Knowledge January 2012 | 111

Solutions

Business Model
Innovation
By Olivier Serrat

Sri Kalika Devi

Almost 80 years ago, Joseph Schumpeter,1 the prophet of
innovation, distinguished five types: (i) a new good, (ii) a new
method of production, (iii) a new market, (iv) a new source of
Who is your supply of raw materials, and (v) (the carrying out of) a new
customer? What does organization of any industry (or market). Regrettably, the
the customer value? body of knowledge he engendered then lay dormant until the
end of the 20th century, with precious few other insights.2 In
How do you deliver
modern parlance, the five cases were reinterpreted as product,
value to customers at process, market, input, and organizational innovations;
an appropriate cost? references to a sixth, innovation in services—a sector that did
Business models that not exist in Joseph Schumpeter’s time—began to show up in the mid-1990s.3
focus on the who, So far, so (relatively) still: right
what, and how to You may not be interested in strategy, but until the inception of the online era,
clarify managerial strategy is interested in you. pretty much everyone played by the
choices and their —Apocryphal same, slowly evolving rules. However,
consequences in the wake of the continuing internet
underpin the
operations
1
Joseph Schumpeter (1883–1950), an Austro-American economist and political scientist, held that capitalism
can only be understood as an evolutionary process of innovation, the unremitting nature of which wreaks
of successful creative destruction in waves favoring those who grasp discontinuities faster. He hypothesized that instability
organizations. brought about by entrepreneurs, rather than equilibrium and optimization, is the norm of a healthy economy
and the central reality for economic theory and practice. See Joseph Schumpeter. 1934. The Theory of Economic
Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. Oxford University Press.
On the process of creative destruction, with which his name is interchangeably associated, he presciently
remarked that “… the problem that is usually being visualized is how capitalism administers existing structures,
whereas the relevant problem is how it creates and destroys them.” See Joseph Schumpeter. 1942. Capitalism,
Socialism, and Democracy. Harper and Brothers.

2
Notwithstanding, Peter Drucker was, 50 years later, the first to champion innovation and entrepreneurship as a
purposeful and systematic discipline. Helpfully, he identified seven sources of innovation: the first four lie within
the enterprise; the others originate outside it. They are (i) the unexpected—the unexpected success, failure, or
outside event; (ii) incongruities—discrepancies or dissonance between what is and what is assumed or “ought
to be;” (iii) process needs; and (iv) changes in industry (or market) structure that catch everyone unawares; (v)
demographics; (vi) changes in perception, mood, and meaning; and (vii) new knowledge, both scientific and
nonscientific. See Peter Drucker. 1985. Innovation and Entrepreneurship: Practice and Principles. HarperCollins
Publishers. Elsewhere, theoretical enhancements cast a barren light on professed levels of innovation intensity:
(i) incremental—innovation as improvement, (ii) radical (next generation)—innovation as change, and (iii)
systemic (breakthrough)—innovation as revolution.

3
A familiar definition of innovation transpires from this: innovation is the successful exploitation of new ideas.
Then again, if it is deemed a competence and not just a process, innovation is the ability to deliver new value to
clients, audiences, and partners.
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Solutions

revolution—notwithstanding the dot.com fiascos of 1995–20004—business model innovation is the rage.5 (This
kind of innovation is often more valuable and transformative than the other types: it reduces risks and, conversely,
allows more risks to be taken. It has also, perforce, encouraged organizational innovation; for instance,
internet-sped innovative processes and structures include
peer-to-peer and open-source organization,6 collaborative The real voyage of discovery consists not in
mechanisms that would have been inconceivable to our seeking new landscapes but in having new
parents, let alone Joseph Schumpeter.) In the globalized eyes.
economy, not forgetting that about 2.5 billion people —Marcel Proust
live on less than $2 a day, the growing significance of
business models is a logical reaction to excessive choices and associated competition from deregulation and
technological change.7 Undeniably, certainly for customers and organizations alike in high-income economies
and increasingly elsewhere too, distinguishing between many products and services on a purely functional basis
is not easy.8 In 2005, drawing from a survey of more than 4,000 senior executives and two dozen interviews
with corporate decision makers in 23 countries in Europe, the Asia and Pacific region, and the Americas, the
Economist Intelligence Unit urged organizations to revisit their business models, regularly.9

