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ALEKSEI BEREZNOI

Business Model Innovation in Corporate Competitive Strategy

In this analysis of business model innovation, a key competitive instrument

for major corporations, the author explores the concept of the business

model, identifies the features of innovative business models being used as

competitive tools in today’s volatile markets, and describes the challenges

involved in various approaches to implementing innovation. Innovation’s

role as a key driver of game-changing industry shifts is examined, and it is

concluded that business model development and implementation are

becoming a strategic imperative for most global players.

Keywords: Business innovation, business model, competitive strategy, corporate organization, global competition, large corporations

Jel Classification: D21, F23, L20

Since the beginning of the twenty-first century, change has become the

norm in almost all spheres of economic life, and the pace and scale of

this change have only grown. It can be stated with certainty that future

economic development will see faster and more profound shifts.

14

English translation q Taylor & Francis Group, LLC, from the Russian text q 2014 NP “Voprosy ekonomiki.” “Innovatsionnye biznes-modeli v konkurentnoi strategii krupnykh korporatsii,” Voprosy ekonomiki, no. 9, 2014, pp. 65–81.

Aleksei Bereznoi is a Doctor of Economic Sciences and director of the Center for Industrial Market Studies and Business Strategies at the Institute of Statistical Studies and Knowledge Economics, National Research University–Higher School of Economics in Moscow.

Translated by Nora Favorov.

Problems of Economic Transition, vol. 57, no. 8, December 2014, pp. 14–33. q 2014 Taylor & Francis Group, LLC ISSN: 1061-1991 (print)/ISSN 1557-931X (online) DOI: 10.1080/10611991.2014.1042313

This unprecedented pace and scale of change has highlighted the

importance of a particularly powerful tool: the innovative business

model. Not so long ago a major corporation that had successfully

established itself within a particular market could count on maintaining

its position long term by steadily improving an essentially unchanged

way of interacting with its customers. Today, however, this is rarely

enough. In almost any industry, no matter how mature a company is, it is

likely to be challenged by competitors introducing new business models

that radically change the “rules of the game.” Furthermore, unlike in the

case of innovative products and manufacturing methods, this is not

necessarily a matter of high technology. In business innovation, the

decisive role is played not by scientific discovery, but by an

entrepreneurial idea, by the identification of a new market need and

the skillful joining of ways to satisfy this need with effective demand

based on nonstandard ways and means of creating and delivering

consumer value to the target market.

Under current conditions, where even the most successful business

models are relatively short-lived, the introduction of business

innovation is becoming an important tool in dominating markets and

defending them against competitors for the vast majority of participants

in global competition. Innovative business models were behind the past

decades’ most remarkable corporate ascents: Apple, Walmart, Amazon,

Cisco, FedEx, and Virgin, to name a few. Corporations that have

become business innovation leaders become global leaders in their

industries. From this standpoint, the experience of developing and

introducing new business models is of clear interest for Russian

companies as they increasingly enter the competitive fray of global

markets.

The features of business models as competitive tools

Attempts to identify the features of business innovation that serves as a

competitive weapon for large corporations inevitably leads to the task of

defining the very concept of the business model. Although this concept

is neither new nor rare within the literature of economics and business, it

remains a subject of lively debate (Afuah, 2014; Johnson, Christensen,

and Kagerman, 2008; Kaplan, 2012; Magretta, 2002; Osterwalder,

2004; Osterwalder and Pigneur, 2010; Shafer, Smith, and Linder, 2005;

Teece, 2010).

DECEMBER 2014 15

One reason for the lack of a clear definition of business models and an

insufficient understanding of the concept overall is its interdisciplinary

nature. “The economics literature has failed to even flag the importance

of the phenomenon, in part because of an implicit assumption that

markets are perfect or very nearly so. The strategy and organizations

literature has done little better. Like other interdisciplinary topics,

business models are frequently mentioned but rarely analyzed:

therefore, they are often poorly understood” (Teece, 2010, p. 192).

Without getting into the details of the debate over defining business

models (a topic in its own right), we should note that in our opinion this

concept amounts to more than an arbitrarily constructed understanding of

the basic mechanism through which a particular company operates (such a

broad interpretation essentially deprives the concept of any meaning). The

concept incorporates a number of specific business characteristics that are

fundamental to any company: (1) a means of creating consumer value and

delivering it to a target group of consumers; (2) a means of generating

profits; and (3) a means of using existing resources and processes to

promote the stable interaction of mechanisms for creating consumer value

and generating profit as well as ensuring enduring competitive advantages.

These fundamental characteristics, which as a system essentially define the

entire“logicofabusiness,”comprisethebusinessmodeloutofwhichgrow

other, secondary elements of the architecture of the enterprise as a party to

market relationships: competitive tools and possible models of market

behavior, the organization of interactions with suppliers (the supply chain

model), the specific organizational structure and organization of business

processes (the operational model), and so on.

