Business Model Innovation Proposal

PLEASE NOTE THAT GRAY AREAS REFLECT ARTWORK THAT HAS BEEN INTENTIONALLY REMOVED. THE SUBSTANTIVE CONTENT OF THE ARTICLE APPEARS AS ORIGINALLY PUBLISHED.

WINTER 2018 MIT SLOAN MANAGEMENT REVIEW 65

BUSINESS MODEL INNOVATION has be- come an increasingly hot topic in management circles,

and understandably so. No management activity is

more important than having clarity about how the or-

ganization creates, delivers, and captures value. It

requires, among other things, knowing what custom-

ers want, how value can be best delivered, and how to

enlist strategic partners to achieve maximum benefit.

Although the ability to develop strong value prop-

ositions can enable companies to “get by,” in our view

many of today’s most successful businesses are those

that are able to place themselves in the “sweet spot” of

business model scalability. Scalability is about achiev-

ing profitable growth and is therefore a fundamental

consideration for managers and investors alike. If

managers are incapable of factoring scalability attri-

butes into their business model design, they risk

being left behind, much the way bookstores owned by

Borders Group Inc. were eclipsed by Amazon.com Inc.

Over a five-year period, we studied scalability in the

context of more than 90 Scandinavian businesses and

also examined the experiences of a number of well-

known businesses, including Google, Apple, and

Groupon. (See “About the Research,” p. 67.) In the course

of our research, we identified five patterns by which

companies can achieve scalability. The first pattern in-

volved adding new distribution channels. The second

entailed freeing the business from traditional capacity

constraints. The third involved outsourcing capital in-

vestments to partners who, in effect, became participants

in the business model. The fourth was to have customers

Building Scalable Business Models

S T R A T E G Y

Many of today’s most successful companies are able to leverage business model scalability to achieve profitable growth. Executives need to factor scalability attributes into their business model design or they risk being left behind. BY CHRISTIAN NIELSEN AND MORTEN LUND

THE LEADING QUESTION How do companies develop scal- able business models?

FINDINGS �Scalable business models are flexible and turn new resources into increasing returns.

�Scalability often involves connecting strategic partners to a company’s value proposition.

�One key is to find smart ways to lever- age the resources of partners.

66 MIT SLOAN MANAGEMENT REVIEW WINTER 2018 SLOANREVIEW.MIT.EDU

S T R A T E G Y

and other partners assume multiple roles in the busi-

ness model. And the fifth pattern was to establish

platform models in which even competitors may

become customers. Based on these patterns, we have

developed a framework for identifying potential

levers for business model scalability, along with a

road map that managers can use to improve their

business models.

Over and above the need to create value proposi-

tions that are difficult for competitors to replicate,

managers need to develop business models that are ca-

pable of achieving positive and accelerating returns on

the investments made. When companies restructure

or invest in acquisitions, it’s common for them to iden-

tify synergies that reduce costs and simplify workflows

and product offerings. However, simply thinking in

terms of synergies isn’t enough; such synergies don’t

necessarily lead to improvements in business model

scalability. To achieve scalability, managers and entre-

preneurs need to remove capacity constraints. They

have opportunities to do this in a variety of ways: by

collaborating with partners, by encouraging partners

to play multiple roles in the business model, by creat-

ing platforms to attract new partners, or even by

working with current competitors.

Accelerating Returns to Scale What do we mean by “scalable”? We use the term

scalability to identify where changes in size or vol-

ume are possible and seem worthwhile. Scalability

refers to a system’s ability to expand output on de-

mand when resources are added. Linking scalability

to business models provides us with a framework

for discussing and estimating business potential,

which is important to both executives and many

stakeholders because, among other things, it has

implications for hiring and skill development.

Another important characteristic of scalability is

that the organization has sufficient flexibility to

grow while incorporating the effects of external

pressures, such as new competitors, altered regula-

tion, or macroeconomic pressure.

The first dimension of scalability is the degree to

which increased input can create higher output.

The second dimension of scalability relates to the

ability of the business model to accelerate the re-

turns on the additional investment. Accelerating

returns to scale are typically found in business

models where new resources, capabilities, or value

propositions provide completely new properties to

an existing industry.1 Amazon.com’s retailing busi-

ness model offers a good example. For example, the

company’s algorithms introduce customers to

products they may not have considered but might

be of interest to them as they shop online.

