Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
Business Models Bibliography |
Strategy Related Main Page
The terms "business model" and "strategy" have often been used interchangeably, but they are different concepts. To understand an organization's structure and competitive position one must understand the organization's business model and its competitive strategy. The purpose of this paper is to define these two concepts, and to provide examples to illustrate the significance of their differences.
A Business Model
Every business organization has a business model even if it's not explicitly recognized. Every successful business organization has a good business model that involves a testable hypothesis. A business model is a story that explains how the enterprise works. It answers questions related to how the business expects to make money, who its customers are, what the customers value, and how the business delivers value to the customers at an appropriate cost. Business models are variations of the generic value chain that include two parts: the activities associated with making something (e.g., designing a product, purchasing the materials, manufacturing the product), and the activities associated with selling something (e.g., finding and reaching the customers, transacting the sale, and distributing the product). It describes how the various parts of a business fit together. Understanding the model allows it to be tested and revised when necessary.
American Express provides a good example of a successful business model. Before ATMs were invented travelers had a difficult time translating letters of credit into cash and worrying about being robbed. American Express solved this problem by creating the traveler's check. The model involved charging customers a small fee for the checks. Merchants accepted the checks because they trusted American Express. The process was riskless because the customers paid cash for the checks and the normal cycle of cost-before-revenue was reversed since people paid for the checks before they used them. A successful business model may provide a better way than existing alternatives, provide more value to a group of customers, or completely replace the old way of doing business. Traveler's checks remained the preferred method of traveling with money until the automated teller machine gave travelers greater convenience.
Two Critical Tests
Business models fail because the story doesn't make sense (the narrative test), or because it doesn't produce a profit (the numbers test). The main advantage of correctly defining a company's business model is that it shows how the parts of the system fit together into a workable whole. Flawed models include Webvan's on-line grocery model based on the thin-margin grocery business that could not absorb the additional costs of marketing, service, delivery and technology. It failed the numbers test. Other companies like Priceline Webhouse Club failed the narrative test. Their model was based on representing millions of shoppers who would receive discounts it negotiated with companies like P&G, Kimberly-Clark and Best Foods while taking a fee in the process. But the big companies didn't want to undermine their prices and brand identities. So the story didn't make sense. Other examples include Sears one-stop financial supermarket model, EuroDisney, and Silicon Graphics interactive television. All three of these models failed because they were based on faulty assumptions about customer behavior. On the other hand, the auction model developed by e-Bay provides an example that passes both test. The e-Bay model succeeds because the internet lowers the cost of connecting vast numbers of buyers and sellers who work out the logistics of payment and shipment on their own. The company carries no inventory, incurs no transportation costs, bears no credit risk, and none of the overhead normally associated with those activities. The narrative works and the numbers add up.
A Competitive Strategy
A competitive strategy explains how an organization is different from its competitors. A competitive advantage can be obtained when a company provides something no other company can provide, or delivers it in ways no other company can duplicate. Wal-Mart provides an example that illustrates the difference between a competitive strategy and a business model. Their model is simply discount-retailing, but this model had been around for years before Wal-Mart opened in 1962. It involves applying supermarket logic to the sale of general merchandise. Wal-Mart's competitive strategy was to place stores in small towns that their competitors were ignoring, provide national brands at everyday low prices, and develop innovative practices in purchasing, logistics, and information management.
Dell Computers provides another example. While other computer companies sold through resellers, Dell's business model involved selling direct to customers. This gave Dell an inventory advantage and allowed it to avoid the high cost of obsolescence that the other companies could not avoid. The model functioned much like a competitive strategy because rivals would disrupt their existing distribution strategy if they copied Dell's direct-sell model. However, Dell's competitive strategy was not selling direct, but choosing which customers, products, and services to offer. While most PC makers focused on the low-margin home market, Dell went after the more profitable high-margin corporate market. When everyone in the industry began selling direct, Dell's strategy shifted to become the low-cost producer. Their business model is the same, but their strategic choices related to products, markets, segments, and customers shifts to fit new competitive realities.
A business model tells a story that helps everyone in an organization grasp what the company is trying to create. As a result the model helps everyone see how to adjust their behavior to improve execution. However, many organizations adopt the same business model. A competitive strategy involves determining how to apply the model in different ways to create a competitive advantage. Understanding the distinction between the two concepts is fundamental to achieving successful performance.
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Related summaries:
De Geus, A. 1999. The living company. Harvard Business Review (March-April): 51-59. (Summary).
Johnson, M. W., C. M. Christensen and H. Kagermann. 2008. Reinventing your business model. Harvard Business Review (December): 50-59. (Summary).
Kavadias, S., K. Ladas and C. Loch. 2016. The transformative business model: How to tell if you have one. Harvard Business Review (October): 90-98. (Summary).
Magretta, J. 1998. The power of virtual integration: An interview with Dell Computer's Michael Dell. Harvard Business Review (March-April): 72-85. (Summary).
Mintzberg, H. and L. Van der Heyden. 1999. Organigraphs: Drawing how companies really work. Harvard Business Review (September-October): 87-94. (Summary).
Porter, M. E. 1980. Competitive Strategy: Techniques for Analyzing Industries and Competitors. The Free Press. (Summary).
Porter, M. E. 1987. From competitive advantage to corporate strategy. Harvard Business Review (May-June): 43-59. (Summary).
Porter, M. E. 1996. What is a strategy? Harvard Business Review (November-December): 61-78. (Summary).
Van Alstyne, M. W., Parker, G. G. and S. P. Choudary. 2016. Pipelines, platforms, and the new rules of strategy: Scale now trumps differentiation. Harvard Business Review (April): 54-62. (Summary).
Zhu, F. and M. Iansiti. 2019. Why some platforms thrive and others don't: What Alibaba, Tencent, and Uber teach us about networks that flourish. The five characteristics that make the difference. Harvard Business Review (January/February): 118-125. (Summary).