What distinguishes innovative business models (which are essentially

the systematic result of developing a set of business innovations) from

traditional weapons in the competitive arsenal? Large corporations use

three basic elements of the tried-and-true methods to increase sales in a

competitive market: lower prices, the gradual improvement of existing

products, or the release of new products. All of these levers can provide

(and continue to provide) measurable results from the standpoint of

increasing sales. However, when large corporations have been operating

in their industries for many years, these approaches inevitably begin to

yield diminishing returns.

The point of diminishing return comes particularly quickly in the case

of lowering prices (these days, most often through discounts and sales),

which is considered the simplest way to boost sales. However, many

16 PROBLEMS OF ECONOMIC TRANSITION

companies that lower prices in the hope of a quick yield have learned

that a straightforward price reduction (or the large-scale use of various

sorts of discounts) without making the right changes to other elements of

the business model can quickly lead to reduced profitability. This is a

trap into which major department stores have often fallen after they

turned to large-scale sales: at first they saw a sharp increase in sales

followed by just as sharp a fall in their sales margin.

A solution was found by the pioneers of discount retailing in the United

States, which back in the 1950s began to apply the logic of the supermarket

to the sale of clothing, appliances, and other mass consumption items. This

new business model presumed a number of systemic departures from the

traditional department store: a sharp reduction in the number of sales

personnel; maximum freedom and self-service for shoppers; a redesign of

the sales environment to accommodate large numbers of shoppers; a move

towardpurelyfunctionaldesignofsalesfloors(doingawaywitheverything

superfluous); and changes to the formula for selecting suppliers that

compelled them to offer generous terms. As Joan Magretta has noted, only

after all these elements of the discount business model had been put to

effective use could discounters “offer low prices and still make money”

(Magretta, 2002, p. 91).

In the case of gradual improvements to existing products already

familiar to the market, the ability to apply this competitive method as a

means of increasing sales is exhausted all the more quickly in that

consumer value is generated not by the product as such, but by the

results associated with its use. Companies that continue to stubbornly

focus on improving the product itself can limit their growth potential,

make investments in innovation that are unlikely to be adequately

appreciated by the customer, and, in the end, wind up squeezed out of

the market by more farsighted competitors. A striking example of this is

Kodak, which recently entered bankruptcy after a history dating back to

the late nineteenth century, when it essentially founded and went on to

dominate the photographic technology industry. 1

Beginning with the dawn of the current century, the rapid spread of

digital photography and social networks eliminated the need for the

printing of photographs on a large scale, leading a vast business empire

into financial ruin in 2013. An ironic twist in all this is that the digital

photograph was invented by Kodak engineers (back in 1975). But this

invention was obviously not integrated into the company’s business

model, which was built around the sale of relatively inexpensive

DECEMBER 2014 17

cameras that generated massive sales of film and services to develop and

print photographs using an extensive network of Kodak photography

shops throughout the world.

For many years, the company’s management was absolutely certain of

the durability of this model and concentrated on improving their cameras

and increasing the quality of their film. They made a classic mistake:

focusing on improving the properties of already available goods and

services and ignoring new business models that would enable radical

industry shifts. Locked into their traditional business model, Kodak

essentially lost its connection to the end user, for whom film and printed

photographs per se were not as important as opportunities to capture

memorable moments in their lives and share them with friends and family

(which in our digital age the Internet and social networks offer on an

unprecedented scale). “Kodak’s business model,” according to an article

in Forbes, “was to make its money selling film, and it made a mint that

way. Digital photography didn’t fit that model so Kodak buried its head in

the sand and ignored the coming tsunami of new technology. When film

went from ‘essential’ to ‘old fashioned’ the company never recovered.” 2

When it comes to the release of fundamentally new products, this

classical method of competitive struggle offers greater market

advantages than the usual reduction of prices or improvements to

products already being sold. However in the current era of rapid and

unpredictable change, even this method, in its traditional application,

offers no guarantee of stable long-term growth. The early victories of

Apple—perhaps the most successful corporation of the early twenty-

first century—illustrates this point.

In the late 1990s, Apple was a niche player in the personal computer

market, and it was losing ground to dynamic competitors, old and new

alike. But in 2001, with the release of a new product—the iPod digital

MP3 player—the situation radically changed. In the course of just three

years of sales, a huge, essentially global market worth $10 billion

(approximately half of all Apple sales) was created that paved the way

for other best sellers: the iPhone smartphone and iPad tablet. This story

was covered in many business publications, but one aspect of Apple’s

success went largely unremarked: it was not the first company to release

a digital music player on the market. Diamond Multimedia had begun

selling an analogous product, the Rio, in 1998, and in 2000 the Cabo 64

digital player was released by the Best Data company. Both competing

devices were excellent and considered very stylish by their youthful

18 PROBLEMS OF ECONOMIC TRANSITION

target audience. Nevertheless, the iPod won, and the main reason for this

was not the product’s unique features, but the innovative business model

that Apple was able to design and introduce in record time.

