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BUSINESS MODEL INNOVATION
Rooted in strategic management research, Business Model Innovation explores the con-
cepts, tools, and techniques that enable organizations to gain and/or maintain a competitive
advantage in the face of technological innovation, globalization, and an increasingly knowl-
edge-intensive economy.
Updated with all-new cases, this second edition of the must-have for those looking to
grasp the fundamentals of business model innovation, explores the novel ways in which an
organization can generate, deliver, and monetize benefits to customers.
Allan Afuah is Professor of Corporate Strategy and International Business at the Ross
School of Business at the University of Michigan, USA. He is a recipient of the 2012 AMR
Best Article Award for his paper, “Crowdsourcing As a Solution to Distant Search.” Since
obtaining his Ph.D. from the Massachusetts Institute of Technology, he has written six books
that have been translated into more than ten languages for innovation courses taught at
undergraduate, graduate, and doctorate levels.
BUSINESS MODEL
INNOVATION
Concepts, Analysis, and Cases
Second Edition
Allan Afuah
Second Edition published 2019
by Routledge
52 Vanderbilt Avenue, New York, NY 10017
and by Routledge
2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2019 Taylor & Francis
The right of Allan Afuah to be identified as author of this work has been asserted by him in accordance
with sections 77 and 78 of the Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by
any electronic, mechanical, or other means, now known or hereafter invented, including photocopying
and recording, or in any information storage or retrieval system, without permission in writing from
the publishers.
Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are
used only for identification and explanation without intent to infringe.
First edition published by Routledge 2014
Library of Congress Cataloging in Publication Data
Names: Afuah, Allan, author.
Title: Business model innovation : concepts, analysis, and cases / Allan
Afuah.
Description: New York, NY : Routledge, 2018. | Earlier edition: 2014.
Identifiers: LCCN 2018019527| ISBN 9781138330511 (hardback) | ISBN
9781138330528 (pbk.)
Subjects: LCSH: Strategic planning--Mathematical models. | Industrial
management--Mathematical models.
Classification: LCC HD30.28 .A3467 2018 | DDC 658.4/012--dc23
LC record available at https://lccn.loc.gov/2018019527
ISBN: 978-1-138-33051-1 (hbk)
ISBN: 978-1-138-33052-8 (pbk)
ISBN: 978-0-429-44648-1 (ebk)
Typeset in 9/13 Interstate Light by
Servis Filmsetting Ltd, Stockport, Cheshire
To every family that has been kind enough to welcome a foreign student to its home.
To my grandmother, Veronica Masang Nkweta and the Bamboutos highlands in
Cameroon which she tilled to feed me, but still often had to stay hungry so that my
uncles and I could have something to eat.
CONTENTS
List of Figures ix
List of Tables x
List of Exhibits xi
Preface xii
Acknowledgments xiv
PART I: INTRODUCTION 1
1 Introduction to Business Model Innovation
3
PART II: ANALYTICAL TECHNIQUES 19
2 Business Model Frameworks 21
3 Business Valuation Techniques: A Strategic Management Approach 41
4 Breakeven Analysis in Strategy and the Margin-SalesRate Matrix (MSM) 53
5 Business Model Appraisal Frameworks 68
Part III: CORE CONCEPTS 83
6 Network Effects and Multisided Platforms 85
7 Crowdsourcing 96
8 Disruptive Innovations and Business Models 108
9 Complementary Assets: A Cornerstone of Profiting from Innovation 117
10 Long Tail Strategies in Business Models 125
Appendices
A Strategy and Business Models 134
B Types of Business Models 147
viii Contents
C Glossary of Business Model Terms 153
D Important Formulae 164
PART IV: CASES 167
Introduction to Case Analysis: A General Manager’s Perspective 169
Case 1: Alibaba in 2018 171
Case 2: Tinder: New CEO, New Reputation? Or Should You
Swipe Left
on Tinder? 184
Case 3: Spotify: Now What? 199
Case 4: Snapchat: Another Overvalued Tech Unicorn? 215
Case 5: Pokémon Go: Way to Go? 229
Case 6: SoFi (Social Finance Inc.) 244
Case 7: Airbnb: Innovation in Hospitality 258
Case 8: Pixar: Changing the Rules of the Game 272
Index xiv
LIST OF FIGURES
1.1: Relationship between strategy, business models, and performance 8
1.2: Analytical techniques for exploring business models 9
2.1: Components of the business model builder (BMB) framework 22
2.2: Airbnb’s business model portrait produced using the BMB 28
2.3: A business model in its coopetitive and macro environments 36
4.1: A business model, strategy, and their environments as drivers of performance 54
4.2: The Margin-SalesRate matrix 62
4.3: Strategic implications of an MSM analysis 63
