand ed th e opt ions availab le fo r manip ul a ting th a t in te rfac e thr ough pac kage

and case des ign . The grea t cha lle nge is ho w to choose the righ t m ix of comp onent s to sa tis fy

a giv en ma rket.

Fi nd ing out what a ma rke t want s from a co n tro lle r, on the o the r hand , may yi e ld to mo re

di re ct so lut ions. It w ill lie in the pa rti cul a r games they wa n t to p lay with the contr o lle r. Gr and

Theft Aut o player s m ig ht des crib e th eir idea l contr o lle r a s 'edgy and vio lent ', whil e Da nce

Revo lution play ers m ight go fo r 'g litt e r' Madden NF L playe rs mi ght go fo r hom e team logos,

whi le fant as y games ent hus ias ts wo ul d opt fo r a my s tica l 'amaz ons and liza rds' loo k and fee l.

Whe re innov ative minds may rea lly mee t th e ir challenge is in des ign ing co ntr o lle rs foren tir e ly new mark e ts . By 2007, broa dca st te le v is ion aud ience s had rapidly dwindled and

mov iego ing had s tagnated, be in g repl a ced by int e rne t-enabled ga min g , which emer ged as

the new pil la r o f th e medi a wo rld. Wi th new game conso les , and new co mpute r-base d ga mes

con tinua lly enter ing th e ma rk e t, Mad C atz has amp le la t itude to inn ov a te in the co mi ng

yea rs.

a u

"0 ~ ·c ~u

B\) (\) ;;;> s; . a.;;: (\)

:r:;:u



98 (.1{lIIA[ Ir.;:-';OV,\TIO:-.J '\\A:\A{.ll\lll'l

Qu es tion s fo r th e M ad C a tz ca se study

1. Gi ven th e split o f co sts i n t he Mad Ca tz bus in es s

mo de l, see how man y d iffe rent pr od uc ts yo u ca n

'inv en t' in yo ur m ind th a t a re amenable to Mad C a tz

bu s in es s mode l. C an you t hi nk of an y tha t a re n ot in

th e ga m in g i nd us try '

2. Re vi ew th e Ma d C at z i nn ova tion ex amp le g iven in

th e Mo rpho logi ca l B o x i n nov a tio n wo rk out. Ass um eth at m ark e tin g has determined th a t unit demand fo r

th e Mad Ca tz inn ova tion has been computed fr om

hi s tori ca l da ta and ma rk e t te s ts by your ac count ing

depa rtm ent . Ov era ll price inf lu e nc es (redu ce s)

sa les vo lum e b y t he fol low in g formula : vo lum e

(unit s) = ($700 - Sa les P r ice ) 10000. Wh a t is th e

m o st p ro fitabl e co mbina tion o f co mp onent s fo r th e

pr odu c t>

CHAPTER QUESTIONS FOR REVIEW

~ Bu sin es s mode ls can be des c rib ed on seve ra l diff erent le vels. In th e chapt e r, th re e fo rms

we re desc r ibed: a s tor y , a s to ry with f ina nc ia l pro jec t ion s, and a graph ic a l bubble- a rr ow -

box m od el:

a. Des c ribe th e s itu a tion in whi ch ea ch m igh t be app ropri a te.

b. If yo u we re g iv en on e m inute to pr ese nt yo u r i nn ova tion to a wealth y in ve sto r, w h ich

fo rm o f bu s in es s mod e l wo ul d be bes t' Wh y'

c . If yo u we re gi ve n on e hour to pr esent yo ur innov ation , wh ich fo rm wo uld bebe s t> Wh y' Is the re any thi ng tha t yo u mi ght ad d if yo u had a f ul l hou r to se ll yo ur

'bus in es s mod el' for the innova tio n '

£l Typ ica lly 50 to 9 0 pe r cent o f th e co s t o f running a bus iness repre se nts routin ized

'ope ra tions ' -l ega l, acco unt ing, in for ma tion sys tems, an d so fo rth - th a t a re no t sp ec if ic

t o the inn ov a tion :

