11 Theory section
11.2 The business model generation
11.2.1 Business Model Framework
Osterwalder (2004) identifies four main areas that constitute the essential business model issues of a company; customer interface, product, infrastructure management, and financial aspects. These four areas, or pillars, are broken down to a set of nine interrelated elements that comprise the business model.
Pillar Building blocks
Product Value proposition
Customer interface
Customer segments Distribution channel Customer relationship Infrastructure
management
Key resources Key activities Key partnership Financial viability Cost structure
Revenue streams
Table 2 – The business model framework overall key contributions
Osterwalder & Pigneur (2010) establish a canvas; see Figure 3, page 28, which is a strategic tool for describing, designing, challenging, inventing, and pivoting one’s business model. It is a visual representation of the nine elements or components of a business model. Each component gives its perspective on how an organization creates, delivers, and captures value. The purpose of the canvas is to take one component at a time and investigate how it contributes and/or captures value. According to Osterwalder & Pigneur (2010) their framework and tools differs from other business models tools since
28 they propose starting by defining the customer and working your way up to the business infrastructure.
Through their experience with business modeling they suggest taking a bottoms-up approach instead of a top-down.
“The goal is to create a customer viewpoint for continuously questioning your business model assumptions. Customer profiling enables you to generate better answers to questions such as: Does this Value Proposition solve real customer problems? Would (s)he
really be willing to pay for this? How would (s)he like to be reached?”.
(Osterwalder & Pigneur, 2010, page 133)
The bottoms-up approach suggests defining the customers (customer interface), which should be done first. In conjunction with defining the customer it is important to figure out how to deliver value to them (offering). When the value proposition and customers is in place you can define what is needed in order create, support, and deliver value to the customer base (infrastructure management). The last step is to test the models financial viability of the three other pillars.
Figure 3 - Business model generation canvas - Osterwalders 2010 11.2.1.1 Customer interface
Customers are the heart of any business, without them no business would survive for very long.
When we intend to define our customers, it is almost impossible doing so without also considering our
29 core-offerings, since the customer interface pillar defines to whom and how the company wants to offer their value proposition.
Customer segments
The customer segment component, as the heading suggests, is where the customers are segmented.
The top level distinction of customers exists between businesses and end-user, also referred to as business-to-business (B2B) and business-to-consumer (B2C) (Osterwalder, 2004). Segmenting the customer portfolio is done in interplay with the company’s offerings. According to Winter (1984) the concept of segmenting customers was acknowledged in the literature from the late 1950s. Today ICT has made it possible, through CRM systems, and (can be) economically viable to have a one-to-one marketing relationship with customers. E-commerce systems and direct-to-customer relationships make it possible to not only focus on mass markets, but also niche markets.
“With the expansion of reach through ICT, such as the Internet, companies increasingly target not only groups that are geographically localizable, but also widely dispersed online
communities with common characteristics.”
(Osterwalder, 2004)
Describing the customer segments in greater detail and characteristics can be done by composing a set of criterions based on geographical and socio-demographic elements.
Distribution channels
The distribution channel elements describe how a business links its value propositions with its customer segments. The proliferation of ICT and internet has resulted in entire new ways of reaching out to customers (Wyner, 1995). Delivering value to the customer can either be through a direct channel approach, e.g. via e-commerce systems, or indirect channel approach, intermediaries such as reseller and brokers channel. The tricky part is to find an optimal configuration of channels in regards to the different offerings (described later) and customers.
A distribution channel is comprised of a set of ‘links’ that are the processes and activities involved in delivering value to the customers. Each link is related to a phase in the ‘Customer Buying Cycle’ (CBC henceforth) and has a reasoning status (why it delivers value). CBC describes the behavior and activities a customer goes through when buying a good or service, and represents the possible contact point
30 between the company and customer. It is comprised of four phases (Figure 4, page 30); awareness, evaluation, purchase, and after sales. These phases describes the customer’s acquaintance with the company and its products and services, the customer’s evaluation of the products and services in relation to the customer’s need, product, or service acquisition and support of the customer’s products or services after the sale (Osterwalder, 2004; Osterwalder & Pigneur, 2010);
Figure 4 - Customer Buying Cycle - CBC
Customer relationships
In every traditional business it is common knowledge to keep your customer happy in order to retain a healthy business. Customer interactions affect the strength of the relationship the company builds with its customers. But a company must define these interactions and thus what type of customer relationship they want with which customers in advance, since they come at a given cost. Through these relationships a company should define how they want to optimize their acquisition and retention of customers.
In our digital society the ideal situation for ICT-software companies is to build a strong platform solution that support an eco-system of complementary technologies that can retain customers from easily jumping from their platforms to the competition, because these platform and surrounding eco-systems come with large switching costs. Examples could be Instagram, Spotify, Facebook, iTunes, iPhone, and Google. The strongest customer relationships and links to your business are gained by transparently lock-in customers through internal/external network externalities via synergies from complementarity. The more the customer is integrated with various business offerings, the stronger the customer commitment - thus cost of switching (Cusumano, 2010).