4.4: A Margin-SalesRate matrix for selected ecommerce businesses 65
4.5: A Margin-SalesRate matrix for Amazon’s businesses in 2017 66
5.1: Components of a VARIM framework 70
9.1: The role of complementary assets in profiting from innovation 118
9.2: Strategies for profiting from an invention 120
10.1: The long tail 126
A.1: Relationship between strategy, business models, and performance 135
LIST OF TABLES
1.1: World’s top five most valuable firms (March 12, 2018) 4
1.2: World’s top six most valuable unicorns (February 26, 2018) 4
2.1: Components of a business model and associated foundational questions 27
2.2: Generic strategies when the goal is to have a competitive advantage 30
2.3: Synthesizing the components of a business model 38
3.1: Amazon and Apple: Expected earnings and revenues to justify their market
valuations (March 12, 2018) 48
3.2: Cisco’s valuation during the dot.com boom and bust 50
5.1: Core questions in a VARIM analysis 71
5.2: Strategic consequences of a VARIM analysis 77
5.3: A VARIM analysis of Uber’s business model 78
5.4: Similarities and differences between the VARIM and VRIO frameworks 80
6.1: Examples of two-sided platforms (networks) 89
8.1: Criteria for determining if a technology will be disruptive 109
8.2: What makes an established technology susceptible to disruption? 110
8.3: Mini mills disrupt integrated steel mills 111
8.4: Innovation outcomes: More than one type of disruption? 113
9.1: Appraising the profitability potential of combining complementary
assets and acquired invention 124
A.1: The evolution of strategic management 141
B.1: Types of business models 148
LIST OF EXHIBITS
1.1: Alibaba income statement highlights 181
1.2: Number of active users and revenue per active user for Alibaba 181
1.3: Gross merchandise value (GMV) for Alibaba 181
3.1: Distribution of owners of Spotify’s ordinary shares at IPO on April, 3, 2018 210
3.2: Spotify’s early funding history 210
3.3: Spotify partial income statement numbers (million €) 211
3.4: Spotify’s operating metrics 211
4.1: Snapchat’s income statement (in million US$) 224
4.2: Snapchat’s quarterly global average daily active users (millions) 225
4.3: Snapchat’s quarterly average daily active users by region (millions) 225
4.4: Snapchat’s quarterly average revenue per user 225
5.1: Percentage of freemium mobile gamers who made in-game purchases
in February 2016, by number of purchases 239
6.1: Student loan market landscape, SoFi loan rates 254
7.1: Airbnb’s funding rounds 268
7.2: How long customers stay/spend at Airbnb versus hotels in different cities 268
7.3: Some interesting Airbnb statistics 269
8.1: An animation movie value chain 278
8.2: Pixar movies at the box office (Gross US sales adjusted for
ticket price inflation) 279
8.3: Top 53 digital animation movies by gross unadjusted theater sales
in the US (March 30, 2018) 279
PREFACE
In the four years since the first edition of this book was published, management scholars
have conducted more research that can help us better understand why business model inno-
vation can be such a powerful driver of profitability and market value. In this second edition,
I draw on that research—and the decades of prior innovation research—to synthesize five
analytical techniques (business model frameworks, business valuation techniques, break-
even analysis, the Margin-SalesRate matrix, and business model appraisal frameworks) and
six digital/sharing economy core concepts (network effects, multisided platforms, crowd-
sourcing, disruptive innovation, long tails, and complementary assets) that can help entre-
preneurs, investors, and managers: (1) perform the analyses to enable them to take more
informed decisions, (2) explain to stakeholders how and why decisions were reached, (3)
lend credibility to decisions and the people behind the decisions, and (4) better explain and
make predictions about organizational actions. The book is also about demonstrating how
these analytical techniques and core concepts can be used to explain and make predictions
about how and why some firms perform better than others—about why, for example, busi-
ness model innovations have contributed massively to the performance of firms in today’s
digital/sharing economy.
Consequently, the book should be valuable to anyone—manager, entrepreneur, investor,
scholar, venture capitalist, policy maker, or specialist—who wants to contribute to the success
of an organization in achieving its goals in today’s digital economy. Thus, the book can be
used to teach senior-level undergraduate or graduate level courses in business, especially
entrepreneurship or strategy. The book can also be used by those managers and investors
that did not take courses which explore the analytical techniques and core concepts of the
book.