Apple’s main achievement was the creation of a unique combination of

software, the device itself, and a service allowing consumers to

inexpensively, easily, and legally download digital music from the

Internet. The sale of the inexpensive (and essentially nonprofit generating)

iTunes software was combined with the sale of the high-margin iPod

device to yield excellent profitability for the business model overall. 3

The Apple story strikingly illustrates the main advantages of the

innovative business model over traditional competitive tools. Unlike

classical methods that relied on innovation in one or two areas of a

corporation’s economic mechanism (such as price or technology), the

introduction of new business models inevitably brings essential changes

to most of its elements, including the choice of the potential buyer’s

target need, the mechanism for generating profits, and the means of

reliably combining the two. These numerous innovations provide

multiple “layers of protection” from attempts by competitors to copy a

successful business model.

Furthermore, since such innovations are part of an integrated business

model, by definition they are coordinated with one another, which sets

up a multilayered defensive system against competitors, substantially

improves the competitive durability of innovative business models, and

extends the time over which “the cream can be skimmed” in the form of

elevated profits. It is hardly surprising that analysis of a database created

by global management consulting firm BCG (in collaboration with

Business Week) of the most innovative companies of the year showed

that companies that had introduced innovative business models

generated the greatest return for shareholders compared with

competitors who limited their innovation to the introduction of new

products or processes. 4 Furthermore, the success of business model

innovators proved to be more enduring: even ten years out they

continued to lead their competitors by a number of important measures.

The main types of innovation and problems in introducing IT

Since every successful business model is unique, it is hard to identify

a standard algorithm for “correctly” developing prospective business

innovations. It is, however, possible to identify some of the main

DECEMBER 2014 19

pathways of change that have already brought success to today’s

business model innovators in the marketplace.

The first of these pathways involves rethinking ways to satisfy the

target need underlying a given industry’s dominant traditional business

model (including rethinking just what the target group of consumers

actually needs). The result of this rethinking could be, for example, a

reorientation of the company’s business model from making products to

providing services or achieving certain results important to targeted

consumers. For example, Hilti (based in Liechtenstein), facing

intensifying competitive pressure from Asia (especially China),

radically changed its business model, shifting from the sale of products

to a tool management service for contractors.

After years of working with construction firms in a variety of

countries, Hilti had a good understanding of its clients’ power tool needs

and the problems they faced. First among them was the need to purchase

a wide array of tools in order to have the right tools for every

construction job, a huge expense, especially for start-ups. Second, the

entire fleet of power equipment had to be constantly inspected and

managed to ensure that it is kept in good working condition and in the

right place at the right time. Third, builders were often forced to buy

exceptionally expensive tools that are needed only rarely.

Under Hilti’s new business model, the company does a more effective

job of satisfying its clients’ need for state-of-the art power tools. The

company does this by leasing power tools rather than selling them.

Furthermore, it guarantees clients that they will have as many tools as

they need when they need them and commits to continually update the

collection of tools they lease. This new business model obviously

required that Hilti’s operations be completely restructured and that it

develop the new competencies involved in managing a huge fleet of

equipment and transportation logistics as well as in introducing systems

to manage client power tool fleets, among other challenges. The cost of

this restructuring has been fully recouped: the company’s client base has

greatly expanded and revenues have increased.

Sometimes firms are able to accumulate knowledge about their

customers that reveals problems and needs of which the customers

themselves are not fully aware. For example, the U.S. company

ServiceSource, which specializes in developing cloud technologies for

major software and computer equipment producers, discovered a

potentially huge but often ignored source of revenue for their clients: the

20 PROBLEMS OF ECONOMIC TRANSITION

renewal of contracts to keep recurring revenue streams flowing. According

to the company’s estimates, in the U.S. information technology (IT) sector

alone, software producers lose up to $30 billion annually because

approximately 50 percent of their clients are not approached by sales teams

(who are focused on finding new clients) to renew their contracts.

ServiceSource not only discovered this source of unrealized revenue

but also developed an appealing way for clients to compensate them for

their services that convinced them to share a portion of their revenues.

The company proposed that its services be compensated not through

standard fees for time spent (the norm for consulting firms), but based on

results—on a percentage of income generated through the renewals. The

innovation introduced into ServiceSource’s business model was not just

an original compensation model. What they essentially offered was the

outsourcing of a problem in a sensitive area and the sharing of risks in

exchange for a share of revenues.

