Framework 63 Reviewing Your Business Model

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Introduction

"...A business model describes the rationale of how an organisation creates, delivers and captures value......every business model...... is unique, and presents its own challenges, obstacles, and critical success factors. Every organisation starts from a different point and has its own context and objectives......some may be reacting to a crisis situation, some may be seeking new growth potential, some may be in start-up mode, and still others may be planning to bring a new product or technology to market..."
Alexander Osterwalder et al, 2010

Need to systematically invent, design, review and implement business models to handle the unknown future so that incremental improvements through to major changes/modifications are made to keep a business model relevant. Need to review regularly to detect business model problems from the big picture perspective downwards.

A business model is a system where one element influences the other. It only makes sense as a whole. Thus the need to capture the big picture. This is best done visually - a diagram turns tactic assumptions into a explicit information, thus providing a tangible concept, more focused discussions.

Today countless innovative business frameworks are emerging entirely new industries are forming. Upstarts are challenging the old guard; the latter are trying to reinvent themselves.

Different thinking on business models

Need to challenge the business-as-usual or incremental improvement or market research approaches as these are only playing around at the edges and not challenging the basic concepts via relentless enquiry

An entrepreneur's challenge is to design and successfully implement a new business model. For established organisations, the task is how to implement and manage new models while maintaining existing ones. These established organisations need to become ambidextrous as it is difficult with the new models challenging or even competing with established and successful business models. The new model may require a different organisation culture/structure or target new customers that were formerly ignored.
To help make this decision, ie integration or stand-alone, on how to handle new and traditional business models, you need to consider the following variables, eg
- severity of conflict, eg in-house will have a greater potential for conflict than separation
- strategic similarity, in-house will have a greater strategic similarity than separation
Linked with these 2 are
- risks (what is the potential that the new model will negatively impact organisation in terms of brand image, earnings, legal liabilities, etc)
- synergies (need to find ways to exploit these). For established organisations, there are several options to handle a new initiative, eg
You need to explore ways to position your organisation in the increasingly intensely competitive environment. Competition is coming from anywhere. Some examples of those who have successfully challenged traditional business models include
- Airbnb (hotel industry)
- Uber (taxi)
- Amazon (retailing, especially books)
- Instragram (photography)
- Apple with iPod digital media player and iTunes store (music)
- Skype introduced very cheap global calling rates and free Skype-to-Skype calls built on peer-to-peer technology (tele-communications), etc
Business model innovation is not new. For example, in the 15th century, Johannes Gutenberg introduced mechanical printing that revolutionised book printing by making books more readily available. More recently, Diners Club introduced credit cards in the 1950s; Xerox Inc introduced photocopy leasing and per-copy payment system in 1959. On the other hand, the current scale and speed of development of innovative business models is unprecedented.
Business model innovation remains messy and unpredictable as it has to deal with ambiguity and uncertainty. It takes time. It requires more than analysis. It is too easy to jump quickly to a solution. You need to come up with alternatives to choose from, explore, prototype, test, etc. It can involve messy, opportunistic bouncing back and forth between market research, analysis, prototyping and idea generation. It is less linear than normal decision making which focuses on analysis, decision-making and optimisation.
 3 questions
1. Are you an entrepreneurial spirit?
2. Are you constantly thinking about how to create value and build new businesses, or how to improve or transform your organisation?
3. Are you trying to find innovative ways of doing business to replace old, outdated ones?
If your answer is yes to any of the above 3 questions, you need to use the below method, ie 10 building blocks, etc to review your current and explore future business model(s). In addition to the 10 building blocks, there are 3 core business types, patterns & trade-offs that need to be considered
Business Model Canvas (shared language)
Use 10 building blocks for describing, visualising, assessing, challenging and changing business model(s). These 10 main blocks cover 4 main areas of business, ie
i) customers
ii) offer
iii) infrastructure
iv)  financial viability
The 10 building blocks are
i) Value Propositions
ii) Customer Segments
iii) Channels
iv) Customer Relationships
v) Revenue Streams
vi) Key Resources
vii) Key Activities
viii) Key Stakeholders (excluding customers)
ix) Cost Structure
x) Challenges
NB Customers are at the heart of the business model while the revenue streams are its arteries!!!
i) Value Propositions (explore your core competencies & alternative to solve a customer's problem or satisfy a need. Core competencies can be quantitative (price, speed of service, etc) or qualitative (design, customer experience, etc.))
Some examples of value creation include newness, performance, customisation (mass customisation, customer co-creation, etc), getting the job done, design, brand/status, price, cost reduction, risk reduction, accessibility, convenience/usability, etc.
Answer the following questions:
What are the products and services you provide and what value do they deliver to the customer?
What are your organisation's strengths, ie what does the organisation do best, eg core competencies?
What value do you deliver, ie solving customers' problems or satisfying customers' needs?
What industry and business are you in?
Who are your competitors and what differentiates you from them?
Are there other products and services provided (refer to answers to your strengths)?
Are there other customers who would benefit from your current and potential products and services?
ii) Customer Segments (identify potential and current customer groupings based on common needs, common behaviours and other attributes, etc so that their needs can be solved/satisfied by your value propositions.)
Need to be aware of which customer segments to serve & which to avoid.
Organise those customers you want to serve into segments based on
- those requiring a distinct offer and/or
- different distribution channels and/or
- different types of relationship and/or
- different profitabilities and/or
- those willing to pay for different aspects of the offer
Some examples of customer segments
