The Business Model Cost Structure

All components of a business model have related costs and the size and behavior of the costs provide an indication on the flexibility and scalability of the business model. As all managers know, lowering cost with $1 has a greater impact on the bottom line than increasing the revenue with $1 as revenue almost always comes with an associated cost.

Having a low cost structure is a strong competitive advantage which market leaders in industry after industry recognize, when companies with low cost business models enter their markets. In the steel industry the mimimills took on traditional smelters, in automobile manufacturing standardized Japanese cars won out over customized vehicles, "no frills" airlines such as Southwest Airlines or Ryanair took down traditional airlines such as US Airways and Swissair, open source software has taken large market shares within several software areas, and a hot topic right now is the struggle of traditional newspaper companies as a consequence of low cost online substitutes. See separate post here

Online companies with low costs structures are currently disrupting traditional industries and have created some very high operating margin businesses, with Craigslist perhaps the most referenced example, generating an estimated $100mm in annual revenues with an operating margin of 90%.

The Business Model Framework

The business model concept is a good framework to identify where costs arise, and how it relates to the creation and capturing of value for customers and other value recipients. Identifying significant costs and assets needed, relating to each component of the business model, provides an overview that can be used to improve the existing model or completely alter it.

Not only a number

When doing the cost analysis in relation to each business model component it is important to identify underlying cost drivers, relationships between different costs and the behavior in terms of size, growth, volatility, and whether it is linear, degressive or progressive in relation to increasing activities. This will answer an important question on how the business model will correspond to change, and how predictable that is, and can be used to find ways to balance the need for growth while managing costs and risks.

Knowing how much things costs and how it will change over time is the only way of maintaining a rational cost structure. Also knowing how choices in the different business model components affects costs in other components is a great starting point for business model innovation.

General questions once the full picture is known

Few if any managers and executives have visibility of the costs associated with the different parts of the business model. Especially in times of cost reduction it often ends up cutting too deeply in areas that are critical to the business while leaving money on the table in areas that are less critical. Once the different major costs are identified you can start question each of the business model components:

• How can this be performed differently at lower cost, or even be eliminted?
• What companies are focusing on low-cost alternatives in this particular business model component but perhaps in another industry?
• How could collaboration with another actor lower or eliminate costs?

Below are some examples on more specific questions:

Customers and Value propositions

Do we need to serve all existing customers or market segments? Are some of the segments more costly? What if we configure our value proposition differently? What if we reduced performance, eliminated features, changed the mix of value propositions, adjusted the level of service, and eliminated expensive value propositions exposed to price competition? Would it be possible to create synergies between different value propositions? What if we changed the way or time of delivery? What if we employed or changed to other channels of delivery?

Resources and activities

What if we used other raw materials? Shifted location? Changed specifications for purchased components? Lowered wages paid, amenities provided to employees or training? What if we replaced owning of IT systems and software, and replace it with software as services? What if we abandoned unused patents, or sell and license them back? What if we outsourced development, marketing or installation? What if we invested in new processes? Automation? Simplification? Elimination? Centralization? Standardization? Shared Services? Can we create synergies between different activities or use resources in a more efficient ways?

Partners and relationships:

What if we change specifications? Quality? The number of partners? The type of partnerships? What if we partner with upstream, downstream or horizontal actors? Configure the value network in a different way? Etc.

Even though the cost side of a business model to a large extent determines flexibility and scalability, it is seldom discussed in relation to business model innovation. Growth in revenues is of course important but it’s only half of the value creation equation.

Further reading:

10 Tips on Business Model Innovation

Scalable Business Models

External links:

When Talking About Business Models, Remember That Profits Equal Revenues Minus Costs

Fred Wilson on disruption

An interesting presentation by venture capitalist and blogger Fred Wilson from talks@google, May 13th. Fred, who has invested in companies such as Twitter, Del.icio.us, and Feedburner, share some of his reflections on innovation and the disruption of industries.

"...we are going to get businesses that may be an order of magnitude smaller in terms of revenues, but maybe multiple orders of magnitude smaller in expenses, and could be way more profitable."

"...at the heart of disruption is disrupting things that are non-sustainable and replacing them with things that are sustainable..."

"...any businesses that are end-to-end digital is a good candidate for disruption..."

"...when will the virtual currency become as good as the dollar or gold... ...my guess is that we will start to see that."

10 Tips on Business Model Innovation

How can we start innovating on our business model?