What Is Unique About This Second Edition of Business Model
Innovation?
By drawing on comprehensive research by top management scholars in the field, Business
Model Innovation, Second Edition:
Preface xiii
1. Synthesizes the following analytical techniques to help the reader take and defend
more informed decisions, especially in a digital economy:
• Business model frameworks
• Strategy-oriented business valuation techniques
• The Margin-SalesRate matrix
• Business model appraisal frameworks.
2. Provides a comprehensive description of the following core digital economy concepts
that are critical to understanding business model innovation and its contributions to
firm performance in today’s economy:
• Network effects
• Multisided platforms
• Crowdsourcing
• Disruptive innovation
• Long tails
• Complementary assets.
3. Provides an appendix that explains the differences between business models and strat-
egy, and the evolution of the latter.
4. Provides up-to-date cases about firms operating in today’s digital/sharing economy.
5. Offers an introduction to how to analyze cases in courses that take the general manag-
er’s perspective.
6. Provides a glossary of frequently used strategic management terms in a digital/sharing
economy.
ACKNOWLEDGMENTS
I would like to thank the anonymous reviewers of this second edition of Business Model
Innovation for their suggestions and encouragement.
I continue to owe a huge debt of gratitude to my professors and mentors at MIT. They
introduced me to the subject of innovation, and to the virtues of patience and tolerance. I
am forever grateful to them.
Some of my students at the Stephen M. Ross School of Business at the University of
Michigan gave me very useful feedback when I pre-tested the concepts of Business Model
Innovation in the classroom. Some of the cases in Part IV of the book were written by stu-
dents under my supervision.
In particular, I would like to thank Gina McNamara for outstanding research assistance.
Gina co-authored some of the cases in Part IV of the book, and also researched and edited
the other cases.
Special thanks go to Michael and Mary Kay Hallman for the funding that enabled me to
explore the topic of business model innovation with more freedom and dedication.
PART I
INTRODUCTION
Introduction
On March 12, 2018, the world’s top five most valuable firms by market capitalization were
Apple, Alphabet, Amazon, Microsoft, and Facebook, while the world’s top six unicorns—
privately-held startups valued at a billion dollars or more—were Uber, Ant Financial, Didi
Chuxing, Xiami, Airbnb, and Meituan-Dianping (Tables 1.1 and 1.2). Netflix was the only
member of technology’s FAANGs (Facebook, Amazon, Apple, Netflix, and Google) missing
from the list. The combined market value of the top five firms exceeded $3.5 trillion, with the
most valuable of them, Apple, flirting with the $1 trillion valuation dream. Three of the top
five richest people in the world were founders or co-founders of these top firms. Thousands
of managers and other employees from these firms had also become billionaires or million-
aires. Just as interesting, thousands of individuals who invested in these firms made tons
of money. Of course, many startups and established firms did not fare as well as these top
performers, and the millions who invested in the losers lost tons of money.
These fascinating facts about these overachievers raise many interesting questions
for the entrepreneurs and managers whose overarching responsibility is the performance
of their organizations, and for the investors who want to win by investing their money in
future winners. What is it about the business models of these winners—about the activities
that they perform to build and use resources to generate, deliver, and monetize benefits to
customers—that enables them to perform so well? How were the values of these businesses—
especially the values of the unicorns that were still losing money—determined? That is, how
KEY TERMS
• Analytical techniques
• Business model innovation
• Business models
• Core concepts in a digital economy
• Crowdsourcing
• Macro environment
• Monetization
• Multisided platforms
• Network effects
• Strategy
1 Introduction to Business Model
Innovation
4 Part I: Introduction
did “markets” assign monetary amounts to what these organizations are worth? Could these
top performers have been overvalued? Why did their competitors not do as well, and could
the differences in performances have been predicted years earlier? Is offering excellent
products or services enough to guarantee the types of profits that enable firms to command
such high market valuations? What can an underperformer do, if anything, to topple these
overachievers? Do the phenomenal advances in information technology (IT), social media,
communications, globalization, and trade—some of which have inspired or led to the digital/
sharing or social media economy—have anything to do with the superior performance of
these firms?