- mass markets (customers have similar needs and challenges, eg consumer electronic sector)
- niche markets (specific, specialised, individualised needs, eg supplier/buyer relationship like car parts manufacturers as suppliers to automobile makers)
- segmented (slightly different needs and challenges, eg banks have many types of client, like individuals, business, wealthy, poor, etc)
- diversified (very different needs and challenges, eg Amazon has diversified from retail (books) to cloud computing, ie online storage space & on-demand server usage)
- multi-sided platforms/markets (serving 2 or more interdependent segments, eg a credit card firm has a large base of card holder/users and large base of merchants who accept their card)
List your key customers and answer the following questions:
- For whom are you creating value, ie solving customer's problem and/or satisfying customer's need?
- What services/products/benefits, etc are you delivering to your current customers base?
- Who are your most important customers and what are their needs & expectations?
- Are you satisfying/meetings their needs and expectations? If not, what extra do you need to do?
- What extra services/products could you provide to your current customers and potential customers to better manage their expectations and enhance the commercial relationship?
- Who are the key people for each customer? What motivates these key people? (Is it power, money, ego, caring, publicity, etc that motivates these people?)
Some issues to consider can include
- newness, eg technology
- performance, eg smaller & better
- customisation, eg mass customisation (economies of scale) & customer co-creation
- "get-the-job-done", eg Rolls Royce manufactures and services their jet engines; this allows the airlines to focus on running their businesses, ie flying passengers
- design, eg important in fashion and consumer electronics industry
- brand/status, eg brands imply specific economic positions like an expensive watch signifies wealth; latest "underground brands" can show that you belong to the "in-group"
- price, eg value for money; price-sensitive segments, eg no frills airline to enable low-cost air travel; the low-priced Nano (Indian car) has made automobiles affordable to a whole new segment of the population; using free or complimentary products and services to attract and/or maintain customers, eg mobile phones, etc
- cost reduction, eg helping customers reduce their costs by outsourcing, etc
- risk deduction, eg service guarantees/warranties reduce the risk to customers
- accessibility, eg making products and services available to new customers, eg new technologies, mutual funds (provide access to a diversified investment portfolio for people of limited wealth), etc
- convenience/usability, eg making things more convenient or easier to use, such as iPod & iTunes offered customers unprecedented convenience for searching, buying, downloading and listening to digital music
iii) Channels (communications, distribution & sales to cover the 5 phases, ie awareness, evaluation, purchase, delivery & after sales)
Channels are direct (sales force, own stores, etc) & indirect (wholesaler, partner store, multi-media like print, radio, TV, web, etc). Similarly, channels can be owned (partly or fully) or outsourced, eg a group outside the organisation handles the channel
Five phases
i) awareness (how do your customers achieve a better understanding of your products and/or services?)
ii) evaluation (how do you help customers to appreciate the value of your products and/or services?)
iii) purchase (how do you help customers to accept the price & buy the specific products and/or services?)
iv) delivery (how do you transfer purchased products and/or services to customers?)
v) after sales (how do you provide services to customers after the purchase)
Answer the following questions
- For each customer segment, which channel(s) are you using to reach them?
- Which ones work best, ie most effective & efficient?
- Are you integrating these channels with the customers' routines?
- Can you improve on any of the components of the 5 phases?
"...the trick is to find the right balance between the different types of channels, to integrate them in a way to create a great customer experience, and to maximise revenues..."
Alexander Osterwalder et al, 2010
iv) Customer Relationships - aim is to get a sale (acquisition) and a regular, returning customer (retention) who is an apostle (advocate/promoter) for your products and/or services
Answer the following questions
- What type of relationship does each customer expect you to establish & maintain with them so that it is effective & efficient?
- What type of relationships have you established and why?
- How are these relationships integrated with your business model?
Methods used include
- personal assistance (human interaction using point-of-sale, call centres, e-mails, etc)
- dedicated PA (a staff member allocated specifically to an individual customer, eg key account managers)
- self-service (no direct relationship with customer; provide all the necessary means for the customers to help themselves)
- automation (a more sophisticated form of customer self-service; automated services can recognise individual customers & their characteristics so that solutions can be tailored specially for them)
- communities (on-line communities used to exchange knowledge and solve problems so that you understand customers/prospects better, ie better manage customer expectations, eg pharmaceutical companies using private online communities to evaluate drugs so that they have a better understanding of challenges facing users; facilitate connections between community members.)
- co-creation (create value with stakeholders including customers, etc, eg Amazon invites customers to write reviews, some firms engage customers' assistance in the design of new and innovative products, YouTube solicits customer to create content for public consumption)
v) Revenue Streams (generated from successful implementation of value proposition as a transaction)
This can be either a one-time payment, or recurring, like on-going payment, eg
- asset sales such as selling ownership rights to products like Amazon sells books, music, consumer electronics, etc
- usage fee such as charges for a particular service like phone companies can charge for the number of minutes spent on the phone, a hotel charges the number of nights rooms are used, etc
- subscription/membership fee such as selling continuous access (weekly, monthly, quarterly, annual, etc) to a service for a fee, eg playing an online game for a monthly subscription
- lending/renting/leasing, ie the temporary granting to someone of the exclusive right to use a particular asset for a fixed period in return for a fixed fee, eg renting a house/unit
- licence/franchise, ie allowing customers permission to use protected intellectual property in exchange for a fee, eg technology industry where patents holders grant other companies the right to use a patented technology in return for a licence fee
- brokerage fees derived from intermediation services performed on behalf of two or more parties, eg credit card providers take a percentage of the value of each sales transaction executed between merchant and customers, etc