In those situations where returns to scale are de-

clining rather than increasing, managers should

figure out how quickly to exit the business. If the

returns are falling precipitously, it might make

sense to pull out quickly. Even when returns are flat,

further investments may be unattractive. As a

general rule, executives should invest capital where

they can generate increasing returns to scale.

Scalability Patterns in Business Models A scalable business model is one that is flexible and

where the addition of new resources brings increas-

ing returns. In the course of our research, we searched

for business model attributes that were sufficiently

flexible to cope with internal demands and external

forces and where the potential wasn’t constrained by

physical or material assets (such as labor shortages,

machine capacity, cash liquidity, or storage capac-

ity). Below we will examine the five patterns of

business model scalability individually.

PATTERN A: Add new distribution channels.

While the notion of selling through multiple distri-

bution channels isn’t novel, it’s useful to understand

what happens when an additional channel is added.

As long as the implementation of a new distribu-

tion channel does not cannibalize sales in existing

channels, adding a new sales channel can allow a

company to spread the costs of overhead and reap

benefits from increased sales.

We found this to be the case at Copenhagen

Seafood A/S, a Danish supplier of fresh fish. The

company, which had traditionally sold only to high-

end restaurants, added the sale of fresh fish directly

to retail customers, enabling it to offer restaurant-

quality seafood to individuals at reasonable prices.

Because restaurants typically ask for specific cuts

of fish, the percentage of waste can be high. By add-

ing the retail channel, Copenhagen Seafood was

able to cultivate a new clientele with people who

relished the opportunity to buy from a seafood

SLOANREVIEW.MIT.EDU WINTER 2018 MIT SLOAN MANAGEMENT REVIEW 67

supplier closely associated with some of the city’s

best-known restaurants.2

PATTERN B: Explore ways to work around tra-

ditional capacity constraints. Scalability often

means finding ways to overcome traditional capacity

constraints. Obviously, constraints vary from indus-

try to industry. In the pharmaceutical industry, the

constraints might involve the cost of establishing re-

search infrastructure and the ability to develop new

products and receive approval for new products.

However, when viewing constraints from the per-

spective of business model innovation, companies

should ask themselves if they can find ways to work

around existing constraints. In the private banking

sector, for example, a company might bypass capac-

ity constraints by focusing on customer relationship

activities and outsourcing infrastructure manage-

ment to others. In a similar vein, a consulting

company with a business model focused on hourly

billing for large government organizations explored

bypassing that constraint by marketing standard

outputs and simpler reports to a new customer seg-

ment consisting of smaller businesses.

PATTERN C: Shift capital requirements to

partners. Every organization needs to prioritize its

investments and determine which are most critical.

CFOs are encouraged to optimize the cash liquidity

constraints, cash flow, and working capital attri-

butes of their business models. Given that many

companies place a high value on cash, business

models that shift capital requirements to strategic

partners can be desirable.3

One company we studied was Sky-Watch A/S, a

company based in Støvring, Denmark, that devel-

ops and manufactures drones suited for a variety of

industrial settings. Sky-Watch’s business model has

fewer resource constraints than some of its close

competitors thanks to management’s decision to

concentrate on turning the core platform into an

open platform that allows customers and strategic

partners to add their own hardware and software.

PATTERN D: Leverage the work of partners.

Companies need to pay attention to what their cus-

tomers and strategic partners value. Managers should

use this knowledge to optimize the value proposition

of the products and services they offer to customers.

The key is to find smart ways to leverage the resources

of partners. For example, Tupperware Brands Corp.,

based in Orlando, Florida, is famous for leveraging a

community of sales representatives who have an in-

terest in selling the company’s food-storage products

to a widening circle of people. Groupon Inc. likewise

turns customers into partners by giving them incen-

tives to spread the word about the company. Similar

strategies can be leveraged for distribution methods,

building customer loyalty, giving access to resources,

and performing other activities according to the

value configuration of the business model.

PATTERN E: Implement platform models.

A variation on leveraging partners involves using

platform-based business models. Platform models

are based on collaboration and can take different

forms. For example, PrintConnect.com of Würselen,

Germany, operates a web-based workflow platform

for printing and packaging that links partners across

the value chain. Some platform business models

predate the web: Visa Inc., which connects busi-

nesses with credit card users, is an example.

