What Is Your Business Model?
How do you create value for customers and capture that value?
My favorite book on business models is Business Model Generation¹ by Alex Osterwalder and team. In the first few pages of that book, business models are defined in a few different ways. “A business model describes the rationale of how an organization creates, delivers, and captures value.” “The business model is like a blueprint for a strategy to be implemented through organizational structures, processes, and systems.” “We believe a business model can best be described through nine basic building blocks that show the logic of how a company intends to make money. The nine blocks cover the four main areas of a business: customers, offer, infrastructure, and financial viability.”
Those nine blocks are communicated in the Business Model Canvas (BMC) which the book introduced:
When I first encountered the BMC, I thought it was a brilliant way to summarize an entire business on a single page. I still think that. But I’m not convinced it adequately describes a company’s business model, at least not in a manner that is helpful for people really using the tools to understand and develop real businesses. Others have adapted the BMC to better meet the needs of LEAN startups, but I think we need to go a level deeper.
A new favorite book of mine is Competing in the Age of AI² by Marco Iansiti and Karim Lakhani. The book ultimately is about the business model innovation being enabled by the Connected Intelligence Revolution. The authors introduce business models in this way: “The value of a firm is shaped by two concepts. The first is the firm’s business model, defined as the way the firm promises to create and capture value. The second is the firm’s operating model, defined as the way the firm delivers the value to its customers.” Later they explain “Whereas the business model creates a goal for value creation and capture, the operating model is the plan to get it done.”
Another helpful discussion of business models can be found in Open Business Models³ by Henry Chesbrough. “At its heart, a business model performs two important functions: value creation and value capture. First, it defines a series of activities that will yield a new product or service in such a way that there is net value created throughout the various activities. Second, it captures value from a portion of those activities for the firm developing the model.”
So, there seems to be pretty good consensus that a business model can be defined as “how a business creates value for its customers and captures value from its customers.”
I have found it helpful as I work with teams, especially in the earliest stages of business conception and formation, to break the business model into these two main functions (value creation and value capture). The operating model is what I call the value creation portion of the business model. The revenue model is what I call the value capture portion. You may have slightly different definitions for those two terms, and that’s okay.
Yesterday I introduced the revenue model. Today, we will mostly talk about the operating model. Together, they make up the business model.
The Operating Model
The challenge with developing a generic template for an operating model is that operating models differ significantly depending on what business you are in. If you make products, a significant component of your operating model will be manufacturing. If you own and operate stores, a significant component of your operating model will be retailing. Whirlpool’s operating model looks very different from Best Buy’s operating model. Google’s looks very different from either of them.
One aspect that I have greatly appreciated about the BMC has been the two blocks to the left of the value proposition: key resources and key activities. I would describe these two as “what you need” and “what you do” to deliver the value proposition. The remaining block on the left side of the BMC is key partners, which I typically describe as “who helps you complete the value proposition”. While I like the conceptual structure of these three blocks, they are so broad and so generic that I don’t know that they really help in developing a business.
Below is my Operating Model template.
As I did in previous articles on the value proposition and the revenue model, I’ve reversed the direction compared to the Business Model Canvas. (You might reference the BMC diagram up above for comparison.) The customer comes first and everything follows from that. I’ve broken the BMC’s Key Resources block into two blocks: People, and Assets & Locations. I’ve also broken the BMC’s Key Partners block into two blocks: Suppliers, and Key Partners. I’ve replaced the BMC’s Key Activities block with a value chain which I’ve labeled Value Creating Activities.
In using this template, the work done in populating the four blue boxes is not significantly different from the work done in populating the two corresponding boxes on the BMC, just broken down one more level. That additional step, however, I find really helps leaders think about the unique needs of their business.
The hardest work, however, is in defining the value chain involved in creating and delivering the value proposition for customers.
What is a Value Chain?
Michael Porter introduced the concept of a value chain in his 1985 book Competitive Advantage⁴. Porter describes a value chain as “disaggregating a company into its strategically relevant activities.” Given that it was introduced in a book on competitive advantage, it’s not surprising that he saw it as a powerful tool for focusing on potential sources of competitive advantage.
This is the model of a value chain that Porter introduced:
The value chain for any given business will be somewhat unique, reflecting the specific activities required to create value for customers. In developing a value chain for the Value Creating Activities portion of the Operating Model, I recommend considering the categories of activities identified by Porter, but identifying specific activities at a much more granular and specific level. What are the key activities involved in creating and delivering the value proposition and how do those activities fit together?
As reflected on the Operating Model template, developing a deep understanding of how value gets created in your business also uncovers the financial implications for the business. We will talk more about that tomorrow.
¹Osterwalder, A., & Pigneur, Y. (2013). Business Model Generation: A handbook for visionaries, game changers, and challengers. New York: Wiley & Sons.
²Iansiti, M., & Lakhani, K. (2020). Competing in the Age of AI: Strategy and Leadership When Algorithms and Networks Run the World. Boston, MA: Harvard Business Review Press.
³Chesbrough, H. (2006). Open Business Models: How to Thrive in the New Innovation Landscape. Boston, MA: Harvard Business School Press.
⁴Porter, Michael E. (1985). Competitive Advantage: Creating and Sustaining Superior Performance. New York.: Simon and Schuster.