- advertising earning a fee from advertising promoting a particular product, service, or brand etc.
Using pricing mechanisms, ie fixed or dynamic
- fixed (based on static variables with fixed price list; price depends on number or quality; price can vary on type and characteristic of customers; price depends on quantity purchased)
- dynamic (prices change based market conditions; price negotiation, eg competitive bidding depending on power and/or skills; price varies according to inventory level and/or time of purchase, ie price depends on supply and demand)
Answer the following questions
- How much does each revenue stream contribute to overall revenue?
- For what value are customers willing to pay?
- How are they paying?
- How would they prefer to pay?
vi) Key Resources (use of assets - physical, intellectual, human, financial, etc - can be owned and/or leased and/or acquired to deliver value propositions)
- physical (manufacturing facilities, buildings, vehicles, machines, systems, distribution networks, etc). For example, retailers like Walmart and Amazon rely heavily on physical resources which are often capital intense. Walmart has an enormous global network of stores and related logistical infrastructure, whilst Amazon has an extensive IT, warehouse and logistics infrastructure.)
- intellectual (brands, proprietary knowledge, patents, copyrights, partnerships, customer data base, etc). Some examples include Nikkei & Sony, which rely heavily on brands; Microsoft and SAP depend on software and related IT developed over many years, etc.)
- human (most important in knowledge-intensive & creative industries, etc, eg pharmaceutical industry needs many experienced scientists and a skilled sales force)
- financial (includes cash, lines of credit, shares, stock options, etc. Some companies, like Ericsson, provide vendor financing to encourage their customers to buy exclusively from them)
Answer the following question
- What key resources do your value propositions, distribution channels, customer relationships and revenue streams require?
vii) Key Activities (identify & perform main activities so the organisation performs successfully, eg reaches markets, maintains customers, earn revenue, etc. Some examples are Microsoft (software development); for Dell (supply change management); for McKinsey Consultants (problem-solving)
Main activities include
- production (key activities related to designing, making and delivering a product/service in substantial quantities and/or superior quality, eg for manufacturers, production is the dominant activity)
- problem-solving (key activities involve knowledge management that develops new solutions to individual customers' problems, eg includes service organisations like consultancies, hospitals, training organisations, etc)
- platform/network (networks, matchmaking platforms, software and brands can function as platforms. Some examples include Visa which has a transaction platform between merchants, customers and banks, and Microsoft manages the interface between other vendor softwares and its Windows operating system platform
Answer the following question
- What key activities do your value propositions, distribution channels, customer relationships and revenue streams require?
viii) Key Stakeholders (excluding customers) (, eg network of suppliers, buyers, etc to optimise business opportunities, reduce risk or acquire resources, etc)
Organisations and their stakeholders can form partnerships; there are 4 different types of partnerships, ie
i) strategic alliances between non-competitors
ii) co-opetition (strategic partnerships between competitors)
iii) joint ventures
iv) buyer/supplier relationship eg outsourcing
There are 3 motivations for creating partnerships
i) optimisation and economy of scale (optimise the allocation of resources and activities around reducing costs; this often involved outsourcing or sharing infrastructure)
ii) reduction of risk and uncertainty (competitors form a strategic alliance in one area while competing with one another, eg Blu-ray is an optical disk format jointly developed by a group of the world's leading electronics, personal computer and media manufacturers. This group cooperated to bring in Blu-ray technology to the market, yet individual members compete by selling their own Blu-ray products)
iii) acquisition of particular resources and activities (few organisations own all the resources or perform all the activities required in their business models; some partnerships are motivated by the need to acquire knowledge, licenses, or access to customers. For example, an insurer may choose to rely on independent brokers to sell its policies rather than develop its own sales force)
Answer the following questions
- Who are your key stakeholders (excluding customers)?
- Which key resources do you require from these key stakeholders?
- Which key activity(ies) do your stakeholders perform?
- Who are the key people in each stakeholder group and
i) what motivates them
ii) what is their impact on your organisation?
iii) what are their expectations?
ix) Cost Structure (financial costs fall between value-driven and cost-driven)
Two types of costs are
- value-driven (focus is on value creation, like a high degree of personalised service, eg luxury hotel
- cost-driven (focused on minimising costs wherever possible so maintain the leanest possible cost structure with maximising automation and extensive outsourcing, eg no frills airlines like Southwest are examples of this)
Some characteristics of cost structures include
- fixed costs (costs remain the same despite the volume of goods or services produced, eg salaries, rents, physical manufacturing facilities, etc)
- variable costs (costs that vary proportionally with the volume of goods or services produced)
- economies of scale (cost advantages that a business enjoys as output expands, ie average cost per unit falls as output rise, eg large companies can benefit from lower bulk purchase rates)
- economies of scope (cost of managers that flow from a large scale of operation, eg the same marketing department may support multiple products)
- dis-economies of management (as an organisation gets larger, its organisational structure becomes more complex and it is harder to manage)
Answer the following questions
- what are the most important costs inherent in your business?
- which key resources and key activities are most expensive?
x) Challenges (political, economical, sociological, technological, legal, etc factors that will impact on the other 10 building blocks, ie PESTLE analysis)
Answer the following questions
- what are the political, economical, sociological, technological, legal, etc factors that will impact upon value proposition, customer segments, channels, customer relationships, revenue streams, key resources, key activities, cost structures and key stakeholders (excluding customers)?
- what are the inherent risks of the model for the organisation and different stakeholders?
- how are these risks measured, mitigated & managed?
- what amount of risk(s) are you willing to take, ie limits?
NB
In addition to the building blocks, there are patterns, 3 core business types and trade-offs that need to be explored.