Business Model Innovations have redesigned entire industries and there are many stories on how companies by providing something different, in a different way or to a different customer segment completely change the rules of the game.

There are many ways to explore and analyze markets and the different components of the business model to identify opportunities for innovation. Here are 10 tips on how you can approach business model innovation:

1. Create a common understanding of the existing business model

This might seem obvious but in many organizations the knowledge about how the company operates is widely distributed in the organization. A good idea is to bring together key people from different parts of the organization who understands different parts of the existing business model and the underlying reasons for why things are the way they are. Is it because it always has been in that way? Is it because it was the easiest way to do it at the time the decision was made? A great way to create a common understanding is to visualize the business model by drawing boxes on a whiteboard, using the business model canvas, or as I sometimes do; list business model components in Excel using a projector to facilitate collaboration.

2. Create a common understanding of what is core in the business model

Focusing on what a business does best is often argued the easiest and most efficient way for companies to grow and be profitable. Understanding customers' perspectives and their perception of value is fundamental to identify what is core. Perhaps it’s not what you deliver but how you deliver it, that makes people buy? - Perhaps you should deliver something else as well given your good way of delivering things? - Perhaps it’s not the gadget you sell as such, but the software interface that people like? - Could other gadget manufacturers need your better software interfaces? - Perhaps the reason someone wants to collaborate with you is because your customer relationship and contracts with a certain organization? - Could other companies be interested to get access to the same organization? Read more about identifying the core in a business model here.

3. Identify interrelationship between the different business model components

Discovering real and perceived relationships and interdependencies between different components is important to understand underlying reasons for why things are the way they are. Identifying perceived relationships is also a good way to find underlying assumptions that might be wrong. What are the underlying assets enabling key activities? For what parts of the value proposition are partners and external actors necessary? How do the customer segments affect the choice of customer relationships and delivery methods?

4. Identify drivers of change and trends affecting existing business model

Why do you need to reinvent your business model? Is it because of low cost competition? Niche actors? New actors? New technology? Changing customer behavior? Changing partner behavior? Identifying the drivers of change and trends affecting the existing business model will turn your focus to the most crucial components of your business model.

5. Analyze strengths, weaknesses, opportunities and threats

The SWOT analysis is simple yet a powerful tool to create a common understanding of the current situation and to summarize the findings from the steps above. It is often illuminating to point out what needs to be done and to put weaknesses and threats into perspective. Use precise and verifiable statements rather than lose assumptions or opinions, and prioritize to spend your time on the most significant factors. The SWOT analysis can also be used on the business models of competitors or other external actors to find new ways to compete or collaborate.

6. Analyze theoretical ideal situation and contradictions for each business model component

By exploring what would be the theoretical ideal situation for each business model component you can create out-of-the-box-ideas without being locked into existing solutions. In doing so you can also find the constraints of a business model: why can't we provide this for free? Why not instantly? Why not exactly the way the customer wants it? With the ideal situation identified, the next step is to work backwards to something that is achievable by decreasing benefits and/or increasing costs and harms.

7. Analyze external alternatives that could take each business model component closer to the ideal situation

With a rigorous SWOT analysis and Ideality analysis you are well equipped to analyze how external actors could fill in the gaps you have identified. What if X delivered this instead? What if we replaced some of our existing assets or activities with external ones at lower cost or better performance? What if we created a low cost version? A digital version?

8. Analyze what would happen if applying principles for innovation

You can use the 40 principles for innovation, based on TRIZ adjusted for business problems, to explore "what if" questions for each business component (see example in the business model innovation matrix). What if we took away something? (principle 2), turned something the other way around? (13), did something slightly less or slightly more? (16) etc. Exploring 40 principles on several different business model components is an extensive work and I find two approaches helpful; either have a session on one business model component and apply the different principles, or take a few principles and apply them on all business model components.

9. Decide on ways to explore alternative business models with limited risk

The development of a successful business model is often the result of lots of learning from lots of failures, so it is important to find ways to fail fast and cheap without destroying existing business models. To avoid failing in front of your existing customers and partners, common methods are to set up separate working groups within or outside the company and use closed focus groups, advisory boards, release limited beta versions or try out new business models in limited geographic areas.

10. Track progress and unexpected customer or partner behavior

When tracking the progress of a new business model it is important to not focus blindly on parameters such as costs and revenues, but to identify existing, expected or unexpected customer or partner behavior and iterate the business model.