A fruitful exploration of these questions requires a comprehensive and thorough
understanding of management in today’s economy. In particular, it requires an in-depth
understanding of two management domains. First, it requires comprehension of business
model innovation—comprehension of the building and use of resources to generate, deliver,
and monetize benefits to customers in novel ways. Business model innovation has always
played a critical role in the performance of firms—witness examples from Xerox in its heyday
to Apple, Google, and Facebook today—a role whose significance has increased in today’s
digital/sharing economies. Second, exploring these questions requires an in-depth under-
standing of analytical techniques and core concepts to help entrepreneurs, investors, and
managers (1) perform the relevant analyses to assist them in taking more informed deci-
sions, (2) explain to stakeholders how and why decisions were reached, (3) lend credibility to
decisions and the people behind the decisions, and (4) better explain and make predictions
about organizational performance in today’s economies.
This book is about providing an in-depth knowledge of these two domains—the type of
proficient knowledge that managers, entrepreneurs, and individual investors utilize to make
Table 1.1 World’s top five most valuable firms (March 12, 2018)
Firm Share price (US$) Market value (Capitalization) (US$) P/E
Apple 181.72 922.05B 1 7.78
Alphabet 1,165.93 809.96B 36.32
Amazon 1,598.39 773.79B 349.92
Microsoft 96.77 745.11B 29.64
Facebook 184.76 536.73B 29.99
Source: Daily online stock broadcasts. Retrieved on March 12, 2018.
Table 1.2 World’s top six most valuable unicorns (February 26, 2018)
Unicorn Valuation in 2017 (US$) Total equity funding (US$) Country
Uber 69B 10.7B USA
Ant Financial 60B 4.5B China
Didi Chuxing 56B 17.0B China
Xiaomi 45B 1.1B China
Airbnb 31B 3.4B USA
Meituan-Dianping 30B 8.3B China
Source: Crunchbase Unicorn Leaderboards. Available from https://techcrunch.com/unicorn-leaderboard/. Retrieved
on March 10, 2018.
Introduction to Business Model Innovation 5
informed decisions and, importantly, explain to their stakeholders why and how they arrived
at the decisions. This book is about the analytical techniques and concepts that can be used,
not only to make and defend business model decisions, but also to explain why some busi-
ness models are more profitable than others, or why one should invest in one firm rather
than another. What is business model innovation, and what are these analytical techniques
and core concepts that the book is about?
Business Model Innovation
An organization’s business model is the set of activities that it performs to build and use
resources to generate, deliver, and monetize benefits (embodied in products and services)
to customers.1
That is, a business model is a set of activities for creating and capturing value. Therefore,
a business model innovation is the set of activities for building and using resources to gen-
erate, deliver, and monetize benefits to customers in novel ways.2
It is about creating and capturing value in novel ways. Thus, the innovation in a business
model can be from the novelty in the generation of benefits, delivery of the benefits to
customers, monetization of the benefits and, importantly, in the building and use of the
resources to generate, deliver or monetize benefits to customers. How?
Generation of Benefits
Organizations generate customer benefits by transforming inputs (information, materials,
components, labor, knowhow, land, equipment, capital, and so on) into products, services or
other objects of exchange that embody the benefits.3 The transformation process consists
of performing a sequence of interdependent activities selected to add value at each step—
additions that cumulatively deliver a final product or service that embodies the benefits
that customers demand.4 For example, smartphone manufacturers transform inputs such
as technological knowhow, microchips, touch screens, batteries, microcode, and other com-
ponents into smartphones by pursuing the appropriate R&D, software development, product
design, purchasing, logistics, manufacturing, marketing, sales, distribution, and other val-
ue-adding activities. The cumulative result of the value added by each of these activities to
the inputs results in the smartphone and the customer benefits that it embodies.
Innovation in a business model—when generating customer benefits—can be in the novel
ways in which one or more of these value-adding activities is performed or in the ways in
which the activities interact. For example, one of the innovations in Apple’s iPhone business
model was the crowdsourcing of apps development. That is, rather than developing all the
apps internally or having designated contractors develop them, Apple outsourced develop-
ment in the form of an open call to anyone anywhere in the world that wanted to develop
apps for the phone, with no ex ante contracts on specific apps. The apps from crowdsourcing
significantly increased the value of smartphones to users and the willingness of customers
to pay. The crowdsourcing of apps also changed the rules of the game for app development
in the industry and the role that apps played in the profitability of a firm and, importantly,
the lives of the users of the apps.