Some examples of using Business Review Framework (BRF)
- Apple's iPod/iTunes
- Changing Book Publishing Industry
- Lego (see under long tail)
- Google (see under multi-sided platform)

1. Apple's iPod/iTunes - starting in 2001, the combination that disrupted traditional music industry was
i) device (iPod - portable music player)
ii) software (iTunes - transfer music, etc from iPod to computer; it provided a seamless connection to Apple's online store )
iii) online stores  (purchase and download content)
Linked with this is the deals that Apple negotiated with major record companies to create the world's largest online music live library.
Yet Apple earns most of its music related revenues from selling iPods while using integration with the online music store to protect itself from competitors.
More recently, streaming is posing a threat to Apple's dominant position in the music industry

2. Changing Book Publishing IndustryPatterns
The traditional book publishing model is built on a process of selection whereby publishers screen many authors and manuscripts; selecting those that seem most likely to achieve minimal style targets. less promising authors and their manuscripts are rejected as they could be unprofitable to copy-edit, design, print and promote. Publishers are most interested in books that can print in quantity for sale to large audiences.

New model (on-line), eg Lulu.com
It eliminates the traditional barriers to entry by providing authors with the tools to craft, print and distribute their work to an on-line marketplace, ie anyone can publish. This contrasts with the traditional model of only selecting are "market-worthy" titles.
The more authors the online firms attract, the more they succeed as authors become customers.
It is a multi-sided platform that serves it connects authors and readers with a long tail of user generated niche content.
As the books are only printed in response to actual orders, the failure of a particular title to sell is not important as the failure incurs no cost.

PATTERNS
Patterns that are useful in reviewing business frameworks. These include
- unbundling,
- the long tail,
- multi-sided platforms,
- free,
- open business patterns.
1. UNBUNDLING
Three core business types
There are fundamentally 3 different types of businesses with different disciplines
i) customer relationship businesses (customer intimacy that find and acquire customers and build relationships with them)
ii) product innovation businesses (product leadership that develop new and attractive products and services)
iii) infrastructure businesses (operational excellence that build and manage platform for high volumes, repetitive tasks)
They each have different economic competitive and cultural imperatives. These three are driven by different factors that can conflict with each other or produce undesirable trade-offs within the same organisation. Despite this, the 3 types can coexist in a single corporation like banking

(source: Hegel and Singer as quoted by Alexander Osterwalder et al 2010)

Trade-offs. This refers to differences in efficiency v. effectiveness, conflicts of interests (own product/service v competitor's product/service), small volume/high margin v. large volume/low margin, same product but different markets, in-house v. outsourcing, innovation v. incremental improvement, etc

Some generic examples
i) Highly Serviced Oriented

ii) Product & Service Innovation

iii) Infrastructure services

Some specific examples
1. Private banking (3 businesses in 1). Traditionally, private banks provide services to the very wealthy and it has been long regarded as very conservative, slow to change industry. Thus they were vertically integrated and perform tasks ranging from wealth management to brokerage to financial product design. Outsourcing was expensive and the banks preferred to keep things in-house owing to secrecy and confidentiality concerns. Recently, secrecy is less of an issue and outsourcing has become attractive to breakup of the banking value chain. Due to the emergence of specially service providers, such as transaction banks (focus on handling bank transactions) and financial product boutiques (design new financial products). Thus banking has unbundled its business model, eg transaction-orientated platform business into separate identities to handle other banks and securities dealers, others focus on building customer relationships and advising clients, etc.

Code
green = relationship business    red = production innovation business    blue = infrastructure business
Trade-offs (see numbers 1 to 6 in the above diagram, eg
1. This private banking service has 2 different markets with very different dynamics, ie
- advising that wealthy in a long term, relationship-based business
- selling financial products to other banks is a dynamic, fast-changing business
2. Selling bank products to competing banks in order to increase revenue; this creates a conflict of interest!!!!
3. Preference to sell bank's own products to clients creates a conflict of interest as clients want the most suitable products for them, regardless of origin
4. The cost- and efficiency-focused transaction platform business conflicts with the remuneration-intense advisory and financial products business
5. The transaction platform business requires scale to drive down costs; this is difficult to achieve within a single bank
6. The product innovation business is driven by speed and quick market entry; this conflicts with the long-term business of advising the wealthy
2. Mobile Telecom
Mobile telecommunications firms are unbundling their businesses. Traditionally they competed on network quality, now they are striking network sharing deals with competitors or outsourcing network operations completely to equipment manufacturers. The rationale for this is that they realise that their key asset is no longer the network but their brand and customer relationships.
The unbundling of mobile telecommunications is in 3 groupings (see diagrams below), ie
i) infrastructure management (outsourcing operation and maintenance of some of their networks to equipment manufacturers such as Nokia Siemens networks, Alcatel-Lucent, Ericsson, etc.. These equipment manufacturers operate the networks at a lower cost as they service several telecoms at the same time, ie benefit from economies of scale)
ii) product innovation (become content providers and focus on innovation from multiple third parties which provide a constant supply of new technologies, services and media content, such as mapping, games, videos, music, etc. For example, Mobilizy focuses on location-based service solutions for smart phones)
iv) customer relationships (with unbundling, focus on branding and segmented customers and services; customer relationships becomes the key asset and core business so that firms are able to increase revenue from current subscribers plus leverage investments and retain customers. For example, Bharti Airtel was one of the first mobile telcos to strategically unbundle and is now one of India's leading telcos. It outsources network operations to Ericsson and Nokia Siemens networks and its IT infrastructure to IBM. This allowed the firm to focus on its core competency ie building customer relationships)