CI-IAJ'Tl-.R4 99

a . Ho w d o you 'se ll' in ves to rs on the ro ut ine , no n -inn ovation re lated co s ts o f yo ur

bu s in es s'

b. Wha t op tio ns do you have to co ntro l th e co s t o f op e ra tion s '

:\l On e o f th e mos t d ifficult as pec ts of des ign ing an ap prop ri a te bus iness mo del fo r a n

innova tion is the choice of ma rketin g chann el.

a. Wha t fac to rs in f lu ence your cho ice o f ma rke ting channel '

b . Is it bes t to choo se onl y one chann e l, o r se lect mo re than one chann e l fo r m ark e tin g'

In wha t s itu a tions wo uld yo u reco mmend one ch ann e l ve rsus many ch ann e ls' Wh y'

c. Marke t in te rm edi ar ie s (mid dlemen) hav e bee n c ritic ized for generat ing un necessa ry

cos t and de lay for co nsum e rs . T hi nk o f th ree rea son s th a t th e co s t add by ma rk e t

in te rme di a ries is jus tif ied by th e va lue th a t th ey add to the pro du ct.

IIl"d;\I •.••.•\IODI,

CHAPTER 4: KEY POI TS

Bu s ines s mo de lling is th e manage ria l equiv a lent o f the sc ien tific me th od .

Bu s in es s mo de ls suppo rti n g a n i nno va tion a re c ompose d o f fi rs t, a sto ry , and seco nd,

fin anc ia l ana lys is tied to th e s to ry c ompo nent s .

Stor ies behin d succ ess ful bus in ess m ode ls have bee n ge tt ing prog res s ive ly mor e

com plex:

as tec hnolog y evo lves and o ffers mo re di s tin c t typ es o f oppo rtu ni tie sas co mp etit io n beco mes mo re in tense

a s c ompetit ors ge t be tte r at inn ova tion .

Bus in ess models , like fic tiona l stor ies , a re va ri a tions on a few a rche types gi v in g vo ice

to un ive rsa l th emes un der ly ing a ll h uman expe rience .

C omp lex ity in today 's bu s in es s models requires an i nn ova tive res ponse to p rov iding

fin anc ia l sup po rt for the s tor y suppor ting a new inno va tion .

Va lue prop os iti on s mo tiva te th e ent ire bus in es s mo de l:

they a re th e fi rs t choice th at nee ds to be made i n c ommercia liz in g an innov a tion

th e re may be se pa ra te va lue prop os it ion s fo r ea ch cus tomer g r ou p f or an in vent ion.

Va lue maps gr aph ica lly depic t the co re and supportin g (in ductive ) processe s o f a

bu s in e ss , w hile va lue flows des c ribe how the ir va lue is gene ra ted.

Th e env ironm ent box des c ribes the out s ide pa rti e s (c us tome rs, vendo rs , comp e titors

e tc .) w ith wh ic h th e firm nee ds to i nte rac t.

Th e fund ament a l un it o f va lue is th e tr ansa c tion , whi ch is a packe t th at ca rri e s c os ts ,

re venu es and uni t quantit ies.



100 (.LOI/\1 I~-:O ATO-. '\\AS.\(\ ,\ ,"NTCI-IAl TEH -J .

Cl.irk, 1(. B. .md Fujimoto, K. (1991) l 'rorlnct

I)CI l'/OpW'JlI P(}./iJl·}JI.,J/CC: 51/ } , ,/C:!(V . O1g.,ni:',lli{}JI.

.111r / lI11l}1dgl'}JU}J/ n tbe irorlr! ,m/mlw/"ic iuduso».