In retrospect most business models seem obvious but at the time it's not always that clear. To quote an article in Business Week from 2000 "But how will Google ever make money? There's the rub. The company's adamant refusal to use banner or other graphical ads eliminates what is the most lucrative income stream for rival search engines."

Further reading:

Table of contents

Tools for Business Model Innovation:

Business Model Innovation Matrix

The Business Model Canvas

What elements are core?

The Value Proposition Explorer

Ideality as an innovation tool

TimesOpen: Tim O’Reilly Keynote Video

Tim O'Reilly at Times Open event exploring NYTimes.com as a news and information platform, talking about web2.0 opportunities.

More videos with Tim O'Reilly:
Tim O'Reilly on Open Publishing

Outlook for Newspaper publishing: Moving into multiple business models

The newspaper industry has seen a long-term decline in circulation volume and advertisers have been moving from newspapers to online channels and into new formats to reach its target groups. At the same time several newspaper publishers that have started online TV-like experiences in relation to their online news sites, thus finding new audiences beyond their traditional print readers. The global economic downturn has accelerated the need for many newspaper publishers to adjust their business models to survive and as this 56 page report concludes "there will be some casualties and losses of well-known papers along the way."

The report On the outlook for newspapers in the digital age: Moving into multiple business models, is an interesting read from PricewaterhouseCoopers. Based on interviews with industry actors and 4900 consumers, it focuses on two key issues: the change of consumer behavior with respect to their consumption of news content, and the response of newspaper publishers, advertisers, advertising agencies and media buyers to these changes.

The change of consumer behavior
PwC concludes that print will remain the largest source of revenue generation for some time but will have to coexist with other media in new ways. Consumers see breaking news and general interest news as commodities, something that is more difficult to charge for online than offline. Instead they place a high value on deep insights and analysis provided by journalists, and a growing segment is increasingly demanding specialized information.

Consumers increasingly expect to be part of the debate and to be able to contribute to their newspaper, both in terms of commenting and in providing content. Perhaps surprising is that the rapid adoption of mobile technology and devices, has not yet resulted in high preference to use mobile devices for accessing information due to the difficulty of reading content and thus the overall willingness to pay for news on e-paper and mobile devices is low. Perhaps new business models around Amazon Kindle or perhaps a future e-reader from Apple? will do the trick?

Advertisers' perspective
The authors conclude that the shift of advertising revenue from print to online is expected to continue over the next few years even though TV appears to remain the most attractive medium for advertisers. However, advertisers can, and choose to, use multi-platform approaches, combining newspapers, magazines, mobile, the Internet, TV, cinema, radio, sponsorship and outdoor advertising. Main focus in the economic downturn is to use reliable and measurable media types to achieve the best return on investment. Another interesting conclusion is that advertisers are still reluctant to invest in user-generated content and social networking sites due to the difficulty of controlling the environment.

Publishers' perspective
The authors conclude that traditional newspapers have a relatively loyal reader base even though younger readers increasingly prefer to read news online. And although there is a huge potential for growth online and many younger readers prefer to read news online, the conclusion is that print will remain the largest source of revenue generation for some time. At the same time newspaper publishers are reassessing the role of the aggregator and are starting to introduce new subscription models combining multiple platforms and new technologies as new channels for distributing content.

PwC concludes that there is a shift in the organizational structure of newspaper publishing operations from a structure based on channel distribution to one based on content production. As actors in adjacent industries such as telecom providers are becoming media participants, newspapers can leverage their advantages of being a trusted source of information and having content creation as a core competence.

What about business models around APIs?
Something I miss in the report is the concept of a newspaper as an open platform. Newspapers such as the Guardian and the New York Times, and news organizations such as BBC and NPR have started to provide API (application programming interface) which allow third-party developers to access and reuse content databases in their own applications. This is something that the content owners can chose to charge for, enabling very interesting business models.

How will news be experienced online?
In the early days of the television, news was presented as if being in a newspaper. The Internet is only in its very early days and companies are exploring new ways to use algorithms analyzing twitter conversations to identify breaking news and combine videos, links, blogs, comments and communities to explore ways to provide deep insights and analysis. I believe the consumers answering these questions have a clear perception of how online news is and will be presented, and as Henry Ford allegedly once said "If I'd asked my customers what they wanted, they'd have said a faster horse."

This is a great report to dive into and contains much more than what I have covered above. For those of you interested to read more download the full report and watch a short video here.