2. Unbundled situation (3)

iia Production Innovation

iib Infrastructure Management

iic Customer Relationship

2. LONG TAIL
This framework focuses on a large number of products, each selling in low volumes. It is about selling less of more, ie focusing on offering a large number of niche products, each of which sells relatively infrequently. The aggregate sales of niche items can be as lucrative as the traditional model where a small number of bestsellers account for most revenue. This model requires low inventory cost and a strong platform to make niche content readily available to interested buyers.
This is applicable to the media industry, ie a shift away from selling a small number of hit items in large volumes towards selling a very large number of niche items, or the small quantities. Many infrequent sales can produce aggregate revenues equivalent to or exceeding revenues produced by focusing on hit products. Three economic triggers cause this phenomenon in the media industry:
i) democratisation of tools of production (falling technological costs gave individuals access to tools that were very expensive previously. Thus, many passionate amateurs can now record music, produce short films, design simple software, etc with professional results
ii) democratisation of distribution (the Internet has made digital content distribution a commodity, dramatically lowered inventory, communications, transactional costs, etc and opened up new markets for niche products)
iii) falling search costs to connect supplier with demand (the greatest challenge in selling niche content is finding interested potential buyers. Developments like powerful search engines, user ratings, communities of interest, etc have made this easier)
Some examples include
- online video rental Netflix (move toward licensing a large number of niche movies; with each niche movie being rented relatively infrequently, aggregate revenue from Netflix's last niche film catalogue rivals that from the rental of blockbuster movies)
- online auction site eBay ( based on a huge army of auctioneers selling and buying small quantities of non-hit items)

 LEGO (an example of "long tail")
A Danish toy company that started manufacturing interlocking bricks in 1949. Over the years, generations of children have played with Lego around a variety of themes including space stations, pirates, Middle Ages, etc.
With increased competition in the toy industry, Lego has had to seek innovative new paths to growth like purchasing the licensing rights to use characters from successful movies such as Star Wars, Batman, Indiana Jones, etc. While licensing is expensive, it proved an impressive revenue generator.
In 2005, Lego started experimenting with user-generated content, ie it allows customers to assemble their own Lego kits and order them online. Using software called Lego Digital designer, customers can invent and design their own Lego kits (including the box containing the customised kit; choosing from thousands of components and dozens of colours. This concept turns passive users into active participants in the Lego design experience. This required Lego to
- modify its supply chains infrastructure, eg resources and activities, to suit the low volumes
- go beyond mass consumerisation by entering long-tail territory, ie helping users design their own Lego sets that are then available for other customers online; some have sold well and others poorly.
Lego focuses on user-designed sets expanding its product line that was previously focused on a limited number of bestselling kits.
It is an example of implementing a long tail model complimentary to a traditional mass market focus

3. MULTI-SIDED PLATFORMS (multi-sided markets) , ie 2 or more customer segments, each with its own value proposition and associated revenue streams but the customer segments cannot exist without others.  It involves bringing together 2 or more distinct but interdependent groups of customers. The platform creates value as an intermediary by facilitating interactions between the different groups and involves network effect.
The key is that the platform must attract and serve all groups simultaneously to create value; with the platform's value for a particular user group depends on the number of users on the platform's other side. It is a "chicken and egg" conundrum.
Even though they have been around for a while the platform proliferated owing to recent information technology developments.
Choosing which customer segment to subsidise and how to price correctly are crucial decisions which determine the success of the many multi-sided platform business models. For example, a platform operator who incurs costs by serving all customer groups may decide to attract one segment to the platform with a cheap or free value proposition as a basis for subsequently attracting users elsewhere
Some important questions to explore the suitability of multi-sided platforms
- Can you attract sufficient numbers of customers each side of the platform?
- which side is more price sensitive?
- Can that side being enticed by a subsidised offer?
- Will the other side of the platform generate sufficient revenue to cover the subsidies?
Some examples include
- VISA credit card (link merchants with cardholders and banks)
- Microsoft Windows operating system (computer operating systems link hardware manufacturers, application developers and users. It gave away Microsoft Software Development Kit (SDK) to encourage development of new applications of its operating system. This resulted in attracting more users to the Windows platform and increased Microsoft's revenue) (see below diagram)
 - the Financial Times (newspapers linked readers and advertisers)
- Wii game console (video gaming consoles link game developers with players, ie the console will only attract buyers if enough games are available for the platform. Similarly, game developers will develop games for a new video console only if it has a substantial number of gamers already using it. For example, Sony's PlayStation 3 game console is a case that backfired, ie Sony subsidised each console purchased in anticipation of collecting more ballgame royalties later but fewer consoles were sold than expected)
- Google (see below diagram)
- Facebook (see below diagram)

Google
The basis for its value proposition is providing extremely targeted text advertising globally over the Web, eg AdWords.  Advertisers can publish ads & sponsor links on Google's search pages; with ads displayed alongside search results when people use Google's search engine. Google ensures that only ads relevant to the search engine are displayed. This makes it attractive to advertisers because it allows them to target online campaigns to specific searches and suitable demographic targets. This only works if many people use the Google search engine, ie the more people Google reaches, the more ads it can display and a greater value created for advertisers. Advertisers, they depend heavily on the number of customers attracted to its Web page. Google helps here with its powerful search engine and a growing number of tools such as Gmail, Google maps, etc; to extend this further, it designed an additional service which enables the ads to be displayed on other, non-Google websites, eg  AdSense. It allows third parties to work for a portion of Google's advertising revenue by showing Google ads on their own sites. AdSense automatically analyses a participating web site's content so that it can display suitable ads to visitors. These third party website owners are another Google segment, which enables them to earn money from their content.

Thus Google's multi-sided platform allows it to make money from advertisers while subsidising free offers to 2 other segments, eg Web services and content owners. Plus the more ads it displays to web surfers, the more it earns from advertisers. This increased advertising earning encourages more content owners to become AdSense partners. Advertisers don't directly buy advertising space from Google, instead they bid on keywords (associated with either search terms or content on third-party websites) on AdWords' auction service; the most popular the keyword, the more an advertiser has to pay. This generates revenue so that Google is able to continuously improve its free offers to search engine and AdSense users.