As executive vice president Christine Eckert has stated, “We offer

clients a set of managed services, where we can solve the problem for

them. We can give them everything they need to outsource this problem

to us. We take it on and deliver them back a result” (Lindgardt and

Hendren, 2014, p. 8). ServiceSource’s innovative business model

achieved rapid market success. During 2007–12, the company’s

compound annual growth rate was almost 30 percent, and by late 2013

overall client revenue being managed exceeded $14.5 billion. 5

Other types of business innovation that have proved themselves by

creating successful models in many markets involve changing the way

consumer value is delivered to target customers and the overall

restructuring of interactions with them. An interesting example is the

business model of Nespresso, a fast-growing international company that

is part of the Swiss food giant, Nestlé.

Ever since it first began operation, this company, which was founded

in 1986 to retail high-quality single-serving coffee, was built around an

innovative idea that combined seemingly incompatible aspects: an

individualized approach to each customer marketed on a large scale.

A major role in this “personalization” was played by the way the

company packaged and sold the product: the single-serving coffee,

prepackaged in special capsules, can be brewed using Nespresso

automatic coffee brewing machines (an easy, convenient way to brew an

excellent beverage), and the huge variety of coffees sold in the capsules

allows coffee drinkers to find the blend that best suits their taste.

DECEMBER 2014 21

Most important, Nespresso rejected traditional ways of selling its

products through an impersonal network of outside distributors and

created its own two-level sales system featuring, first, a worldwide

network of Nespresso “boutiques” (327 as of May 2014), and second,

Internet sales through the Nespresso Club. An important role in all this

has been played by a global network of call centers offering around-the-

clock advice on the secrets of espresso making.

This entire system was initially aimed at providing an individualized

approach based on direct contact with all customers (approximately 70

percent of company personnel—more than 5,800 people—work directly

with clients) and involving all customers in the Nespresso Club, through

which they maintain regular contact via e-mail. By late 2012, the club

had more than 7 million members worldwide, and since 2000 the

company has maintained an average annual growth rate of

approximately 30 percent. Such a high rate of growth and the

company’s steady dominance of the coffee capsule market (in 2013, it

had a 31 percent share of the global market, valued at $10.8 billion)

attest to a successful choice of business model. 6

A striking example of a radical transformation of a business model

based on a restructuring of interactions with customers is the recent

reform undertaken by the management of Home Depot, a leader in the

U.S. retail building materials market. In the early 1980s, when Home

Depot first put its business model into practice, it represented a sort of

revolution, essentially creating a new do-it-yourself-renovation market

segment.

This model, which involved the creation of huge building-material

supermarkets and achieved great popularity, primarily among young

consumers with relatively modest incomes, bet on consumers’ desire to

renovate their homes themselves, without employing the services of

expensive designers and craftsmen. However, the crisis of 2008–9 saw

plummeting demand for the materials needed to fix up apartments and

homes and forced Home Depot to seriously rethink its business model.

The main focus of the resulting changes involved interactions with

customers.

Putting the new program into practice meant: (1) bringing the

proportion of time sales consultants are in direct contact with shoppers

to approximately 60 percent of their workday; (2) mobilizing advanced

communication technologies to provide greater convenience and a

positive shopping experience (the use of special iPhone apps allowing

22 PROBLEMS OF ECONOMIC TRANSITION

shoppers to virtually see how a renovation would look in their own

home, to instantaneously and precisely calculate the supplies they would

need and compare the prices with those of competitors, and to pay for

and arrange delivery of their purchases through their mobile apps, etc.);

(3) extending “emotional” contact with customers beyond the sales floor

(including by collecting comments from dissatisfied customers from

social networks and applying lessons learned from them and holding

special seminars led by well-known interior designers and renovation

professionals, etc.). This new model, which brought relations with the

target consumer audience to a new level, permitted Home Depot not

only to significantly improve its customer satisfaction index but also, in

2009–12, to confidently surpass its closest competitor, Lowe’s, in terms

of the rate of annual income growth and EBITDA [earnings before

interest, taxes, depreciation, and amortization].

One important type of innovation that has shaped quite a few

successful business models is the restructuring of income generation

through the introduction of new cost models and new means of

monetizing use value, and the like. For example, for Qantas, the top

Australian airline, the urgent restructuring of profit generation based on

a new cost model proved to be the only solution after the 2001 arrival of

low-cost carriers, led by Virgin Blue (part of Britain’s Virgin Group),

which quickly captured more than 30 percent of that market. The low-

cost business model, which applies the same basic idea behind retail

discounters to air travel, stakes its success on a significant increase in

passenger volume achieved through a sharp reduction in ticket prices

made possible by comprehensive cost cutting across a wide spectrum of

the carrier’s operations. The experience of many of the world’s airlines

has shown that attempts to apply individual elements of this model to a

traditional operating scheme usually ends in failure.

Qantas followed a different path. In 2004 it founded a new company,

Jetstar Airways, which from the start was based on the same principles

as low-cost airlines and in many regards was more severe and

uncompromising in its cost cutting than its international competitors.