Related posts:
The Freemium Business Model
Subscription-based business models

Related videos:
Eric Schmidt on news, newspapers and real time content
Tim O'Reilly on NYTimes.com as a news and information platform
Tim O'Reilly on Open Publishing

Mad Avenue Blues - The year the media died

Other recent reports:
Pharma 2020: Challenging New Business Models

Visualizing value propositions and revenue models

On the website Boardofinnovation 10 generic building blocks are presented to "build any business model". Each building block is presented graphically and the idea is to visualize different business models to enable mapping and comparison of different businesses and "a new way of designing and innovating business models." I find visualizing business models very powerful, see for example the business model canvas, and the way of drawing blocks and arrows is of course a commonly used method to describe business models.


The visualized building blocks are:
Company - the company whose business model is described
Product - from commodities to finished goods
Services - services around a product or stand alone
Experience - not only offering a product or service but an experience
Reputation - a brand experience shaping client identity
Client- receives the product and gives something in return
Money - the normal value of a good
Less Money - less money than the normal value of a good
Attention - a currency of paying attention to advertising
Exposure - a currency of spreading the word

Building blocks to describe value propositions and revenue models
The term business model can be understood in a broad or narrow sense and can be expressed, visualized and explained in many different ways. Common elements in a business model, not described by the 10 building blocks presented above are what internal and external assets and capabilities that are used, what activities that are performed, how the value propositions are delivered, what forms of relationships the company has with its clients and external partners, control mechanisms used and the business model cost structure.

According to me what the 10 building blocks describe is not the business model but the different involved actors, value propositions and different types of revenues and benefits. It gives a first understanding of what a business model is about but it doesn't explain how value is created or delivered and only using the 10 building blocks will make fundamentally different business models look similar if they share some similar principles.

The main contributions with the 10 building blocks are according to me the blocks "experience" and "reputation" broadening the concept of value propositions from products and services, and "exposure" and "attention" broadening the concept of revenue model.

Broadening the concept of value propositions
A value proposition is often defined as "what the customer gets for what the customer pays" or "a bundle of products and services that are of value to the customer". I argue in my post about value propositions that a value proposition is how value is bundled and offered to potential value recipients where the term "value" is not limited to products and services and the term "value recipient" is not limited to customers.

Providing something new, something unique, something more convenient or accessible, customized, with higher performance or to a lower price are all common value propositions towards traditional customers. But value can also be to enable risk- or cost reduction for a supplier, provide access to databases or research tools for early-stage university research, provide user data to "upstream" application developers, out-license manufacturing or quality assurance processes to other companies, cross-license technology & IP, bring passengers to remote airports, provide jobs and environmental responsibility for a region, pay tax to a government, or take active involvement in a community.

The building blocks "experience" and "reputation" adds, according to me, important dimensions to the common perception of the value proposition. "Belonging" is another interesting dimension when the value proposition includes being part of a community, that shares common interests or values. I find conceptualization of products and services and the use of brands highly interesting and I plan to write separate posts exploring the subject in relation to business models.

Broadening the concept of revenue model
As with the term value proposition, the common perception of the term revenue model when used in relation to business models, is according to me rather narrow. I often talk about the "revenue and benefit model" and the main thing I want to understand is "What do I get in return for providing value to each value recipient?" The term revenue model implies revenues, money, but as the website Boardofinnovation shows in its building blocks, benefits can also be other things such as attention or exposure.

I would argue that what a business can get in return for providing value to a value recipient can be much more than attention and exposure, with examples such as cross-licensing of technology and IP to get access to new assets and capabilities, user data to improve services or improve the value for advertisers, adoption of a technology platform or service to create momentum and obtain network externalities, co-development efforts to lower cost and reduce risks etc.


To read more about the 10 building blocks and see some examples please visit Boardofinnovation

Further reading:
What is a business model?
What is a value proposition?
The Business Model Canvas

Interview with Steve Rubel on business models for newspapers and online communities

An interview with Steve Rubel, SVP, Director of Insights for Edelman Digital and blogger at Micropersuasion.com published at blogg.svd.se/utvecklingsblogg. ”Destination-web is dying, centralized things are dying and they’re trying to be distributed.”



More videos on newspapers and online commumities:
Eric Schmidt on news, newspapers and real time content
Interview with Evan Williams, CEO Twitter
Chris Anderson & Guy Kawasaki debate The Freemium Business Model

Pharma 2020: Challenging New Business Models

In a new report Pharma 2020: Challenging New Business Models PwC examines the future of the pharmaceutical industry. It describes some of the key trends now emerging and its implications for the industry. The focus of the report is on open business models and the authors concludes like many others that the traditional fully integrated business model, often referred to as the blockbuster business model, is under huge pressure and, will not work.