Google's key resource is its search platform that provides 3 different services, ie
i) Web search ( Google.com)
ii)  Advertising (AdWords)
iii) third party content (AdSense)
These services are based on a highly complex proprietary search & matchmaking algorithms supported by extensive IT structure. Google's 3 key activities
i) building and maintaining research infrastructure
ii) managing the three main services
iii) promoting a platform to new users, content owners and advertisers

Tesla (electric car maker/seller and energy storage firm that started in 2003)

- over the years many new entrants have been unable to compete with established car makers. Some examples include Tucker (1940s), DeLorean (1970s), more recently Fisker's upmarket petrol-electric hybrids, etc

- Tesla's primary goal is to commercialise electric vehicles, starting with a premium sports car aimed at early adopters and then moving on to more mainstream vehicles, including sedans and compacts to create affordable electric vehicles for the mass market.  Despite this, they regard themselves as a technology company that is disrupting the car industry and encouraging the switch to electric from fossil-fueled cars. As a technology company they are more interested in creating software platforms on top of which a variety of services can be built. This is like Google's Android operating system that is used by various smart phone brands, ie

"...aiming premium products at affluent "thought leaders" is a well-known business strategy in Silicon Valley and the global technology industry, where prices for the first versions of, for example, cellular phones, laptop computers, and flat-screen television start high but drop with subsequent products as technology matures and production volumes increase..."
Wikipedia, 2016

- they believe in a concept called "complex coordination", ie where many innovative pieces fit together in just the right way and when assembled have a tremendous advantage.

- Tesla's approach has been to get into the high price, low-volume car market; followed by a mid price, mid volume sector; then low price, high-volume market. Thus it initially appealed to the "top end" and environmentally-friendly niches of the automobile market, eg Tesla Roadster (the first fully electric sports car using lithium-ion battery cells; base price US$ 109,000). Then mid price, mid volume sector with the Model S (a fully electric luxury sedan with sales starting in early 2012; by end of 2015, 100,000 units were sold; base price was US$ 57,400). In 2016, it plans to introduce Model 3 (a fully electric car with starting price of US$ 35,000) which is aimed more at the mass market where competition is more intense and profit margins slim. Three days after its launch, around 300,000 units were reserved

- in early 2016, its market capitalisation was US$ 29 b.. In 2015 they sold 50,000+ cars and are aiming for 500,000 in 2020. Its market value is around half the value of GM which makes nearly 10 m. cars annually.

- it made a profit for the first time in 2013

- one of the main challenges has been around the battery, ie its storage capacity, cost, size, acceleration, recharging, etc. With improvements in technology by early 2016 it was able to get 400 km between charges and has lightning acceleration

- some of its competitive advantages are

1. i) environmentally friendly, ie cars do not burn fossil fuels
2. ii) classy design

iii) superior technology like touchscreen instrumental panel, autonomous-driving capabilities, carbon-fibre-reinforced polymer body, power electronics modules, etc

1. iv) high-profile figurehead (Elon Musk) who is the public face of Tesla
2. v) "certified pre-owned" (CPO) concept allows owners to return their car to Tesla after 3 years and get reimbursed between 43% and 50% of its initial price; this is similar to the trade-in value of German luxury cars the same age. Also it will provide Tesla with a steady stream of used cars that can be refurbished and sold as second-hand

(NB it is estimated that the margins on selling used cars in the USA is about triple that of new cars!!!!)

1. vi)  using lithium-ion 18650 commodities cell batteries in a powerpack that is cheaper and lighter than traditional batteries

vii) rewritten the economics of making electric cars (see below), etc

vii) encourages technology sharing

viii) autopilot included, ie a camera mounted at the top of the windshield, forward looking radar in the lower grill, ultrasonic sonar sensors in the front and rear bumpers that provide a 360° buffer zone around the car allowing it to detect signs, lane markings, obstacles and other vehicles

- it has demonstrated that the barriers to entry in the car industry are not insurmountable. For example,

1. i) since the global financial crisis (GFC), many car-making factories have become available cheaply and/or gone out of business. Thus Tesla has been able to buy factories, equipment kits, etc at low prices, eg in Fremont, California, they paid US$42 m. for a factory that used to belong to GM and Toyota
2. ii) its frugal approach, eg since 2005, its spending on R&D is under US$4 b.. This is 1/7th of what VW spends annually

iii) figurehead (Elon Musk) with relentless promotion has achieved in a decade what it would normally take 25 years to achieve

1. iv) reduced the economics of making electric cars. eg it has halved the high costs of custom-designed large-ion batteries by stringing together hundreds of small, mass-produced laptop batteries as powerpacks. Also, building with Panasonic a Gigafactory (battery making plant costing US$5 b.) in Nevada will cut costs by another 30%
2. v) its vertical integration is very significant compared with other car makers who are largely brand managers, assemblers, systems integrators, etc who outsource the manufacturing of all parts to build a car; this helps Tesla to spread risk and push costs to suppliers. Tesla makes most of its parts in-house and has built its own worldwide network of 3,500+ roadside superchargers which is provided free to Tesla car owners and will provide an 80% charge on batteries in 40 minutes. In addition to supplying power, superchargers are able to swap batteries
3. vi) sells direct to customers through its website and its showrooms located in shopping centres rather than a network of independent-owned dealerships that the traditional automobile players use. This allowing Tesla to keep the retail markup, estimated to be around 8%. The showrooms are places where people learn more about Tesla but sales are conducted on the Internet. In late 2015, its showrooms were revamped to focus on 4 areas, eg safety, autopilot features, firm's charging network and dual motors that power each axle

- in early 2016, competition was getting stronger

1. i) Apple  - to launch a luxury electric car in a couple of years
2. ii) traditional car makers like Audi, Jaguar, BMW, GM, etc are planning to have electric cars. 