Bovron, J\I.t\ \. : Harvard Business S chool )1n..:-..• Porter,

i\1. E. (1991) "Iow.irds a dvn.unic theory of \rLltcgy:

S/}(l/l:(!,it- t\!,IJI.lg('}J/l·III./fJ/f1"JI,d 12.,pp. 95-11-,

Eivcnmann, T. R. (2.00 2) hrtrruct nUS;}JCS." l\luf/cIJ lllJrI

S);I/(gic.<: Te.vt ,I/If/ CdSI .<, New York: ,\lcGr.I\\'-Hill;

Gul.ui, R. (199X )'A lliancl's .md network ..• SJil/l:(!,i(

1\/tlll"gC1JIl'1IIjollrnr/ II), pp. 29;-;/-,

Boyd . . J . (2002) In community we truvt: online

s t.:C llriry cornmunic.uion at c13a y: jollrll,r/ (!/'C()}II/,Il/cr

Illeriidl£'f/ Connnnnir.ni,». -(,) (April).

+ Clark, K. B. and Fujimoto, 1(.(1991) /'mrillcl /)Cl'c/op-

mrnt Pnjr)}7JJd}J(f: Sl il ltgV, mgtlJli':.tl/iIJJI, .t ud rn.ut-

tiKi'll/i'll/ ill Ibe worlrl dIfIO llfJ/JI/e inrllls/})!, Boston,

1\ laxs .: Harvard Bu sin ess School Press; Oster, S. (1999)

tllllri" ,." Cfll lI/,r lililll' //lld/l'sis, New York: Oxford

University Pn..."Is;Chcm.iwar, P. (1991) C01ll111i/w{'III:

Th« r(l!Jldlllhs f!(i/};I/(~{l!,New York: Free Pres •.. Porter,

1 \1. E. (1996) 'What is strategy" H.m'drr/ Business

/?cl,il'!{', Nov-Dcc, pp. 61-71';'

Drucker. P. F . (196+/1993) tIIdll<1giJ g Jill' Rem/ISCollins.

6 Priem, R. ,\Ild Burlcr, J. E. (wOI)'T;lUtology in the

rcsourcc-b.iscd view and the implic.uion-, o f cxrcr-

n.illv deter-mined resource v.iluc: further commcnr-,'

. Jctl~/l'J/~)1~(,\Itl"dgl'}l/l'''1 Reoia» 2.6, pp. 5--6-.

- ~1.1grL·tta,Jo.1I1 (2.002.) 1I!J.ll AIIIJlflgCJIIl'JlII.i: Holt, it

uork», 111Ir/1l'/~1'(,' ('('l'I~)I()JlC:irnsincss, New York: Free

Press.

Th i-, conn'-pt iv .It the centre of t1K rcvourcc b.i s cd

view of \tr.1tegy, presen ted f or ex ample ill Priem , R .

.m d Burler.]. E . (100 1) 'is the r cvourcc-b.iscd "view" ,I

useful perspective for srr.ltegic man.lgelllellt research?'

•-Jctlr/1'1/~v(!li\Il1hlgCJIIl'II/ /?l'l'icll' 2.6.pp. 2.2-+1; Collis.

D. J . and "lonrgoll1ery, C. A. (199») 'Competing on

re."lOUITL·\:\rr~ lt egks for the 1990"': /-/r1l'l'tlrr/ Husiuc«

Rcnicu-. July-Aug. pp. IIS-2S: Barney, J. B. and Ari-

k.m, A. ~1. (2001) 'TIle rc sourcc-haved view: o ri gin ..•

and iruplic.irions,' working paper, Fisher College of

Business, Ohio Stare University; Burney, B. ('00 1)

'Is the rc..•urcc-hascd "view" a tI."Ieful perspective

for srrart.:gic managCI1ll:IH research? Yl:S', "/(dd(,}/~l' ( ~ f '

l\1tlllllgIJIIl'JlI /?t'Jiil'f(' 26, p p. + 1-57·

9 Bell, D. (1960) 'tbc blf/o/1ric%gy, Glencoe, III.: Free

Press; Bell, D. (1976) /I", (; 1 / /1 1 " , 1 1 COiliar/irlio/lS

oj' Capit.ilisn), HarperCollins: Bell, D. (19-l) 'II",

Coming (~ f ' Posl-!J"III.i/riill Socia», New Yo rk : lttsk

Boob.