The new company did not stop at half measures, such as cramming more

seats into the cabin or reducing free in-flight services. It opted for the

ultra-low-cost model, taking advantage of every possible savings:

economizing on airport services (using second-tier airports and

nighttime flights); minimizing ground time (precise planning and

adherence to schedules and optimizing the time spent on boarding and

DECEMBER 2014 23

refueling); maintaining a new and uniform fleet of planes (which enables

savings on fuel and spare parts and the interchangeability of personnel

and crews); the introduction of a flexible pricing policy (a base price

plus paid options for all sorts of in-flight services, including baggage,

food and beverages, access to audio and video entertainment, etc.);

dispensing with connecting flights (to avoid having to compensate

passengers who miss a connection due to delays); mandatory electronic

reservations and check-in (saving on preflight services); and eliminating

seat assignments for faster boarding.

Consistent application of the new model proved highly successful for

Jetstar. Foreign low-cost airlines lost out and became niche players in

the Australian air travel market. 7 Jetstar’s annual income has passed the

US$3 billion mark, and it has become more profitable than its parent

company, which targets higher paying segments. Furthermore, Jetstar

became the first airline in the world to successfully apply the low-cost

business model to transcontinental flights.

In recent years, the importance of the innovative business model in

achieving competitive success has become increasingly clear to the

leaders of major corporations. According to American economists,

more than half of the most successful companies, those included on

lists such as those of Fortune and Forbes ranking the largest

corporations traded on U.S. stock exchanges during the ten-year period

beginning in 1997, achieved this specifically because of their

innovative business models. 8 Not surprisingly, a 2005 survey by the

authoritative Economist Intelligence Unit of more than four thousand

top executives of leading corporations from twenty-three countries

showed that a majority of them (55 percent) believe that a new

business model is a more important competitive asset than new

products or services (EIU, 2005, p. 9).

Nevertheless, when corporations set their priorities in the area of

innovation, the development of business models winds up far from the

top of the list. According to a study by the American Management

Association, global corporations spend no more than 10 percent of their

overall investment in innovation on developing new business models

(Johnson, Christensen, and Kagerman, 2008, p. 52). The paradox of the

parallel existence of two contradictory trends—a growing awareness of

the competitive importance of innovative business models and the

persistence of underinvestment in this area—usually has to do with how

major corporations are currently organized.

24 PROBLEMS OF ECONOMIC TRANSITION

First of all, unlike other sorts of innovation (those associated with

new products and processes), innovative business models by definition

require coordinated, simultaneous changes in several key areas of a

company’s operations. The risks such large-scale changes entail are

many times greater than for other sorts of changes, and the cost of

getting it wrong can be devastating for the entire business. This means

that launching the development of a new business model, to say nothing

of introducing it, demands not just routine decision making by a

particular central management department (as would be the case for

innovations of products or technologies), but decisive and coordinated

action by the company’s top management. Today, it can be difficult for a

large corporation with a complex management structure, sprawling

bureaucracy, and problematic relationships among various divisions and

services, to overcome inertia and turn its “corporate ship” in another

direction.

Numerous studies have shown that the internal organization of

today’s major corporations, even those adapted to develop and

introduce innovative products and technologies, often does not lend

itself to recognizing and realizing new business models. When

deciding which innovative projects to invest in, they tend to choose

those that fit into the current business model, even if that means

ignoring the ideas that offer the most promise. This tendency is one of

the main reasons for Kodak’s bankruptcy, and it deprived the Xerox

Corporation of an opportunity to make use of a number of interesting

technological innovations (including the first personal computer) that

were developed by its engineers, but later realized with great success

by others. 9

Furthermore, a lack of flexibility in decision making at major

corporations often creates insurmountable barriers to experimenting

with and testing new business models—both of which are essential.

In the opinions of Karan Girotra and Serguei Netessine, “Large

companies have the resources and capabilities to create and exploit

business model innovation ideas on an extraordinary scale. But their

failure rate is nonetheless unacceptably high because so far too many

have not shown enough commitment and flexibility in the way they

develop and roll them out.” 10

This is why companies that manage to

overcome “built-in” internal corporate barriers and unleash their

innovative potential to create and—just as important—introduce

innovative business models quickly become industry leaders.

DECEMBER 2014 25

The driving force behind industry revolutions

The importance of innovative business models as a competitive tool for

major corporations is most obvious when they prove to be the main

drivers of radical industry shifts. The unique role of the transformer, a

company that changes the “rules of the game” in a particular industry,

is not a new phenomenon belonging exclusively to business models of

recent years. In fact this role has been an important feature of the best-

known business models throughout the history of capitalism.