When looking at business model innovation from

a platform perspective, an important question is,

“How do we turn competitors into partners or perhaps

even customers?” For example, The Relationship

Factory,4 a company based in Aarhus, Denmark,

that organizes professional networking groups for

managers, opted for a platform model to achieve

business model scalability. It makes its software

platform available to competitors on a private-label

basis, thereby providing the company with a sup-

plemental and recurring revenue stream on top

of its traditional service-based activities. While

ABOUT THE RESEARCH Business models offer a novel perspective from which to understand how companies can become profitable, competitive, and sustainable. They offer distinct recipes for how companies do business,i including activities and resources, customer relationships, partnering strategies, and revenue models.ii

Our research focused on business model innovation in conjunction with 10 networks of collaborating companies, where the companies were collaborating either through joint ventures or via more open and informal arrangements. The research, which was conducted between 2008 and 2013, was aimed at helping participating companies develop a process for pursuing new global business opportunities and providing a solid base of relevant qualitative data. A total of 92 Scandinavian companies participated. We used longitudinal methods, augmented by a series of semi-structured interviews, to examine business model innovation pro- cesses. Our team followed the companies through workshops, company meetings, board meetings, and observations, which were recorded and/or documented with minutes, pictures, or video.

68 MIT SLOAN MANAGEMENT REVIEW WINTER 2018 SLOANREVIEW.MIT.EDU

S T R A T E G Y

competitors continue to rely heavily on their sale of

service hours, the company is able to generate in-

cremental revenue by selling “ease of use” to its

competitors as well as benchmarking data across

the industry.

A Road Map to Business Model Scalability The patterns we have discussed above describe how

companies can adjust their business models to make

them scalable. While traditional thinking typically

leads to synergy effects and, at best, positive returns

that are linear to the investments, some of the com-

panies we studied showed that it was possible to

redesign business models to achieve accelerating

returns. However, achieving accelerating returns is

not easy. It requires thinking strategically in terms of

the value propositions of stakeholders, strategic

partners, and customers involved in the immediate

business ecosystem. Aligning and leveraging the

competencies and motivations of these stakeholders

can lead to better cooperation. It can also build

greater trust and loyalty among partners, which will

pay off in the long term.

To implement the patterns for scalability, it is

often necessary to identify activities and resources

where collaborating with partners is advantageous

and can strengthen the offering’s value proposition

to customers. These patterns can assist managers in

rethinking how their business models make use of

partners, customers, and other stakeholders. Rather

than just relying on traditional analytical exercises

such as analyzing cost structures, product-segment

profitability, and market-segment growth, manag-

ers can work on achieving business model scalability

by asking a different set of questions. The questions

will often lead to the identification of new partners

and potentially new roles.

We suggest that companies pursue three steps:

1. Identify potential strategic partners. Scalability

typically involves connecting strategic partners to

the value proposition, either through sharing activi-

ties or resources. Given that scalability requires

thinking beyond simply sharing costs, executives

should ask themselves the following:

• Are there potential strategic partners that could

perform activities in our business model — or

provide resources to it — in ways that would help

improve the value proposition to our customers?

2. Ask questions that reveal a road map to scal-

ability. Asking questions can trigger ideas about

how to reconfigure a business model. When en-

countering novel ways of doing business, managers

should analyze how such a business model would

play out for their own company. We have found

that the following questions can be helpful:

• How does this novel business model challenge our

existing way of thinking about the business?

• What would we need to do differently to imple-

ment this business model?

• Which other companies excel at what we are try-

ing to do, and what can we learn from them?

• What are the key value drivers of this particular

business model?

• Could this business model lead to scalability?

Based on the ideas you are able to generate, we

recommend using the following questions to help

clarify potential avenues for scalability:

• Are there potential strategic partners that can

offer features (at minimal or no cost to our com-

pany) that enrich the existing value proposition to

our customers, while receiving value themselves?

• Are there alternative configurations that free the

business model from existing capacity constraints?

• Would it make sense to establish a platform for

other businesses to buy into — and thus create

alternative ways of generating revenue?

• Is it possible to change the role of existing stake-

holders and utilize them in multiple roles in the

business model?

Achieving acclerating returns is not easy. It requires thinking strategically in terms of the value propositions of stakeholders, strategic partners, and customers.

SLOANREVIEW.MIT.EDU WINTER 2018 MIT SLOAN MANAGEMENT REVIEW 69

• Who would pay for either access to our customer

base or knowledge about our customers and their

characteristics?