31 11.2.1.2 Product
Product refers to the products and/or services (offerings) that a company has to offer its customer, which addresses a customer need and delivers a value to their customers. It also describes how it differentiates from competitors (Osterwalder, 2004). Traditionally, companies concentrated on their own position on the value chain where companies upstream in the value chain provide inputs to companies further downstream the chain. Each actor in the value chain adds value to these inputs, before passing them downstream to the next actor in the chain, eventually reaching the end-user/consumer. But with the globalization and rapidly changing markets, conditions and technologies, the fundamental logic of value creation has changed from the value chain assembly line, to a notation of inter-networked firms co-producing value (Normann & Ramírez, 1993). According to Osterwalder (2004), superior market performers are companies who are able to innovate and constantly transform their value proposition.
Value proposition
Osterwalder (2004) describes value proposition as the ‘statements of benefits’ a firm delivers to their customer segments and other constituent group through their products and/or services and complementary value-added services. In order to define a value proposition, Osterwalder suggests decomposing it into a set of offerings (products and/or services). Each offering and its value contribution can be described using a set of elements; reasoning, value level price level, and life cycle.
Reasoning: the reason why the firm thinks its value proposition or a specific (bundle of) offering(s) is valuable to the customer. The value is either created through using it (e.g.
making a phone call from your cell phone), reduction of risk (e.g. phone insurance) or reduction of efforts (e.g. home delivery after phone purchase)
Value level: each offering can be attributed a value based on a comparison to the competitors offering. On one end of the scale it can be a me-too, which doesn’t differentiate in value in regards to the competitions. With a little value differentiation, it can be an innovation imitation that imitates a competitor’s value proposition and improves the value by adding innovative elements. On the other side of the scale, a firm can achieve excellence in value creation. Last the offering can be an innovation either by being completely new or a revolutionary combination of products and services not seen before.
Price level; as the nave suggests it is the comparison of the firms value proposition’s price level to the competitors. It can either be for free, low-end economy that is priced lower than
32 competitors, have the same price as the rest of the market or priced premium in the high-end.
Life cycle; Since a value proposition should be studied over its life cycle, it is relevant to determine at what stage of a value life cycle that an offering creates value. Offerings can generate value at its creation (e.g. through customization), purchase (e.g. one-click shopping), use (e.g. listening to music), renewal (e.g. software updates) or transfer (e.g.
selling of used books).
11.2.1.3 Infrastructure management
Infrastructure management describes how a company creates and delivers its value proposition.
When an entrepreneur for instance proposes a value proposition he or she would need to figure out what is needed in order to see the proposition through. Infrastructure management is comprised of the components key resources, activities, and partners.
Key resources
It is no secret that any company needs resources in order to operate - like the gasoline for a combustion engine. It is therefore a very important aspect and component for executing the whole business model properly; without the right resources you cannot deliver your value proposition, just like a diesel engine cannot run on gasoline and vice versa. Tangible resources are typically the only resources regarded and valuated through the financial balance sheet, disregarding intangible and people-based skills (Grant, 1991). Resources are not just the physical resources you can touch and feel, but also the intangible and human resources. Tangible resources include the firm’s buildings, equipment and cash reserves. Intangible resources include patents, copyrights, reputation, brands and trade secrets.
Human resources include the firm’s people and skills (Osterwalder, 2004).
Key activities
The key activities, in correlation with the key resources, is what builds the essence of a value proposition which determines the outcome result for reaching the overall goal of new markets segments and maintaining a healthy customer relationship. These key activities are those actions that are needed in order give the whole customer aspect substance and create and deliver value. Osterwalder (2004) distinguishes between three types of configurations a firm can have; value chain based on Porter (2001), value shop based on Stabell & Fjeldstad (1998), and last the value network also based on Stabell &
Fjeldstad (1998). These configurations determine the nature of the company’s activities;
33
Value chain includes activities related to inbound logistics, operation, outbound logistics, marketing and sales, and service.
Value shop contains activities related to problem-finding and acquisition, problem-solving, choice, execution, and control and evaluation.
Value network comprise of three main activities; network promotion and contract management, service provisioning, and network infrastructure operation.
Key partners
As described earlier, globalization and rapid changing market conditions causes companies to create alliances and partnerships with other firms in order to co-create value. It is often not economically feasible to be a sole creator of a product or service, or the business lacks the activities or resources needed to create and deliver the value proposition. Another perspective could be to reduce risk associated with the value proposition or creation of new businesses (Osterwalder, 2004). Osterwalder &
Pigneur (2010) distinguishes between four different types of partnerships;
1. Strategic alliance between non-competitor
2. Co-opetitetion: strategic alliance between competitors 3. Joint ventures to develop new businesses
4. Buyer-supplier relationships to assure reliable supplies.
11.2.1.4 Financial viability
The last pillar, financial viability, comprises of the components revenue streams and cost structure and affects all other components of the business model. It determines the company’s competitive abilities and profitability of the overall business model.
Revenue stream
A company can have many different revenue streams depending of their offerings and customer segments. Determining what value each customer segment is willing to pay for is the tricky part.
Revenue streams are categorized in types of either transaction based (one-time payment) or recurring based (recurring payments)
Each revenue stream can have different pricing mechanism, which are either fixed (predefined prices based on static variables) or dynamic (prices change according to market conditions) (Osterwalder 2004;
Osterwalder & Pigneur 2010).
34 Cost structure
The purpose of the cost structure is to analyze every component of the business model and estimate the costs associated with the proposed business model. Everything a company does has an economic consequence, so it is important to determine whether your firm is value-drive or cost-driven, and if costs are greater than revenues, then it is obviously advisable to revise the business model. Incurring costs can have different characteristics; fixed costs, variable costs, economy of scale and economy of scope.