Collaborative networks
The report has an interesting discussion on emerging collaborative networks and the authors envision not only collaborative R&D models, but various other permutations, including networks focusing on different therapeutic areas and covering everything from R&D through to sales and marketing, networks focusing on different enabling technologies and networks focusing on the management of outcomes in specific patient segments. To summarize the discussion "the key social, economic and technological changes currently taking place in the pharmaceutical and healthcare arena will all necessitate the development of multinational, multidisciplinary networks drawing on a much wider range of skills than Pharma alone can provide".

The authors see two pharmaceutical business models emerging; both based on that companies are becoming more collaborative with other industry players:

The Federated Model is based on a network of separate entities that share a mutual overall goal such as the management of outcomes in a given patient population. It can also share funding, data, access to patients and back-office services. The model enables each player to build a specific area of expertise and might encourage greater cross-fertilization and deliver bigger improvements in performance without forfeiting any flexibility. How the cake should be sliced between the different participants in these networks is essentially more complex than the co-development and co-distribution agreements that are being used today.

The Fully Diversified Model is based on that the pharmaceutical company expands from its core business into related products and services through collaborations, in-licensing or mergers and acquisitions. For me this model is very similar to what pharmaceutical companies have been doing for years.

The authors believe that the federated model will ultimately dominate, primarily because it is quicker and more economical to implement. They also conclude that "The transition will not be easy, for collaborative business models are far more complex than the integrated model that has previously prevailed".

Download the full report here.

Further reading:
What is core in your business model?
The Blockbuster Business Model
Open business models

What is core in your Business Model?

Focusing on what a business does best, is often argued the easiest and most efficient way for companies to grow and be profitable. In the 1980s Tom Peters and Robert Waterman referred to this as "sticking to your knitting" in their classic book In Search of Excellence,a decade later Gary Hamel and C.K. Prahalad described the concept as focusing on "core competencies" in the Harvard Business Review article The Core Competence of the Corporation.

The core is not only unique competences

For me working primarily in intellectual asset and intellectual property management, the core is very often a set of innovations, unique technology, patents or developed software. But the core in a business model can equally be a unique way of delivering services, a unique position within a network of actors, a strong relationship with a certain kind of customer, strong strategic alliances, a unique recipe, a low cost operation, an established brand etc.

Increasing levels of collaboration

The trends in many industries are that markets show high dynamics in rapid development of new products, rapid commoditization of products and high price erosion. This puts pressure on the companies to open up processes and collaborate with external actors to shorten time to market, get a lead time over competitors and obtain higher margins in early phase markets. So with the increased pressure on the companies and the possibility to use external assets and capabilities, what elements of the business model should you focus on? What elements are core in your business model?

Questions to find the core

Identifying what is core and what is not, is a great starting point for business model innovation. To identify what is core in your business model a systematic way to start is to map out the different components of the business model, using the business model canvas, listing the different parts in Excel or just drawing boxes on a whiteboard and for each of the components ask:

In relation to what others could provide, how unique is:

• Your assets and capabilities?
• Your value propositions?
• Your target customers?
• Your relationships with the customers?
• Your revenue model?
• Your distribution channel?
• Your control mechanisms?
• Your partnerships?
• Your cost structure?

Also:

• How important is each of the elements for your business and the positioning in your value network?
• How important is it for your overall business model, does it reinforce other parts or is it a weak link?
• How difficult is it for others to imitate?
• What future opportunities would you lose or gain if someone else provided it?
• What are the risks of letting someone else provide it?

Identifying and using what is core

When starting to analyze what is really core in your business model you often find opportunities for business model innovation. Perhaps it’s not what you deliver but how you deliver it, that makes people buy? - Perhaps you should deliver something else as well given your good way of delivering things? - Perhaps it’s not the gadget you sell but the software interface that people like? - Could other gadget manufacturers need your better software interfaces? - Perhaps the reason someone wants to collaborate with you is because your customer relationship and contracts with a governmental organization? - Could other companies be interested to get access to the same organization?

Other tools for business model innovation:

Business Model Innovation Matrix

The Business Model Canvas

The Value Proposition Explorer

Ideality as an Innovation Tool