The Theory of the Business

The concept of value and the differentiation10 it rests on are integral to business (and much else). For consumption
or use, every organization strives to sell products and
If life—the craving for which is the very services that customers value.11 To a customer, value added
essence of our being—were possessed of any that satisfies tangible needs and intangible wants, and
positive intrinsic value, there would be no embodies concepts such as brand equity, is what he or she
such thing as boredom at all: mere existence expects from a purchase. The notional value derived from a
would satisfy us in itself, and we should want purchase will abstract what costs—both actual (monetary)
for nothing. and circumstantial (convenience, time, etc.)—a transaction
—Arthur Schopenhauer entailed.12

4
At the time, the concept of business models was just about synonymous with e-business—the use of information systems and technology
to manage administration and financial systems, including human resources, as well as external processes such as marketing and sales,
supply of goods and services, and customer relationships. (Successful e-business models introduced novelty, created efficiencies compared
with existing ways of doing business, forged complementarities, and enabled the lock-in of customers.) Alas, web-based business models
that promised wild profits did much to misrepresent the concept and undermine its intrinsic usefulness. Nevertheless, the experience
concentrated attention on (possibly different) ways of doing business and, much as the notion of intellectual capital did from the mid-
1990s, on nonfinancial value drivers in organizations.
5
Tellingly, The Economist launched in 2009 a new column titled Schumpeter to champion the role of innovation and entrepreneurship in
modern business and management.
6
The features these working arrangements share are self-governance, adaptive network interaction, and openness to any person who has
something to contribute.
7
The rise of new technology-based and low-cost rivals is challenging established players, reshaping industries (or markets), and redistributing
profits. This said, exacerbated by economic stagnation in the West, the pressure to penetrate emerging economies and developing countries
is driving business model innovation worldwide.
8
Of course, products and services matter: however, they are vulnerable to replication and therefore cannot offer durable competitive
advantage.
9
The Economist. 2005. Business 2010: Embracing the Challenge of Change. Economist Intelligence Unit. In the private sector, 55% of the
executives surveyed declared new business models would be a greater source of competitive advantage than new products and services
by 2010. In the public sector, 54% of the executives who responded thought success in 2010 would hinge more on the ability to innovate
with delivery channels than with services themselves. (Pursuant to the global financial crisis of 2007–2008, many public sector agencies
are in any case cutting services as they struggle to cope with the aftermath of the recession.) In declining order of complexity and degree
of change, options for alternative delivery channels include strategic partnerships, joint ventures, outsourcing, shared services, and lead
authority models.
10
Differentiation, the result of efforts to make a product or service stand out as a provider of unique value to customers vis-à-vis competitors,
is the wellspring of competitive advantage. Nonperformers focus on obstacles; performers focus on results: the sharper the differentiation,
the bigger the advantage. Chris Zook and James Allen mapped three major clusters, all of which wear with age, that high-performance
organizations relentlessly build day in day out, usually maximizing customer feedback in virtuous cycles; they are management systems,
operating capabilities, and proprietary assets. Chris Zook and James Allen. 2011. The Great Repeatable Business Model. Harvard Business
Review. November. pp. 107–114.
11
Value is created by solving a problem, upgrading performance, or reducing risk and cost.
12
In short, Value = Benefits − Costs.