In the 1870s, a business model conceived and realized by Swift and

Co. in the United States was built around a new system for storing and

transporting frozen meat and led to a complete restructuring of the meat

processing industry in the United States. 11

The razor/razor blade model

(also known as the Gillette model) has long since been included in

business school textbooks. This model—designed around the sale of one

product (the razor) at a low price on the assumption that the sale of an

accompanying, more highly priced product (replaceable razor blades),

would assure a steady revenue stream—launched a revolution in the

razor industry in the early twentieth century. First realized by the

renowned American entrepreneur King Gillette in 1903, it not only

forever changed “the face of the shaving world,” 12

but also became a

classic mechanism for generating profit that has been widely emulated in

many business models today, such as by producers of jet engines (the

engine/spare parts model), and in the area of photocopy technology (the

copier/cartridge model), among others. In the 1930s, the new

supermarket business model completely changed the retail landscape

in the United States, and beginning in the 1950s it continued its

triumphant advance across Western Europe. In the 1970s the low-cost

airline model paved the way toward fundamental changes in

international air travel, and in the 1980s, Sweden’s IKEA, with its

innovative “self-assembly” model became a dominant force in

essentially all the main markets for inexpensive furniture.

In recent decades, the world economic environment has changed and

is now even more favorable to innovative business models, which have a

greatly increased potential influence on the fate of any given industry.

Among several causes are this environment’s dynamism and volatility.

This concerns above all the massive spread of an assortment of new

and revolutionary technologies, including information and telecommu-

nication technologies, which create unprecedented opportunities for the

26 PROBLEMS OF ECONOMIC TRANSITION

development and introduction of innovative business models and

magnify their impact on an industry (or even across multiple industries).

Second, a huge role is played by globalization processes, which have

permeated virtually all sectors of the modern economy, simultaneously

intensifying the effects of the interdependence and instability of world

and national markets and forcing the development of new business

models that take the economy’s global scale into account. Third, the

heavy involvement of emerging markets in the global economy is of

increasing importance, and the specific nature of these markets forces

major corporations to transform business models that have been

developed over years, adjusting them to adapt to widely varying

circumstances.

When it comes to information and telecommunications technologies,

since the dawn of the new century it has been hard to find a new business

model that does not take advantage of the opportunities they offer.

Attempts to ignore them generally do not end well.

Take the case of Blockbuster. This former U.S. video-rental leader

seemed, as late as in the mid-2000s, not to notice the appearance of the

Internet and was quickly squeezed out of the market by its competitor,

Netflix, which put in place a more efficient and convenient model for

ordering DVDs through the mail via online subscriptions. As a result, a

company with billions in revenues and a huge network of outlets across

the country (more than nine thousand) was forced to file for bankruptcy

protection in 2010, while Netflix rapidly expanded its subscriber base to

more than twenty-six million in the United States and abroad. “Netflix

didn’t invent any new technology,” writes Saul Kaplan, “What Netflix

invented was a new business model—the ability for the customer to

avoid the trip to the video store by delivering the DVD by mail”

(Kaplan, 2012, p. 6).

Naturally, the information and telecommunications technologies that

have taken economic life by storm have led to more than just redesigned

business models that have become industry standards. They have also

led to the creation of fundamentally new industries for which the process

of devising even the first generation of business models is not yet

complete and in and of itself serves as a field for heightened competition

among new industry leaders. A good example is the Internet commerce

sector, which after the dot-com boom of the 1990s and subsequent crash

of most of its participants gradually acquired a rather stable industry

structure with clear business models for the remaining top players. Most

DECEMBER 2014 27

major Internet companies have striven to create a large user base by

engaging with them through social networks (Facebook, Twitter) or

search engines (Google), games, and so on, and then “monetize” this

base through online advertisements. Others have immediately attempted

to activate e-commerce mechanisms, although as Amazon’s experience

shows, this has not brought big profits.

Recently analysts have taken note of the phenomenal growth of

China’s Tencent, which has succeeded in surpassing Western global e-

commerce leaders by introducing an entirely new model for monetizing

its user base. This company started out—like many others in the Chinese

market—by copying Western experience in the area of social networks

and the spread of electronic games, but unlike some global giants (such

as Google and Twitter), for a long time it remained in the shadows,

acquiring weight in the domestic network space, protected against

outside competition. However in September 2013, when Tencent’s

market value exceeded $100 billion, surpassing Facebook (and not only

by this standard but also in terms of revenues and profits), the company

found itself the focus of attention by investment experts. It turned out the

Tencent’s monetization model was fundamentally different from the

models used by its Western competitors.