6 Part I: Introduction
Walmart’s rise to become the world’s largest company (by sales revenues) has also been
attributed to business model innovation. The company started out in small towns in parts
of southwestern United States and then scaled its activities by building stores in contiguous
towns without leaving “holes” behind for competitors to move in and occupy. According
to former Walmart CEO, David Glass, “We were always pushing from the inside out,” Glass
explained. “We never jump and then backfill.”5
Delivery of Benefits
Business model innovation can also be in the way benefits are delivered to customers. For
example, in the 1990s, Dell very successfully sold its computers directly to end customers
online, changing the rules of the game in an industry where PCs had been sold through
powerful brick-and-mortar distributors. In 2001, when Apple also bypassed distributors to
sell directly to end customers, it changed the rules of the game further by building its own
brick-and-mortar retail stores to sell its own products. Apple’s retail stores would go on
to have the highest sales per square foot of any retailer, for many years. More recently,
startups such as Warby Parker and Hubble Contacts have used direct-to-consumer (DTC)
business models to bypass retailers, stealing market share from incumbents once believed
to be invincible.
Monetization of Benefits
A firm monetizes customer benefits when it converts them into money or other legal tender
whose value is greater than the cost of providing the benefits. Thus, innovation in the mone-
tization of benefits can be in which customers get to pay how much for which benefits, when
and how payments are made, or in reducing the cost of providing benefits to customers.
To monetize its search engine, Google at first rented out the engine to other firms such as
Yahoo. However, it was only after it turned to paid-listing advertising that revenues and
profits took off. An even more captivating example of innovation in monetization comes right
out of the pages of the Xerox 914 photocopier story decades before the birth of Google.6 The
machine was an innovative copier but was going to cost so much, if sold outright, that Xerox
was advised by a reputable consulting firm to shelve the product because of its economics.
Xerox’s management decided not to take the advice and leased out the machine instead of
mothballing it. The machine’s sales and profitability shot through the roof. The subsequent
phenomenal performance of the machine earned Xerox the honor and right for its name to
become a verb—to “Xerox” something, as in to “photocopy” something—much the same as
Google’s search capabilities would, decades later, endow its name with the verb “to Google”
someone or something.
Of course, innovations in monetization are not limited to technology companies like
Xerox and Google. In its agreement to get Euro Disney built in France, Disney decided to be
paid a share of Euro Disney’s revenues rather than a share of profits. This revenue model
insured that Disney would make lots of money from the venture even when the venture
(Euro Disney) lost money.
Introduction to Business Model Innovation 7
Building and Using Resources
To generate, deliver, and monetize benefits to customers, a firm needs resources—it needs
an organization with the right people in the right roles and with the right competences
performing the right activities. These resources include brand equity, culture, data, human
resources, payment systems, personnel, relationships (internal and external), reputation,
trust, and funding, especially for startups. For example, providing customers with conven-
ient, safe, and readily available transportation requires drivers with the skills, trustwor-
thiness, and cars, as well as the right organization to coordinate the activities of these
drivers. Innovation in the building and use of resources can be in using novel coordination
mechanisms, selecting the types of people that have to run such organizations, building and
managing relationships with customers or government regulators, and in the management
of who controls what resources when, and how. It can also be in the way ventures or projects
are funded. For example, rather than turn to family, venture capitalists, or angel investors
to fund its activities, a startup may turn to crowdfunding in which anyone anywhere in the
world can directly invest in the venture. Innovation can also be in novel ways of motivating
employees. For example, Google encouraged its engineers to use 20 percent of their time to
work on projects of their own choosing that they were not officially responsible for.
Delivering the products and services that embody customer benefits requires access to
distribution channels and shelf space, or direct access to the right customers. Thus, innova-
tion here includes a move from owning brick-and-mortar resources to owning virtual (online)
resources. Witness Amazon’s building of virtual resources such as shopping experiences
including virtual shopping carts and so on. Effectively, building resources can range from
hiring the right personnel to acquiring, analyzing, storing, and protecting massive amounts
of data on people, their activities, needs, and wants.
In any case, whether the novelty in a business model innovation is in generating, deliver-
ing, monetizing the benefits to customers, or in building the resources to pursue these activ-
ities, the resulting innovation can make a huge contribution to performance. How much of
a contribution an innovation makes depends very much on the choices that managers make
in deciding which activities the organization performs, why and how it performs them, when
it performs them, where it performs them, how novel the activities should be, who performs
which activities, and how the activities collectively contribute to the organization’s success
in achieving its goals.7 Making these decisions effectively also depends on understanding
the relationship between business models and performance—a crucial relationship that we
now turn to.