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 Business Model Innovation

It follows that the notion of value should dominate any discussion of business models; sorry to say, this is
not always the case. What is more, as befits a rapidly evolving field, there is no generally accepted definition of
what a business model is: literature offers generic, broad, or
Price is what you pay. Value is what you get. narrow typologies that singly or jointly provide incomplete
—Warren Buffett and confusing pictures of the perspectives, dimensions,
and core issues of the business model concept depending
on the lens used. This ought to matter: after all, if having a good business model is an important goal for
organizations, they need a simple, logical, measurable, comprehensive, operational, and meaningful definition
to plan, monitor, and evaluate deliverables. (However, most
organizations can find it difficult to describe their business Markets are designed to allow individuals to
model in 25 words or less, let alone explain how it is used look after their private needs and to pursue
to reach decisions.) A business model is not an explanation profit. It’s really a great invention and I
of how a company hopes to make money; it is not strategy wouldn’t underestimate the value of that, but
either.13 A business model is the core design,14 the logic, they’re not designed to take care of social
that enables an organization to capture, create, and deliver needs.
value to meet explicit or latent needs (and in so doing, of —George Soros
course, derive some form of profit itself).15 (Most likely, the
handiest metaphor would embody characteristics of an organization’s way of thinking, operational system, and
capacity to generate value.) The best customer value proposition is the viable set of means and ends—at their
simplest, resources and processes driven by a formula—that does just that.16 A proposition that is clear, focused,
and consistent—no mean feat—is astonishingly powerful:
We don’t ask consumers what they want. business model innovation in one or more areas of the
They don’t know. Instead, we apply our brain customer value proposition can forge a stronger theory of
power to what they need, and will want, and the business to enhance, at least for a while,17
an archetypal
make sure we’re there, ready. large organization’s business structure, organization, supply
—Akio Morita chain, products and services, customer service, customer
experience, and administration.

13
A strategy is a long-term plan of action designed to achieve a particular goal. With respect to business models, it would be the contingent
plan to create a unique and valuable position involving a distinctive set of activities, of which business processes and organizational design
would be ingredients. (While every organization has some form of business model, not every organization has a strategy.)
14
Design thinking is a compelling process for exploring new ideas: a good business model will be concise yet complete in every important
respect. (Each element or building block will have been carefully thought through and individually crafted, yet with an eye to the sum of
synergizing parts.)
15
More philosophically—but not less pertinently—business models have been described as stories that explain how organizations work, in
short, the theory of the business. See Peter Drucker. 1994. The Theory of the Business. Harvard Business Review. September–October. pp.
95–104. Paraphrasing, a theory of the business has three parts: (i) assumptions about the environment of the organization—society and its
structure, the market, the customer, and technology; (ii) assumptions about the specific mission of the organization; and (iii) assumptions
about the core competencies needed to accomplish the organization’s mission. The specifications for a valid theory of the business are that
(i) the assumptions about environment, mission, and core competencies must fit reality; (ii) the assumptions in all three areas have to fit one
another; (iii) the theory of the business must be known and understood throughout the organization; and (iv) the theory of the business
has to be tested constantly.
16
Even if it is only implicit, all organizations operate by way of a business model. (The days of those that do not are now short.) For example,
government agencies may depend on fees, service revenues, or taxes but they are still held accountable for meeting public needs.
Nongovernment organizations may not provide a financial return to investors or owners but they must still deliver value if they are to attract
donations, grants, or membership dues. Social enterprises may be mission-driven but must still know how to scale their activities.
17
Inevitably, every theory of the business—even the soundest—will become obsolete then invalid because the environment of organizations
changes constantly. Paraphrasing Peter Drucker further, preventive care, early diagnosis, and cure can help keep to a tolerable level the pain
of bringing an organization’s behavior in line with the new realities of its environment, with a new definition of its mission, and with new
core competencies to be acquired or developed.

