Insights from CompanyCrafters #5

Does Your Business Model Present Opportunities for Innovation?

This article is part of a series that explores how established organizations – corporations, research institutions, even nonprofits – can apply entrepreneurial thinking to become more innovative and successful.

In the last couple of issues of Insights from CompanyCrafters, we've explored ways that successful entrepreneurs have developed a sustainable competitive advantage for their startup by innovating around their business model – i.e., situations in which business model innovation has been more important to their ultimate success than any technological or scientific innovation.
                                                                                  
What is a "business model"?  In the simplest terms, it’s the answer to the question, "How does your business make money?"  To be more specific, an enterprise's business model is its unique way of addressing these four factors:

1. Product line structure – What is your product/service mix?

2. Value chain position – What part of the value chain will you occupy and how?

3. Pricing model – How are you going to extract economic value for your products or services (how are you going to get paid and by whom)?

4. Distribution channels – What are your marketing and sales channels (i.e., how do you get your products or services to market)?

Let's look at an example, this time a made-up one, to better understand how entrepreneurs – or, for that matter, established corporations looking to launch new business initiatives – can innovate around their business model in order to optimize their chances of success.

Let's say we're a manufacturer of widgets – expensive (non-commodity), bulky and oddly-shaped widgets – and, in the process of refining our operations, we've developed some neat software that enables us optimally package our products for shipping.  We've implemented the software in our worldwide operations, and it's been shown to reduce our shipping costs by 22 percent – a huge advantage in our competitive industry – while reducing shipping breakage significantly.  Our engineers who developed the software cleverly labeled it WHIPS (Widget Hyper Impressive Packaging System)… a typically scary result of allowing engineers to do branding. 

Our packaging and shipping experts point out that WHIPS ought to be just as helpful to any enterprise that ships oddly-shaped, expensive items in quantity; in other words, companies in a broad array of manufacturing or distribution sectors that spend lots of money on shipping could benefit similarly from this tech solution.  (And our guys helpfully note that if the software were marketed outside the widget industry, it could be renamed – groan – HIPS.) 

So how do we best exploit this new business opportunity?

Do we just keep WHIPS to ourselves and continue to only deploy the system internally as a competitive advantage in our own industry?  (This is clearly the path of least resistance since, as a widget manufacturer, commercializing WHIPS is a significant departure from our corporate mission.  But it strikes many of us, particularly the software's developers, as a lost opportunity.)

Do we patent the approach and proactively try to license out the technology to others?

Do we form a new business unit internally (a corporate "spin-up," if you will) to market our invention to other companies?

Or, do we create a stand-alone company (a corporate spin-out) to commercialize WHIPS?

If we take the tech licensing approach, we're deciding that we're only interested in occupying the first stage in the value chain (namely, coming up with the invention) and that we're leaving the balance of the value chain – turning our innovation into a commercial product, and then marketing, selling and servicing it – to others.  The advantages of this approach are two: it doesn't take much additional capital investment, and it doesn't distract the management team from our core widget business.  The downside of licensing is that it's not likely that anyone else will do everything it takes to successfully commercialize our invention; nobody will care as much about our baby as we do.  In addition, even in the best of cases, our share of any commercialization success will be limited to very modest licensing fees or royalties.

But let's say our internal developers of the software are passionate about commercializing WHIPS, and we're convinced we've got a proprietary solution that's a great improvement over the current state-of-the-art, and our preliminary investigations point to a significant potential market and willing customers.  In that case, we roll up our sleeves and seriously consider actually commercializing the software ourselves by forming a spin-up or spin-out. 

So what's the optimal business model for WHIPS? 

The first factor we might want to think through is the product line structure.  Based on the "whole product" that customers will expect – for instance, the application software itself, plus documentation, maintenance and enhancement releases, customer support, professional services from engineers expert in using and customizing the software, users groups, etc. – what is our vision for a product-and-service mix that will deliver against that expectation?

The second business model factor to consider is our value chain position: What steps in the business-to-business software value chain are we going to occupy (i.e., perform that function ourselves), which steps are we going to control but outsource to a contractor, and which steps are we going to address through strategic alliances?  So for each value-chain stage we need to consider whether we're good at that function already (is it a core competency?) or are we ready to become good at it.  We also need to consider the tradeoffs of each stage (how much would it cost us to do it vs. how much of the overall margin does that stage command?).  For the additional margin we can command on each sale, is it worth it for us to build up a commercial-grade software productization team (product planning, development, documentation, testing, release, etc.)?  Then, for the 20 to 35 percent additional margin on each sale that we'd garner by doing the marketing and sales, is it worth the expense and risk of building and operating a sales force from scratch?
  
The third business model factor we should evaluate is pricing.  If the "whole product" our customers are expecting includes not just software but a rich mix of expert application engineering as well, do we even want to sell the software at all?  Should we instead consider just providing expert packaging-engineering services, where our packaging S.W.A.T. team is the only one on the planet with the "secret sauce" of the WHIPS software (and therefore able to command a premium price)?  Alternatively, if we do decide to sell the software, is it licensed on a subscription basis or paid-up?  What are the trade-offs?

And finally, we need to consider distribution channels: Are we doing the marketing, selling and supporting ourselves?  Or are we just doing the branding and marketing but signing up a network of resellers to do the selling, complementary engineering consulting and after-market support?

As you can see, there are a lot of moving parts when it comes to devising a winning business model – in essence, developing your startup strategy.  And it's important to note that there's no one right answer.  But experience with hundreds of tech businesses leads us to this fundamental realization: 

While inventors consider the technological or scientific innovation 90% of the work, it's only the first 10%.  The hard part – the other 90 percent – lies in crafting the business.  

We'll leave you with that thought.  In our next Insights from CompanyCrafters, we'll continue our exploration.