The Transformative Business Model

12 September, 2016 / Articles

We usually associate an industry’s transformation with the adoption of a new technology. But although new technologies are often major factors, they have never transformed an industry on their own. What does achieve such a transformation is a business model that can link a new technology to an emerging market need.

MP3 technology is a classic case in point. Early MP3 devices represented an order-of-magnitude increase in capacity over magnetic tapes and CDs: Users could carry thousands of songs on a small device. But MP3 players revolutionized the audio devices market only after Apple coupled the iPod with iTunes in a new business model, swiftly moving music-recording sales from the physical to the virtual world.

What, exactly, enables a business model to deliver on a technology’s potential? To answer that question, we embarked on an in-depth analysis of 40 companies that had launched new business models in a variety of industries. Some succeeded in radically altering their industries; others looked promising but ultimately did not succeed. In this article we present the key takeaways from our research and suggest how they can help innovators transform industries.

How Business Models Work

Definitions of “business model” vary, but most people would agree that it describes how a company creates and captures value. The features of the model define the customer value proposition and the pricing mechanism, indicate how the company will organize itself and whom it will partner with to produce value, and specify how it will structure its supply chain. Basically, a business model is a system whose various features interact, often in complex ways, to determine the company’s success.

In any given industry, a dominant business model tends to emerge over time. In the absence of market distortions, the model will reflect the most efficient way to allocate and organize resources. Most attempts to introduce a new model fail—but occasionally one succeeds in overturning the dominant model, usually by leveraging a new technology. If new entrants use the model to displace incumbents, or if competitors adopt it, then the industry has been transformed.

Consider Airbnb, which upended the hotel industry. Founded in 2008, the company has experienced phenomenal growth: It now has more rooms than either InterContinental Hotels or Hilton Worldwide. As of this writing, Airbnb represents 19.5% of the hotel room supply in New York and operates in 192 countries, in which it accounts for 5.4% of room supply (up from 3.6% in 2015).

The founders of Airbnb realized that platform technology made it feasible to craft an entirely new business model that would challenge the traditional economics of the hotel business. Unlike conventional hotel chains, Airbnb does not own or manage property—it allows users to rent any livable space (from a sofa to a mansion) through an online platform that matches individuals looking for accommodations with home owners willing to share a room or a house. Airbnb manages the platform and takes a percentage of the rent.

Because its income does not depend on owning or managing physical assets, Airbnb needs no large investments to scale up and thus can charge lower prices (usually 30% lower than hotels charge). Moreover, since the home owners are responsible for managing and maintaining the property and any services they may offer, Airbnb’s risks (not to mention operational costs) are much lower than those of traditional hotels. On the customer side, Airbnb’s model redefines the value proposition by offering a more personal service—and a cheaper one.

Before platform technology existed, there was no reason to change the hotel business in any meaningful way. But after its introduction, the dominant business model became vulnerable to attack from anyone who could leverage that technology to create a more compelling value proposition for customers. The new business model serves as the interface between what technology enables and what the marketplace wants.

Let’s look now at what features make a business model transformative.

The Six Keys to Success

We selected the 40 new business models we analyzed on the basis of how many mentions they received in the high-quality, high-circulation business press. All of them seemed to have the potential to transform their industries, but only a subset had succeeded in doing so. We looked for recurring features in the models and found six. No company displayed all of them, but as we shall see, a higher number of these features usually correlated with a higher chance of success at transformation.

The science man and innovator, Fernando Fischmann, founder of Crystal Lagoons, recommends this article.

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