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About Business Models and Innovation Published: Sunday, January 21, 2007 By: Dr. Manuel Ángel Morales

In a very interesting book, Capitalism, Socialism and Democracy, Joseph A. Schumpeter coined the term “creative destruction” as a business and economic ongoing process, stating that if companies (and organizations) stick to thing as usual they will not live forever.  Organizations don’t have any intrinsic right to exist; instead this right must be continually earned in the marketplace against fierce competition, coming these days from any part of the world.

The creation of an organization or the restructuring of an of an existing institutional system must assure that at the end this venture value (wealth) is created.  A business organization is primarily an economic entity.  If may have social and political features, but the reason for its existence is economic.  This refers to a promise of delivering products and services to its customers base in such a way that its revenue is larger than costs, including capital costs.  If the company does not clearly generate value, as oppose to other alternatives, its existence is highly questionable.  As businesses leader know, companies must meet, this extraordinary challenge. 

Last week in a breakfast meeting, a very distinguished and capable friend asked me if I could elaborate a little on my understanding of how a business model relates to a strategic diligency.  So I said that in a summary business models are a relative new concept in strategic management, though Peter Drucker used a very similar term in the 1990’s referring to “business systems”.  I explained to my friend that a business model is a method by which the company generates revenue and profit, and it addresses the question of how the business makes money.  It specifies what activities the company undertakes, where is positioned in the value chain, and how it generates revenue.  A point of alert: a business model is not the strategy of the company! 

In a given industry, we may see companies competing with fundamentally different business models, and moreover innovation can occur with the invention of a new business model that provides competitive advantage (Dell and IBM employ different models in the PC industry; Dell with direct distribution, IBM with its value-added resellers).  The core message is that innovation in business models is very important. You cannot work at introducing a new business model if there is a profound innovation activity. Rather than being forced by competitors to reinvent business models, companies should be experimenting, on the alert for alternatives, whether precipitated by global market changes or by the company itself.

 

A given business model has a life-cycle (growth, maturity and decline).  Strategic management should continually challenge and test the business model, as well as to study others.  Innovation in business models requires that we understand the current model and then deconstruct it, understanding its underlying assumptions, and pondering what could cause it to leak consistency with new market realities or technology trends.  If this is properly done then companies are not condemned to decline or to lose competitiveness.

The issues involved in working with business models parallel those of strategy formulation and deployment.  The old historical model for delivering shareholder returns was to reduce cost and explore alternatives for revenue growth of market by targeting new growth segments, and this was an incremental strategy for muddling through.  The new growth strategies instead places the emphasis on developing novel business models, which requires a managerial framework in which innovation, working culture change and coping with uncertainty, rather than equilibrium are the order of the day.  This is a revolutionary approach.   

Finally, some strategies for transforming a work culture, as established by the Novel Laureate Herbert  A. Simon in a spectacular book titled Organizations, are following: 1) create a dramatic sense of urgency; 2) structure and nourish a powerful change and direction coalition; 3) create and communicate a future vision; 4) educate with high intensity all members on the consequences of the new business model; 5) empower people to work with the vision and the new business model; 6) measure and divulgate short and medium terms results; 7) raise the bar during the journey; 8) incorporate new knowledge, competencies and approaches.

It is about strengthening and putting to test the institutional leadership.


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