- some challenges for Tesla include

1. i) it requires large amounts of cash to finance its business model, especially the vertical integration, selling cars direct and selling components to other automobile makers, etc
2. ii) its move from sole focus on luxury to mass market. These 2 markets have different types of customers. In the mass market, people want to buy a car, not an engine; are less concerned about image and the environment; and care more about performance and cost.  These customers most likely rely on one vehicle and lack the space for home charging. Also, greater competition from fossil-fuel cars; thus lower margins

iii) technological changes

1. iv) raising capital, ie in 2008 it had to raise money to avoid bankruptcy. The US government has provided funding as well as individuals (Elon Musk, founders of Google (Sergey Brib & Larry Page), former eBay president (Jeff Skoll), Hyatt heir (Nick Pritzker), etc), venture capital firms (eg JP Morgan Chase), traditional car makers (Daimler and others like Abu Dhabi's Aabar investments)
2. v) local laws working against Tesla, eg in 48 states in the USA, there are limits or bans on manufacturers selling vehicles directly to customers

4. "Free" as a business model
This means that at least one substantial customer segment is able to continuously benefit from a free-of-charge offer with non-paying customers being financed by another part of the business model or another customer segment.
Receiving something for free has always been an attractive value proposition. This concept has increased with the use of the Internet and digitalisation. The challenge is how can you systematically offer something of free of charge and still earn substantial revenue. This is partly achieved when the cost of producing certain giveaways, (eg online data storage capacity), has fallen significantly. On the other hand, to make a profit, these organisations need to generate revenue elsewhere.
Some examples include
- advertising (part of multi-sided platforms)
- freemium model (provides basic services free of charge and premium services for a fee)
For example, creating a recording of a song costs an artist time and money. On the other hand, the cost of digitally replicating and distributing the work over the Internet is minimal. Thus an artist can promote and deliver music to a global audience over the Internet, as long as they find other revenue streams like concerts and merchandise.
There are 3 patterns to this concept
i) free offer based on multi-sided platforms (advertising-based)
ii) free offer for basic services with optional premium services (freemuim model)
iii) "bait and hook" model, ie a free or inexpensive initial offer lures customers in to repeat purchases

1. ADVERTISING

NB
i) free products or services generates high platform traffic & increases attractiveness to advertisers
ii) with the right product or service and high traffic, the platform becomes interesting to advertisers, which in turn allows the  charging of fees to subsidise free products and services
2. FREEMIUM
it is characterised by a large base of free service users subsidised by a small base of paying users; the latter pay a premium for additional benefits.
Income stream = (users X percentage of premier users X price of premium service) X growth rate X churn rate
growth and churn rate show how many users defect and/or join the user base
Cost of service = (users X percentage of free users X cost of service to free users) + (users X percentage of premier users X cost of service to premier users)
Operating profit = income - cost of services - fixed costs - customer acquisition costs

Comments
- the platform is the most important asset in freemium framework as it allows free basic services to be offered at a low marginal cost
- there are 3 parts to the cost structure, ie substantial fixed costs, very low marginal costs of services to free accounts and cost of premium accounts
- customer relationships ( needs to be automated and low-cost in order to handle large number of free users)
- an important metric to follow is the rate at which free accounts convert to premium accounts
- needs to attract many users
For example, Skype (a freemuim pattern that disrupted the telecommunications sector by enabling free calling services via the Internet). It developed its own software when installed on computers or smart phones, enabling users to make calls from one device to another free. Its cost structure is different from that of a traditional telecom carrier, ie its free calls are fully rooted through the Internet based on peer-to-peer technology that employs user hardware and the Internet as communications infrastructure. Thus Skype does not have to manage its own network and incurs only minor cost to support additional users. It requires very little of its own infrastructure, besides back-end software and servers hosting user accounts. Users pay a minimal rate only for calling landlines and mobile phones.

Skype v. Telco
"...Skype is a voice calling service company operating under the economics of a software company. Giving away software allowing customers to make free Skype to Skype calls cost the company little..."
Alexander Osterwalder, (2010)

Insurance model (freemium upside down)    

3. BAIT & HOOK
This is characterised by an attractive, inexpensive or free initial offer that encourages continuing future purchases of related products or services, eg "loss leader" (a subsidised, even money-losing initial offer, with the intention of generating profits from future purchases. There needs to be a close link between the initial offer and a follow-up items); with the latter having a high margin. Also, it is important to "lock in". Some examples
-  Gillette with its first disposable razor (1904) sold razor handles at a steep discount in order to create demand for the disposable blades; many patented consumer products with 1,000+ patents covering everything from lubricating strips to cartridge-loading systems
- HP, Epson, Canon, etc sell inkjet printers at a very low price while generating high margins when selling ink cartridges
- mobile telecommunications firms offer free telephone handsets bundled with service subscription; the operator initially loses money by giving away handsets but easily covers the loss through subsequent monthly service fees., ie instant gratification with a free offer that later generates recurring income

Comments
- the initial purchase generates little or no revenue but is off-set by repeat follow-up purchases of higher margin products/ services; focus on delivery of follow-up products/services
- tight link or lock-in between the initial product and the follow-up products/services; it is closely linked to a (disposable) follow-up item or service
- customers are attracted by the initial gratification of a cheap or free initial product/service
- bait and hook focus usually requires a strong brand
- the cost structure elements include subsidising initial product/service and the costs of reducing follow-up products/services
Mobile phones

OPEN BUSINESS MODELS 
Linked with innovation and involves collaborating with outside partners via
- "outside-in" (exploiting external ideas, technology, intellectual property, etc within the organisation)
- "inside-out" (providing external parties with ideas for assets - including technology, intellectual property, etc - lying idle within the firm, eg opening up an organisation's research processes to outside parties).
By distributing knowledge, organisations can create more value and better exploit their own research by integrating outside knowledge, intellectual property and products/services to innovative processes. Much of this lies idle within an organisation and can be commercialised by outsiders through licensing, joint ventures, spin-offs, etc
Principles of innovation