Tencent energetically developed its social network, WeChat, and its

instant messaging service, QQ, which has hundreds of millions of

Chinese users, while at the same time introducing a fundamentally

different means of generating revenue based on electronic games: as

soon as users get hooked on a new game, the company offers them the

opportunity to pay for additional services that “add value,” such as

flashier clothing or weaponry for their avatars or a chance to visit a

virtual VIP lounge, and so on. Whereas Western leaders of the global

Internet industry earn approximately 80 percent of their revenue through

advertisements, Tencent earns 80 percent by providing services to users

for an extra charge. It is this new business model that prompted the

Economist to say that Tencent has a “better business model than its

Western peers” and that this model has given the company the highest

shareholder total return for 2008–12, surpassing even such champions

as Apple. 13

As globalization processes become more pervasive, they shape the

design of new business models in a variety of ways. On one hand, the

qualitatively higher level of interpenetration and interdependence

among national economies creates new opportunities for combining the

28 PROBLEMS OF ECONOMIC TRANSITION

best resources from various countries to shape business models that

more easily withstand outside competition by relying on global

networks of corporate partners. On the other, under globalization,

business model life cycles have shortened due to heightened

competition among a rapidly growing number of global competitors

(including networks of competitors), and has accelerated the rate at

which destructive effects can spread during economic downturns, which

can quickly become global.

A striking example of a business model resting on the principles of a

global network and aspiring to become an industry standard is the one

behind Boeing’s creation of the Dreamliner (a wide-bodied 787

passenger jet). The design of this innovative airplane and the process

that brought it into commercial operation took international cooperation

(not unusual for civil aircraft construction) to a whole new level, with

first-wave suppliers alone totaling forty-four worldwide. This network

model, according to experts, shifted the industry paradigm. As scholars at

Aalborg University rightly point out in commenting on the consequences

of globalization, “The new environment demands new competitive

parameters, where the focus on internal optimization is no longer

sufficient . . . . The focus has thus changed from businesses competing

against businesses on BMs [business models], to networks competing

against networks on BMs” (Pedersen et al., 2013, pp. 103–4).

The demand for new business models has markedly increased since

the beginning of the current century, when major Western

corporations began accelerating their expansion into developing

markets. Simply transplanting models that work in developed

economies rarely works in these markets (see Bereznoi, 2014,

pp. 7–9). The reasons for this usually boil down to a failure to fully

appreciate two essential features of these markets that lead to the

rejection of imported business models.

First, the key characteristics of the group of consumers being

targeted by Western corporations is different. Adapting products and

sales methods in these new markets requires more than cosmetic

adjustments tailored to local tastes and practices. Unless the tiny sliver

of the population whose incomes and consumption standards differ

little from those in the West is being targeted, fundamentally different

approaches are needed to reach the typical consumer in emerging

markets (the segment that the current expansion of Western

corporations is targeting). In the words of experts from Innosight, an

DECEMBER 2014 29

international consulting firm: “Many multinationals simply import

their domestic models into emerging markets. They may tinker at the

edges, lowering prices . . . . But their fundamental profit formulas and

operating models remain unchanged, consigning these companies to

selling largely in the highest income tiers, which in most emerging

markets aren’t big enough to generate sufficient returns” (Eyring,

Johnson, and Nair, 2014, p. 90). At the same time, Western firms often

need new business models to solve problems such as the absence in

developing markets of reliable suppliers of high-quality materials and

services, adequate transportation, and commercial and financial

infrastructure, among other needs.

For example, the American fast-food giant McDonald’s encountered

a completely unfamiliar situation when it entered the Russian market in

1990. Unlike in Western countries, where the company focused on

running its restaurants, outsourcing the entire supply chain, in Russia at

the time no suppliers could be found that were capable of providing the

necessary level of quality and the required delivery schedule. Attempts

to attract traditional suppliers from Europe to invest with them in the

Russian market met with failure. But McDonald’s persisted and—not

giving up on the strategic decision it had made—decided to make

serious changes to its tried-and-true business model and undertook to

create a fundamentally new vertically integrated structure. 14

These

efforts and investments totaling approximately $250 million led to great

success in the huge Russian market, where in an essentially new fast-

food industry, McDonald’s became the undisputed leader for many

years (fifteen years after opening its first restaurant, McDonald’s

accounted for approximately 80 percent of fast-food sales).

When it entered the Pakistani market, Telenor, the largest Norwegian

mobile communications company, encountered the situation that most

of the population did not use banks. This meant that the company could

not receive payments using its traditional model. After several years of

preparation, however, Telenor managed to transform this problem into a

competitive advantage and gain a dominant market position. In 2009 the

Norwegian firm launched a service called Easypasia that gave Pakistanis

an easily accessible system of mobile banking that allowed customers to

make payments, get cash, and even open a savings account—all with

their mobile phones. The company even acquired a small local bank in

order to obtain a banking license. By 2010, Easypasia was available at

more than 20,000 retail outlets, offering financial services throughout

30 PROBLEMS OF ECONOMIC TRANSITION

Pakistan (the country’s entire banking network consisted of 8,500

branches). Although 89 percent of the country’s adult population did not

use banking services, 62 percent used mobile phones. As a result of this

undertaking, the number of Telenor subscribers in Pakistan grew to

more than 22 million. In essence, the Norwegian mobile operator used a

new technology to compensate for a largely absent banking sector and in

so doing achieved unprecedented growth among the local population

through the use of an unconventional business model.