Business Models and Performance
Managers and entrepreneurs who have overarching responsibility for the performance of
their organizations are very interested in the relationship between a business model and
its performance. This relationship is presented in Figure 1.1 where an organization’s busi-
ness model activities—the activities that it performs to build and use resources to gener-
ate, deliver, and monetize benefits to customers—determine the benefits perceived by its
customers, the revenues generated by the benefits, the costs incurred, the organizations,
8 Part I: Introduction
assets and liabilities as well as its market valuation. An organization’s business model is, in
turn, driven by its goals, strategy, and environment (Figure 1.1) where a strategy is a plan to
achieve goals in the face of uncertainty, and an environment can be internal or external. An
external environment is made up of the coopetitive (cooperative competitive) and macro
environment, while an internal environment is made up of factors such as culture and inter-
nal events that influence employee behavior. (For more on these important relationships,
see Appendix A of this book.) Because the relationships of Figure 1.1 can be very complex
and yet critical for the thriving or very existence of an organization, making decisions about
which activities to perform, why, how, where, and when to perform them can be full of uncer-
tainty and challenges. Luckily, a thorough understanding of analytical techniques and core
management concepts can reduce these uncertainties and challenges, improving managers’
likelihood of arriving at and defending more informed decisions.8 What are these analytical
techniques and core concepts?
Analytical Techniques
Analytical techniques are powerful tools for zooming in on answers to strategically important
questions—answers that often require combining proven ideas in novel ways and/or using
them in novel ways. For example, by drawing on ideas from economics, Professor Michael
Porter zoomed in on the answer to an important question: What determines the profitability
of an industry? The ideas helped him generate his very popular Five Forces framework—a
model which contends that five competitive forces from suppliers, rivals, buyers, potential
new entrants, and substitutes drive the profitability of an industry and, therefore, the profit-
ability of the firms in the industry.9 The BCG Growth-Share matrix zooms in on the question
of how to allocate scarce resources among different business units, exploiting the idea
that scale drives down costs thereby raising profitability.10 Also called frameworks, models,
matrixes, algorithms, and tools, analytical techniques can be qualitative or quantitative.
Note that although they usually start out addressing one question, good tools often end up
being adopted to solve many other problems. Witness the many uses of Porter’s Five Forces
framework, the BCG Growth-Share matrix, Balanced Scorecard, and others.11
Effectively, good analytical techniques can help managers, entrepreneurs, and potential
investors zoom in on strategically important questions and answers about how a firm’s busi-
ness model activities—together with its strategy and environment—determine the perceived
EnvironmentSTRATEGY
BUSINESS MODEL
Goals
Benefits
perceived by
customers
Share prices
Revenues
Costs
Assets and liabilities
PERFORMANCE
Figure 1.1 Relationship between strategy, business models, and performance
Introduction to Business Model Innovation 9
customer benefits, revenues, costs, market valuation, assets, and liabilities of the business
(Figure 1.2). Five such analytical techniques are: business model builder frameworks, val-
uation techniques, breakeven analysis, the Margin-SalesRate matrix, and business model
appraisal frameworks (Figure 1.2).
Business Model Frameworks
Recall that an organization’s business model is the set of activities that it performs to build
and use resources to generate, deliver, and monetize benefits to customers. A business model
framework is a basic structure that spells out the building blocks (components) for acquiring
and using resources to generate, deliver, and monetize customer benefits.12 Importantly,
it is a shared language that can be used to zoom in on strategically meaningful activities
and their consequences for value creation and capture. Thus, the framework can be used
to develop a new business model or paint a portrait of an existing model. In Chapter 2, we
will explore one such framework. To distinguish it from other business model frameworks
such as the Business Model Canvas, we will call it the business model builder (BMB).13 Made
up of five components—value proposition, market segments, revenue-cost model, growth
model, and capabilities—and the linkages among them, the BMB can be used to explain and
make predictions about how firms generate, deliver, and monetize benefits to customers.