10 Oster. S. (1999) l\lorlC}'n Cowpel ilil'l' . hltl(V.iis.

New York: Oxford University Press, p. z: S,I-

OTESrive, rhuv t he choice \\\1., m.ldc to p.lttnn value nl.lp~ on

the DFD modelling .ippro.ich. [Thi •..•. .orr sccrion b

ha •..•... on Bu.iiJll'.i..•.Proirss /"'prm}{'IJ1l'nl '·.J.O Office

of lnform.irion Technology (AIT), Fcdcr.il Aviation

Adminisrr.irion \\".I -,hinnron, DC,;o lovcmbcr 1995.)

Barncv, LB .. lIlt; Arikan~ A. ~I. (2001) 'lllc resource-

h.ived view: origin x ,1I1d imp lic.ir ions , working paper,

Fi sh er College of Buviucsv, Ohio Stare Univcrsirv,

2.001; Ba rnc v, B . (2.001)'1'1 the r• ..... .urce-b.ivcd "view" ,1

lI..•ful pcrxpccrivc for srrategic lll.ln:lgcllll'nt rc ..•arch?

Yes', .·lcfull'1J~)I(~/~\Ill1hlgl'lIIl'JJI Rt'l,il'Il' 26, pp. +1-5-·

Rumc lr, R. (1991) 'How m uch doc s indu ..•r)' matter?'

S/}illl'e/( ,\III11IIf(l'JlU}JljOI/}'IItd 12. pp. 16--NS·

2+ Thesc'" themes '-play .in imporr.mr role in J \ Ichacl

Porter's work, including (1996) '\X'hat is stratcgy?'

Haru.m! Busincs, Rci-inr, ov-Dcc, p . 6N; (19No)

Compctiurc . l/r.r/lg)/: 7abuifllll'sj;)}' Illlll(lls iJJg il/rllls-

IH\IN.S" ,\\onl" 101

loner. G ., Shcp. ir d. A. .md Podolny.]. (!001) SIIOII:<{I

1\I.rJltl•..!,C1IUJlI.Ne w York: \'\'ilt-y, P: 2-9.

\I BO\\'l11an, E. H. and Hclf ,ir . C. E. (WOI) 'Doc,

corporare •..r.uegy m.urcr?' SI1illlgil' l\ltlJl,lgl'JJll'JlI

./,,"m,II!!, PI'. I-!>; Drucke r, P . (199+) "Th e rhcorv

of ..•cuegy: Harr'llrr/ Bu siness Rrricu', Sept=Ocr, pp.

95-10).

12 See Dvcr.}. H. (1996) 'Specialized supplier network-

a..•a source of competitive :ldVanr.lgL': evid en ce f rom

the auto induvrry' SIJilllgir Alll1Itlgl'JIIl'}I/ [onru.r!

1-, PI " !-1-91: Dyer,J. H. ,\I1d No beo ka, 1(. (woo

'C« .',lting and m.lI1:lging;l high performance knowl-

edgc:-sluring network: the Toyota case: SI}illl~f(1l

A/dllllgl'UUII ./fllIJ'ntll ~, pp. ,+5-6,.

13 Scc Cranr, R . j\1 . (2002) C{)Jlfl'JJlpm;l}:J '.)'I}~l/lg)l'-/;hrl-

vsis: Couccpt; trrhniqm«, tlpplic'fllioll.i, Oxford, U.K.:

·Blackwell. p. l07; Culari, R, Nohria, N. and Z"heer,

A. (2000) 'Srrategic ncrworks' S/lilhXh AltlUdgl'}lfClI/

[onru.t] 21, PI': ~0;-15; Burney . . J . B. (2002) (;.ri;Jillg

.uir! .)'If.;ltliniJJg Cmllpl'Iilil'l' .lrh. dJlldgl', RClding.

1\ lass .: Addi,on-\'vblcy, 1'.6.

