Excursion 7

Business models are systems

If you have worked with business models before, you have probably realized that they are systems. In other words, business models require two levels of thinking and analysis. At the lower level, business models incorporate organizational elements, such as activities, resources, processes, and so on. At the higher level, business models describe how all those elements work together to create and capture value.

The most common flaw in business model analysis is developing the lower level elements without thinking about how the system of elements works. Entrepreneurs and managers often complete a business model canvas or map with care and thought, developing detailed explanations of each of the organizational elements. But they commonly fail to think about how the elements work together. Are the elements complementary or constraining? Do the elements generate synergy or conflict? Do they enable or inhibit value creation?

Business model coherence is not obvious or simple

In Chapter 8, we’ll discuss the role of “coherence” in building a business model narrative. For now, you can just think of coherence as how all the elements of a business model work together.

The key problem with business model coherence is that, despite appearances, it is neither obvious nor simple. Coherence is, arguably, the critical characteristic of viable business models. Extensive research on strategy has shown the importance of synergy or “resource complementarity.” Some resources generate more value combined than the sum of their separate value. Coherence is both more complex and more subtle. It refers to heterogeneous organizational elements, not just resources. Rather than perfect synergy, coherence only requires that elements combine into a unified configuration.

There are two key lessons from this. First, a single valuable resource (or capability or transaction process), on its own, is unlikely to generate a sustainable business model. If the other business model elements do not fit well or suggest conflicts, the model is likely too flawed to exploit that key resource. On the other hand, seemingly “perfect” configurations are probably illusory as well. This can easily be seen in the business models of many low-cost competitors. Even though the company competes primarily on cost, the business model is likely to show organizational elements where significant, differentiated investment is needed.

Consider WalMart’s investment in distribution systems and electronic tracking for returns or Southwest Airlines investment in human resources and training. If successful strategies or business models require perfect consistency, then it would be difficult to justify these investments by companies that focus on low costs. In reality, investing in and maintaining these systems help companies like WalMart and Southwest retain their cost advantage, because they effectively prevent or reduce related costs, such as the cost of product returns or lost luggage.

Currently, there is no systematic tool to measure business model coherence. Later in the book we’ll look at an example from research, but even that tool is barely a prototype. Right now, the best guide for evaluating business model coherence is probably the combined wisdom from smart people with industry-specific experience.