Outside-in Patterns
- works well for established companies with strong brands, strong distribution channels & strong customer relationships; can leverage off existing customer relationships
- sometimes people from completely different industries are able to offer valuable insights, knowledge, patents, already-made products
- building on external knowledge requires dedicated activities that connect external identities with internal business processes and R&D groups
- taking advantage of outside innovation requires specific resources to build gateways to internal networks

Inside-out pattern
- organisations with substantial internal R&D operations possess under-utilised knowledge, technology and IP that can be utilised by other organisations
- when there is a strong focus on core business, some valuable intellectual assets lie idle that could be of use to other organisations

Some examples include
- Procter & Gamble (connect & develop concept - starting in 2000, they structured a new innovation culture that moved from internal to external/open R&D. It aimed at exploiting internal research through outside partnerships by setting an ambitious goal of 50% of their innovations to come from outside partners when the current level was around 15%. In 7 years it exceeded the goal; productivity had soared 85% with only a marginal increase in R&D spending. The process involved building 3 elements into the business model, ie technology entrepreneurs, Internet platforms and retirees.
i) technology entrepreneurs were the senior scientists within the firm who formed relationships with the outside researchers, such as universities and other organisations; also, they scanned the outside world for solutions to their internal challenges
ii) Internet platforms were used to connect expert problem solvers, so that some of its internal research problems were exposed to outside researchers who earned cash prizes for developing successful solutions
iii) solicited knowledge from retirees through a special Internet platform)
- GlaxoSmith Kline (patent pools - commercialising unused internal assets like patents and technologies. The aim was to make drugs more accessible to the world's poorest countries, and to facilitate research into understudied diseases. This was done by placing intellectual property rights relevant to developing drugs to such diseases into a patented pool open to outside researchers. As pharmaceutical organisations mainly focus on developing blockbuster drugs, intellectual property related to less studied diseases often lies unused. The patents pools of aggregate intellectual property allow better access and help prevent R&D advances from being blocked by a single rights-holder.
Patterns Overview (unbundling business models, the long-time tail, multi-sided platforms, free as a business model & open business models)

Consider business model innovation by explicitly analysing the 10 building blocks (value proposition, customer segments, communication channels, revenue streams, etc) as a starting point. There are 5 epicentres in a business model innovation that affect other business model building blocks:
i) resource-driven (originates from an organisation's existing infrastructure or partnership to transform the business model, eg Amazon)
ii) offer-driven (create new value propositions s, eg Cemex, a Mexican cement maker, promised to pour cement within 4 hours rather than the 48 hour industry-standard. As a result it has gone from a regional Mexican player into the world's second largest cement producer)
iii) customer-driven (based on customer needs, facilitated access, or increased convenience, eg 23andMe introduced personalised DNA testing for individuals so that testing could be done through mass customised Web profiles rather than just for health professionals and researchers)
iv) finance-driven (driven by new revenue streams, pricing mechanisms, or reduced cost structures, eg Xerox with the first plain paper copiers that were too expensive. To handle this, it leased the machines at $95 per month, including 2,000 free copies plus 5 cents per additional copy)
v) multi-epicentre-driven (based on a combination of epicentres, eg Hilti, global manufacturer of professional construction tools, moved away from selling tools to renting sets of tools to customers. This was a substantial change in value proposition and revenue streams)
(NB these epicentres can serve as starting points - individually or as a group)
Can use a SWOT(T) analysis and scenario planning (for more detail see other parts of this knowledge base) on an epicentre

Not-for-profit applications of the 10 building blocks (including charities, social ventures, philanthropic, etc)
To survive, every organisation has to create and deliver value that must generate enough revenue to cover expenses. The for-profit organisational focus is to maximise earnings while the not-for-profit sector has a strong non-financial focus on issues like ecology, social causes, public-sector mandates, triple bottom line (accounting for environmental and social as well as financial issues). Some examples include
- third-party funded models, ie where the product or service recipient is not the payer. The products and services are paid for by a third party which might be a donor or the public sector like government. Examples of this include government/public services (using tax payer money) to provide education, health, transport, emergency services, justice, etc. Different from the for-profit business model, the third-party rarely expects to receive direct economic benefits other than personal satisfaction.
One of the challenges of this model is the value creation incentives can become misaligned, eg the third party finance becomes the main customer while the recipient becomes a mere receiver. This can occur as a survival of the enterprise depends on the contributions. Thus the incentive to create value for the donor may be stronger than the incentive to create value for recipients. This is one disadvantage of third-party funded enterprises when compared with recipient-funded frameworks. Conventional business-like selling of products and services does not always work in areas like education, health care, utility services, etc
To handle the not-for-profit situations, we need to add to 2 extra building blocks to the 10 already used (see below)

An alternative example is Grameenphone (using a profit model to increase social benefits and rural development in Bangladesh)

In other words, Grameenphone allowed villagers in Bangladesh who are too poor to afford phones to partner with Grameen bank (micro finance institution) to provide local women with micro-loans to purchase mobile phones. These women sold calling services in their villages, repaid the loans and earned income. Grameenphone went beyond establishing near universal access to telephone services and earning a profit. It had substantial social impact by providing village phone ladies with earning opportunities and improved their social status. Grameenphone has provided over 200,000 women in rural areas with income earning opportunities, raised their social status, connected 60,000 villagers to a mobile phone network reaching 100 m people while also being profitable

Some questions to help you understand the 10 building blocks by ticking the appropriate box (based on Alexander Osterwalder et al, 2010)

(source: Alexander Osterwalder et al, 2010)