Not only can the BMB be used to paint a portrait of an existing business model or develop
a new model, it can also be used as a starting point for identifying a firm’s strategy and
other drivers of the firm’s performance. Thus, as we will see in Chapter 2, the BMB can help
managers, entrepreneurs, and investors perform the analysis to take more informed and
defendable decisions, paint a portrait of an existing business model, generate a new busi-
ness model, identify a firm’s strategy, and understand the actions of other firms.14 However,
the BMB and other business model frameworks are not equipped to value a business. That is,
the framework cannot be used to place a monetary amount—such as the market valuations
of Tables 1.1 and 1.2—on what a business is worth. Therefore, it cannot be used to determine
Figure 1.2 Analytical techniques for exploring business models
EnvironmentSTRATEGY
BUSINESS MODEL
Goals
Benefits
perceived by
customers
Share prices
Revenues
Costs
Assets and liabilities
PERFORMANCE
Valuation techniques
Business model builder
(BMB) framework
Appraisal model
(VARIM)
Breakeven analysis
Margin-SalesRate matrix (MSM)
10 Part I: Introduction
whether the super performers of Table 1.1, or any other businesses, are overvalued or not.
For that, we turn to business valuation techniques.
Business Valuation Techniques
Business valuation techniques are used by investment bankers, venture capitalists, fund
managers, individual investors, and other stakeholders to place monetary amounts on the
worth of businesses, stocks, bonds, and any other marketable assets. The techniques are
rooted in two core ideas. First, they are rooted in the idea that the value of a business,
stock, bond, or any other asset, is the net present value of all expected future cash inflows,
discounted at the asset’s cost of capital. Thus, estimating the expected cash flows from a
firm—such as the super-performers of Table 1.1—can tell an investor a lot about the monetary
value of the firm, including whether it is overvalued or not. Second, valuation techniques
are rooted in the idea that customers—including the investors who buy into startups such as
the unicorns of Table 1.2—are arbiters of value.15 That is, customers “make the call” when it
comes to placing a monetary amount on what products, stocks, bonds, or any other assets
are worth. A reputable venture capitalist that scrutinizes a startup and pays a certain amount
for it is often the arbiter that makes the call about what the value of the startup should be.
In Chapter 3, I build on these two core valuation ideas to sketch several simple analytical
techniques for valuing a business from a strategic management point of view. Not only can
the techniques be used to understand how businesses such as the unicorns of Tables 1.2 can
be valued, they can also be used to explore the question of whether a firm is overvalued
or not. These valuation techniques depend on the use of numbers such as price/earnings
rations, share prices, earnings, and other numbers that are easily available to the public.
As powerful as valuation techniques can be, they treat a firm as a black box that takes
inputs (investments) and transforms them into earnings or other outputs. They do not look
inside an organization to understand the critical transformation process, and how or why
it can be expected to create and capture the value that can enable it to earn the types of
future cash flows suggested by or assumed in valuations. (As we will see in Chapter 3, one
exception is when investors value a startup in the early stage.) The next three analytical
tools look inside the firm to understand how inputs are transformed into outputs. These
tools are the (1) breakeven analysis, (2) Margin-SalesRate matrix (MSM), and (3) business
model appraisal frameworks such as the Value, Adaptability, Rareness, Imitability, and
Monetization (VARIM) framework.
The Breakeven Analysis and the Margin-SalesRate Matrix (MSM)
A breakeven analysis is a simple but powerful tool that can be used to explore the relation-
ship between the point at which a business stops losing money (and starts making money
from there on), and the prices that it charges, its fixed costs and variable costs. The analysis
gets inside an organization (black box), using profitability-driving numbers—for example,
contribution margins, fixed costs, and sales rate—some of which may not be as readily avail-
able outside the firm as the numbers used in valuation analysis. As we will see in Chapter
4, this simple tool can provide a lot of useful information about a business and a sense
Introduction to Business Model Innovation 11
of its strategic direction. However, taking strategic decisions often requires information
about competitors and potential alliance partners—information that a breakeven analysis
provides very little of. A Margin-SalesRate matrix (MSM)—derived from breakeven analysis
variables—can be used to analyze the profitability of competing firms, products in a firm’s
portfolio of products, operations of the same business in different countries, or different
strategic business units. Managers can use the tool to better anticipate and deal with the
effects of competition and change. Thus, the MSM differs from the growth-share matrix in
that it is more directly focused on profits, competition, and change than the latter—phe-
nomena that are more frequent in an innovative environment such as a digital/sharing
economy.
Like valuation techniques, both the breakeven analysis and the MSM depend on the avail-
ability of reliable profitability numbers to perform dependable analyses. What if a business,
such as a startup, has not yet started generating profitability numbers, or the numbers that
are available are not reliable? Can one still estimate the profitability potential of a business
model without reliable profitability numbers? The answer is “Yes”—using the right business
model appraisal framework.