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Table 1: 37 Possible Innovation Targets

Business Organization Supply Chain Products and Customer Customer Administration
Structure Services Service Experience

Product Offering
Structure Type
Brand and
Product
Image
Availability
Manufacturing Information
Decision-Making Stocks and Flows
Process Technology
Capital (Evident) Communication
Formation

Process to Technology
Improve (Hidden)
Advertising
Processes
Research and
Development
Facilities
Infrastructure Manufacturing
Manufacturing
Communication Automation
Sales Model Communication
Facilities
Process
Effectiveness
Distribution

Information User Interface

Technology
Infratructure
Packaging
Feedback
Alliances
Emplyee and Functionality Service Process
Contractor Mix
Distribution Insourcing and
System Lifestyle Model Outsourcing of
Services
Employee
Sustainability Customer
Experience
Relationship
Management
After-Sales
Service

Source: Adapted from Langdon Morris. 2003. Business Model Warfare: The Strategy of Business Breakthroughs. InnovationLabs.
Available: www.innovationlabs.com/busmodelwarfare.pdf

There’s a Better Way to Do It—Find It!

Competitive advantage can only be achieved by delivering
unique products and services for which customers are willing It is difficult to get a man to understand
to pay a premium. To be able to perform at a higher level something, when his salary depends upon his
than others in the same industry (or market), organizations not understanding it!
must make choices that optimize their business ecosystem. —Upton Sinclair
Joan Magretta thinks their choices must meet two critical
tests: the narrative test (the story must make sense), and the numbers test (the profit and loss statement must
add up).18 Across the private and public sectors, there is no single business model as the next figure illustrates.
(Organizations that deliver the same product or service can have quite different business models, their relative
success hinging on how well they meet customer expectations.) While sundry approaches to fitting systems
into a working whole exist, as a select list of currently
You can’t do today’s job with yesterday’s prominent publications on key elements of a business model
methods and be in business tomorrow. demontrates, most pay attention to five interrelated elements:
—Anonymous (i) markets, (ii) products and services, (iii) processes, (iv)

Joan Magretta. 2002. Why Business Models Matter. Harvard Business Review. May. pp. 3–8.
18

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people,19 and (v) economics. Notwithstanding the respective

strengths and weaknesses of approaches to the subject, the In the end, an organization is nothing more
greatest benefits will be reaped when organizations prepare than the collective capacity of its people to
for a successful business model design project, research and create value.
analyze the elements needed for the effort, generate and test —Lou Gerstner
viable options and select the best, implement the prototype
in the field, and continually adapt and modify the business model in response to industry (or market) reaction.

Figure: Examples of Business Models

Auction Bait and Hook Bricks and Clicks Bricks and Mortar Chemical Leasing

Collective Direct Sales Disintermedition Fee In Fee Out Franchise

Freemium Industrialization Low-Cost Carrier Loyalty Monopoly

of Services

Multi-Level Network Effects Online Content Online Delivery Open Source

Marketing

Service Servilization of Subscription Traffic and Other Business

Products Advertising Models

Source: Author.

If you don’t do it excellently, don’t do it at all. Because if it’s not excellent it won’t be
profitable or fun, and if you’re not in business for fun or profit, what the hell are you
doing here?
—Robert Townsend

Most approaches have strengths but most also fall short of a necessary and sufficient accent on people. Configurations of organizations
19

vary—and will undoubtedly change further in the future—but it is generally accepted that an organization’s personnel plays a vital role in its
business: individually and collectively, what personnel contributes, looks to get in return, and wants to achieve conditions an organization’s
ability to capture, create, and deliver value. To engage personnel, the business model that an organization uses to describe, reflect on, and
enrich its customer value proposition should therefore be used as the basis for communication and motivation.

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Table 2: Key Elements of a Business Model

Chesbrougha Hamelb Johnsonc Mullins and Osterwalder and Skarzynski and

Komisard Pigneure Gibsonf

Customer
Value Segments
Revenue Who Do We
Proposition Core Strategy Customer Value Serve?
Proposition Model
Value
Proposition

Market Segment
Gross Channels
What Do We
Margin Provide?
Strategic Profit Model
Resources Customer
Formulas
Relationships
Value Chain
Revenue How Do We
Operating
Streams Provide It?
Model
Cost Structure
and Target Key
Customer Key
Margins Resources
Interface Resources
Working
How Do We
Capital Key Make Money?
Model Activities
Value Networks

