Business model converts innovation to economic value for the business. The business model spells-out how a company makes money by specifying where it is positioned in the value chain. It draws on a multitude on business subjects including entrepreneurship, strategy, economics, finance, operations, and marketing.
Simply put, a business model describes how a business positions itself within the value chain of its industry and how it intends to sustain itself, that is to generate revenue.
Chesbrough and Rosenbloom list the following six components of the business model:
- Value proposition – a description the customer problem, the product that addresses the problem, and the value of the product from the customer’s perspective.
- Market segment – the group of customers to target, recognizing that different market segments have different needs. Sometimes the potential of an innovation is unlocked only when a different market segment is targeted.
- Value chain structure – the firm’s position and activities in the value chain and how the firm will capture part of the value that it creates in the chain.
- Revenue generation and margins – how revenue is generated (sales, leasing, subscription, support, etc.), the cost structure, and target profit margins.
- Position in value network – identification of competitors, complementors, and any network effects that can be utilized to deliver more value to the customer.
- Competitive strategy – how the company will attempt to develop a sustainable competitive advantage, for example, by means of a cost, differentiation, or niche strategy.
Business Model for the Xerox Copier
Chesbrough and Rosenbloom illustrate the importance of the business model with a case study of Xerox Corporation’s early days in the copy machine business with its Xerox Model 914 copier. (Before changing its name to Xerox Corporation, the company was known as the Haloid Company and then Haloid Xerox Inc.)
The Model 914 used the relatively new electrophotography process, which is a dry process that avoids the use of wet chemicals. In seeking potential marketing partners, Haloid repeatedly was turned down by the likes of Kodak, GE, and IBM, who had concluded that there was no future in the technology as seen through the lens of the then-prevalent business model. While the technology was superior to earlier copy methods, the cost of the machine was six to seven times more expensive than alternative technologies. The model of selling the equipment below cost and making up the difference by large margins in the sale of supplies was not viable because the cost of the supplies was about the same as that of the alternatives, so there was little room to maneuver.
Xerox then decided to market the new product itself and developed a new business model to do so. The new model leased the equipment to the customer at a relatively low cost and then charged a per copy fee for copies in excess of 2000 copies per month. At that time, the average business copier produced an average of only 15-20 copies per day. For this model to be profitable to Xerox, the use of copies would have to increase substantially.
Fortunately for Xerox, the quality and convenience of the new copy technology proved itself and companies began to make thousands of copies per day. As a result, Xerox sustained a compound annual growth rate of 41% over a 12 year period. Without this business model, Xerox might not have been successful in commercializing the innovation.