* * *

Given the increasing instability and volatility of the economic

environment, the importance of innovative business models has grown

significantly as one of the most powerful tools in competition among

major corporations. Competitive reality unambiguously shows that even

a recognized engine of market success like technological innovation can

achieve much greater power if it is integrated into an innovative business

model. As European Commission experts stress, “Technologies as such

do not have a specific value. Their value is determined by the business

models used to bring them to a market.” 15 Given this circumstance, only

corporations that have armed themselves with a business innovation

strategy and mastered the practice of renewing business models that take

into account dynamically changing market demands and ever faster

developing technologies will emerge triumphant in global competition.

The development and implementation of new business models has

become a strategic imperative for most of today’s large corporations.

Notes

1. Until recently this company was still counted among the mostrespected pillars of big businesses in the United States. Founded in 1888, for the better part of a century Kodak was considered one of the most innovative corporations in the world, known for its commitment to exceptionally advanced technologies and cutting-edge marketing solutions. By 1976 the company controlled 85 percent of the American photographic camera market and 90 percent of the photographic film market. Until the 1990s, it was regularly among the five most expensive international brands.

2. Forbes, August 20, 2013; available at www.forbes.com/sites/avidan/2013/ 08/20/the-death-of-scale-is-kodaks-failure-an-omen-of-things-to-come-for- corporate-america/.

3. As American economists Raphael Amit and Christoh Zott have noted, “Rather than growing by simply bringing innovative new hardware to the market,

DECEMBER 2014 31

Apple transformed its business model to encompass an ongoing relationship with its customers . . . . In this way, Apple expanded the locus of its innovation from the product space into the business model” (Amit and Zott, 2012, p. 43).

4. The BCG analysis showed that although both groups of innovative companies had an average total shareholder return above their industry’s average, business model innovators on average earned returns four times greater than product and process innovators (Lindgardt et al., 2009, pp. 2–3).

5. ServiceSource 2014 investor relations; available at http://ir.servicesource.com. 6. As noted in a special study of the Nespresso business model, “The idea of

selling coffee in capsules has now been copied many times but what is hard to copy is the entire system—the business model. This non-duplicable business model provides the foundation for sustained success” (Matzler et al., 2013, p. 36).

7. An expert comparing the day-to-day effectiveness of Virgin Blue’s and Jetstar’s business models concludes that: “As a low cost carrier, Jetstar is the reality of flying’s present and a vision of travel’s future” (“Decoding the New Economy,” April 23, 2013; available at http://paulwallbank.com/2013/04/23/jetstar-vs-virgin- airline-flying-in-australia/).

8. Forbes, April 10, 2012; available at www.forbes.com/sites/rahimkanani/ 2012/10/04/business-model-innovation-is-the-fastest-path-to-greatness/.

9. “Like Xerox, however,” Henry Chesbrough lamented in this regard, “companies have many more processes, and a much stronger shared sense of how to innovate technology, than they do about how to innovate business models” (Chesbrough, 2010, p. 356).

10. HBR Blog Network, September 27, 2013; available at http://blogs.hbr.org/ 2013/09/why-large-companies-struggle-with-business-model-innovation/.

11. Until 1870, livestock in the United States destined for processing plants was sent to East Coast slaughterhouses from the main livestock centers of the Midwest before being turned into fresh, packaged meats that were then sold to consumers in major cities. Swift and Co. applied a fundamentally different approach: it set up slaughterhouses in the main livestock-producing regions, supplying them with powerful cold storage facilities, and then created a system for transporting frozen meats in specially equipped train cars to the main centers of consumption. Having thus sharply reduced costs, the company was able to radically reduce prices and quickly gained the dominant position in the industry. Its competitors were forced to follow the same model, which became the industry standard.

12. See http://wiki.badgerandblade.com/History_of_Shaving. 13. Economist, September 21, 2003; available at http://lb-stage.economist.com/

news/business/21586557-chinese-internet-firm-finds-better-way-make-money- tencents-worth.

14. With the help of Moscow’s local government, several farms were found and given the means to buy modern equipment. A herd of cattle was brought in from the Netherlands and a special variety of potato from the United States. The company then built a huge production facility outside Moscow to produce prepackaged beef, frozen french fries, dairy products, and the company’s hallmark sauces and ketchups. It also had to put together its own fleet of trucks to ensure on-time deliveries to restaurants in accordance with a strict timetable.

32 PROBLEMS OF ECONOMIC TRANSITION

15. European Commission, New Forms of Innovation, Research and Innovation portal, December 11, 2013; available at http://ec.europa.eu/research/participants/ portal/desktop/en/opportunities/h2020/topics/2470-inso-2-2014.html.

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