Key
Partnerships How Do We
Value Key Investment Differentiate
Competetive Network Process Model and Sustain
Strategy Cost an Advantage?
Structures

a
Henry Chesbrough. 2003. Open Innovation: The New Imperative for Creating and Profiting from Technology. Harvard Business
School Press.
b
Gary Hamel. 2002. Leading the Revolution: How to Thrive in Turbulent Times by Making Innovation a Way of Life. Harvard Business
School Press.
c
Mark Johnson. 2010. Seizing the White Space: Business Model Innovation for Growth and Renewal. Harvard Business School
Press.
d
John Mullins and Randy Komisar. 2009. Getting to Plan B: Breaking Through to a Better Business Model. Harvard Business School
Press.
e
Alexander Osterwalder and Yves Pigneur. 2010. Business Model Generation: A Handbook for Visionaries, Game Changers, and
Challengers. Wiley.

f
Peter Skarzynski and Rowan Gibson. 2008. Innovation to the Core: A Blueprint for Transforming the Way Your Company Innovates.
Harvard Business School Press.
Source: Author.

To say the least, public sector organizations have their work cut out as well. In the words of Gus O’Donnell,
“[they are] … too inclined to settle for the legacy structures and systems [they] inherit[ed] from the past, and
not good enough at going through a design process that selects and tailors delivery systems that are capable
of delivering the required outcome, drawing on a repertoire of approaches to structure, incentives, delivery,
relationships, governance, and so on …”20 (The context of Gus O’Donnell’s remarks was the program of
capability reviews that the Government of the United Kingdom launched in 2006 for all central government
departments. To all but the hard of hearing, it rings a familiar bell elsewhere.) Apart from the kind of return—
with financial profit making up the larger distinction—there are no reasons public sector organizations should
reap smaller rewards from good business models compared to the private sector.21 Public sector organizations

20
Andy Neely and Rick Delbridge. 2007. Effective Business Models: What Do They Mean for Whitehall? Sunningdale Institute. Available: www.
nationalschool.gov.uk/downloads/effectivebusinessmodels.pdf
21
To begin, however, they need to edify their understanding of what a business model constitutes: too often, public sector organizations
consider business models merely in terms of resources, key result areas, and outputs.

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deal with the allocation, production, and delivery of basic public goods and services at the local, national,
regional, or global level. For sure, considerable complexity is added by the political context within which they
operate, the heterogeneous nature of most of them, and the resulting slower rate of structural change. Therefore,
the value of business models would lie particularly in terms of their ability to help these organizations articulate
clearly what they will do and, by the same token, what they will not do. Among others, they can also gauge
the coherence between an organization's strategic agenda and public needs, help match public needs to an
organization's business processes, make obvious the financial implications of an organization's delivery chain,
support diagnoses of the need for change and ways that might be achieved, and facilitate communication within
an organization and both to and from it.

Further Reading
ADB. 2009a. Value Cycles for Development Outcomes. Manila. Available: www.adb.org/documents/
information/knowledge-solutions/value-cycles-for-development-outcomes.pdf
―――. 2009b. Harnessing Creativity and Innovation in the Workplace. Manila. Available: www.adb.org/
documents/information/knowledge-solutions/harnessing-creativity-and-innovation-in-the-workplace.pdf
―――. 2010a. Sparking Innovations in Management. Manila. Available: www.adb.org/documents/information/
knowledge-solutions/sparking-innovations-in-management.pdf
―――. 2010b. Design Thinking. Manila. Available: www.adb.org/documents/information/knowledge-
solutions/design-thinking.pdf
―――. 2011. A Primer on Intellectual Capital. Manila. Available: www.adb.org/documents/information/
knowledge-solutions/primer-intellectual-capital.pdf
Alexander Osterwalder and Yves Pigneur. 2010. Business Model Generation: A Handbook for Visionaries,
Game Changers, and Challengers. Wiley.

For further information.

Contact Olivier Serrat, Head of the Knowledge Management Center, Regional and Sustainable Development Department,
Asian Development Bank (oserrat@adb.org).

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Asian Development Bank

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