• Which mechanisms are in place to create customer

lock-in?

• How agile is our company in reacting to threats

from new entrants or new technologies?

3. Analyze the scalability attributes of business

model options. When all of the ideas generated have

been presented, executives should facilitate a discus-

sion to start to evaluate potential business models.

They should analyze the attributes of the various op-

tions and consider how they might be configured to

achieve accelerating returns on investments.

Traditionally, some companies have developed

business models that focus on achieving economies

of scale while other companies have been more

geared toward creating economies of scope through

differentiation. We have found that scalability goes

beyond this traditional distinction and that identi-

fying the sweet spot of business model scalability

involves identifying accelerating returns on input.

In cases of declining returns to scale, managers

should focus on downsizing the business so as not

to cannibalize existing value. In cases where the re-

turns on additional inputs are constant, managers

should attempt to find ways to increase returns or

invest excess capital elsewhere. When the business is

able to generate positive, albeit linear, returns on ad-

ditional inputs, the existence of synergies can make

this a favorable place to be, although the company

may be stuck with a business model that is at best

average. In this case, managers should attempt to

improve their business model using one of the five

patterns described above.

Having a road map for business model scalability

can be enormously helpful for managers, whether

they are involved in developing new business models

from scratch or innovating, rejuvenating, or redesign-

ing existing business models. Although much of the

recent research about business model innovation ex-

amines the alignment between value propositions

and customer needs,5 business model scalability

depends on close alignment between the value propo-

sition and strategic partners.

The patterns we have identified as gateways to

scalable business models (for example, enriching

value propositions, removing capacity constraints,

and changing the role of stakeholders in business

models) provide avenues for managers to explore.

Identifying business model configurations that

allow for such characteristics should be a top prior-

ity for managers as they develop and review their

corporate strategies.

Christian Nielsen is a professor of business models and performance reporting at Aalborg University in Aalborg, Denmark, and at Inland Norway Univer- sity of Applied Sciences in Norway. Morten Lund (@mortenlunddk) is an assistant professor and director of the Business Model Design Center at Aalborg University. Comment on this article at http://sloanreview.mit.edu/x/59206.

REFERENCES

1. C. Nielsen and H. Dane-Nielsen, “The Emergent Properties of Intellectual Capital: A Conceptual Offering,” Journal of Human Resource Costing & Accounting 14, no. 1 (2010): 6-27; and H. Dane-Nielsen and C. Nielsen, “Understanding Business Models from an Intellectual Capital Perspective,” in “Handbook of Intellectual Capital Research,” ed. J. Guthrie, F. Ricceri, J. Dumay, and C. Nielsen (London: Routledge, 2017).

2. This is an example of the type of complementary fit, where activities are mutually reinforcing, identified by C. Zott and R. Amit in “The Business Model: A Theoreti- cally Anchored Robust Construct for Strategic Analysis,” Strategic Organization 11, no. 4 (November 2013): 403-411. See also P. Milgrom and J. Roberts, “Comple- mentarities and Fit Strategy, Structure, and Organizational Change in Manufacturing,” Journal of Accounting and Economics 19, no. 2-3 (March-May 1995): 179-208. According to Milgrom and Roberts, activities are comple- ments when the marginal value of one activity increases as the other activity is increased.

3. See Y. Taran, C. Nielsen, M. Montemari, P. Thomsen, and F. Paolone, “Business Model Configurations: A Five-V Framework to Map Out Potential Innovation Routes,” Eu- ropean Journal of Innovation Management 19, no. 4 (2016): 492-527; and H. W. Chesbrough, “Open Innovation: The New Imperative for Creating and Profiting from Technol- ogy” (Boston: Harvard Business School Press, 2005).

4. This is an English translation of the company’s name, Relationsfabrikken ApS. See www.relationsfabrikken.dk.

5. A. Osterwalder, Y. Pigneur, G. Bernarda, and A. Smith, “Value Proposition Design: How to Create Products and Services Customers Want” (New York: John Wiley & Sons, 2014).

i. C. Baden-Fuller and M.S. Morgan, “Business Models as Models,” Long Range Planning 43, no. 2 -3 (April-June 2010): 156-171.

ii. Taran et al., “Business Model Configurations: A Five-V Framework.”

Reprint 59206. Copyright © Massachusetts Institute of Technology, 2018. All rights reserved.

Reproduced with permission of copyright owner. Further reproduction prohibited without permission.