J + POITer, J\1. E . (198S) Compctiiire . lrh. dJJld...!; C ' : Crl'dliJlg

tlllr/ SfSdillillK suprrior p('}ji}}·w.tll(c. New York: FreePress; ,\IcG,lh"n, A. "I. ,\I1d Porter, ,\1. E. (19')-

'How m u ch d oc v indu ..•rv m.irtcrr Rc.illv?' SI}illl'r!,I(

J\/llJJdgl'JJlCII/./fJllJ'Jlld IN (\lIllllntT ..•cci.tl iss ue ]. p p .1)-;0; Porter, J\1. E. (1998) 011 CmJlpl'lili()JJ, Bo-ron,

~ lasv.: Harvar d Bu si ness S chool Pre".

15 Grover, R, Palmer i, C. .i n d E k rr om , 1 '. (WO!) 'Q\\'e't:

the is."IUl'Sgo beyond .\ccolllHing: Bnsiurss I f 'ca', 2.)

"l.lrch, pp. 66-X.

16 Th e journal h.1."l..ncc ch.l I1 ged i t\ n .u nc t o 1\lllrl'CI"Jg.

Counnnnic.uion«.

17 Rybc zv nsk i. \X '. (!DO l) (Jill' Good Tu ru: .l 11.11111;1/

hislory of'lbc scrctrdrircr .uu! /he st reit', NL'\\, York:

Scrib;le~ / First Touchstone .

18 Adler, I. (19XX) 'An ,llgebr,1 tor dar .i R ow d iagr,ulI

process dccompovirion 1 1 : 1 : .' 1 :. ' '/;i1lJ. S(~fill'.tr(

l:.:JlgiJJ{'criJlg, Feb.

19 Wiltord, J. N. ( !DO ') ' / 7J C M<1/,III,d,I/Ci,London:

Pimlico, p. 25;.

20 Thompson, A. A. and Strickland, A.J. ( xoo v) Smlllgi,

j\/,'llflgClIICJJI: COJl(C/,I.idJlr/t,l.ic ..••New York: ~1((;r.I\\·-

Hill. p.l; Chandler, A. D. (196!) SII;lltgj<,/lIdSrI/,-

t urc : CIJ.tP/CI:\ irr ,he /Ji.i/m:v ( ! / i / ){ ' i"rlff.i/ri,d l'II/('}jJri'l',

Cambridge, Mass.: "liT Press, P: I,. .

21 Our value Illap borrows symbols .1I1d terms ~rnJll

D,ltaAolV Diagrallls (DFD), whereas ABC t)'l)ic,dly

lJ\ed all IDEFo Illodelling tool, with more iJlvoked

terms and modelling techniques. Both can be ~ho\\'n ro

he equivalent to Pari nc ts, and thus provide the v,IJlK

1.1Ilgu,Iger ichness. DFD."I .irc s impler .lIld mor t' inrui-

22

2 ,

Iric.(IUJr/aoJlpt'/iltn), New York: Frc c Prcvs: (1990) T hr

CmJlpe/ilil'l' . Jr/"".tJlI"ge (~(Nations, New Yor k: F re e

Pre •..•..(19-9) 'How competitive torcc •.. Il.lpe •..r.ltegy:

Hnrr.nrl Busiucss Ra-icu), i\Ltrch-April. pp. q--,6.

25 From the once popular h n.mce t ex tb ook hy Gordon,

j\ I. (1962) Tln: hnvsnncut, li'Jlllllo'Jlg .mrl ! .dn.uio» (!(

tl rc COJ/,II/;lI IJII, Homewood, III .: Irwin.

26 P.lgl.-S. H. (1999) 'A note on th e Gordon growth

model with non•..arionurv dividend growth', Ihnk

for lnrcrnntion.il Scttlcrncnt-, \X'orking Paper no. 'S.

Bax lc, Swirzcrl.ind.

27 Original et]u ipmcnr manufacture (0 E1\I) is a rcrm usc d

to describe companies rh ,u manufrcrurc (.lnd often

de.\ign, too) products that an.' sol d und er a different

company's br.md name (such as Toys'R' Us). 111(' term

i."lso widely u • . •. . : d that it i s common to hear it :lS both

noun ;lnd verb.

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