Business Model Appraisal Frameworks
Business model appraisal frameworks are tools for estimating the profitability potential of
business models. The Value, Adaptability, Rareness, Imitability, and Monetization (VARIM)
framework is a tool for qualitatively estimating the profitability potential of a business
model—that is, a tool for appraising the profitability potential of a business when there are no
reliable numbers to use. As we will see in Chapter 5, managers, entrepreneurs, and investors
can use the VARIM when there are no numbers to use in performing analyses, or when there
are numbers but a manager or investor wants to confirm what the numbers say. (Trust but
verify!) Like the business model builder (BMB) of Chapter 2, the VARIM is a shared language
for zooming in on strategically important questions and ideas. However, and importantly, the
VARIM differs from the BMB and other business model frameworks in that it explicitly incorpo-
rates the role of competition and change in determining the profitability of a firm. Other busi-
ness model frameworks, such as the Business Model Canvas,16 do not explicitly consider the
role of competition and change—two critical components in strategizing, especially in a digital
or sharing economy. Thus, the VARIM can help us explain why one would expect, or not expect,
firms such as the super performers of Table 1.1 to continue to outperform their competitors,
and why. Importantly, because the VARIM is a qualitative framework, it relies a lot more on
management concepts, than the frameworks that are rooted in numbers, to explain and make
predictions about business models. What are these concepts on which the VARIM and other
frameworks rely? We now explore six of these concepts that are crucial in exploring business
model innovation questions, especially in a digital/sharing economy context.
Core Concepts for Business Model Innovation
Management concepts are proven ideas that can be used to explain and make predictions
about relationships and phenomena, or that can be combined to build frameworks such as
12 Part I: Introduction
the ones sketched above. For example, the concept of economies of scale can be used to
explain why firms with large market shares can be expected to have lower per unit costs
than their counterparts with smaller market shares. It can also be used to explain why a firm
with a low-cost strategy would be interested in a large market share. Popular management
concepts include core competences, economies of scale, first-mover advantages, network
ties, open innovation, price elasticity, organizational norms, social capital, social ties, sunk
costs, transformational leadership, and numerous others. Effectively, there are many con-
cepts that can be used to make and defend decisions. However, for making business model
innovation-related decisions—especially in a digital or sharing economy—six core concepts
stand out: Network effects, multisided platforms, crowdsourcing, disruptive innovations,
complementary assets, and long tails. Understanding these concepts can help managers and
entrepreneurs not only to better make, explain, and defend business model innovation deci-
sions in today’s economy, but they can also help management scholars better understand
and explain the outstanding performances of the firms of Tables 1.1 and 1.2 above, and more.
Network Effects and Multisided Platforms
A technology, product, or service exhibits network effects if the more people that use it, the
more valuable that it becomes to each user.17 Facebook’s service exhibits network effects
because the more people that use it, the more valuable it becomes to each user since each
user is now more likely to find the type of person that he or she would like to “friend”
and/or interact with. A multisided platform is a technology, product, or service that enables
two or more groups of users—that perform distinctly different functions—to interact directly
with each other.18 All the firms and unicorns of Tables 1.1 and 1.2 create and capture value
using multisided platforms. For example, Google’s business model is rooted in its multisided
platform of the users who conduct searches (on one side) and the advertisers who value
users’ attention (“eyeballs and ears”) on the other side. Many multisided platforms exhibit
network effects because the more people that there are on side one, the more valuable that
the side becomes to the users on side two and vice versa. Ever since the dot.com boom of
the 1990s, network effects and the derivative concept of winner-takes-all have been used
to explain and make predictions about which firm is likely to perform well and when.19 In
Chapter 6, I explore how and why multisided platforms and network effects can be central to
the competitive advantage of a firm in the digital economy, and why some of the phenome-
nal performances of the firms of Table 1.1 can be explained by the two phenomena.
Crowdsourcing
Another phenomenon that has the potential to help firms better generate, deliver, and
monetize benefits to customers—that may explain some of the performances of Tables 1.1
and 1.2—is crowdsourcing. In crowdsourcing, a firm gets a problem solved by broadcasting
it in the form of an open call to anyone anywhere that wants to self-select and solve the
problem, rather than having someone who has traditionally solved similar problems (such as
a designated contractor or employee) solve the problem.20 For example, rather than create
the videos that run on its channels or contract the task to designated producers, YouTube
Introduction to Business Model Innovation 13
crowdsources the task by letting anyone anywhere in the world who wants to create videos
for the firm self-select and create a video with no ex ante contract for producing the particu-
lar video. Apple’s crowdsourcing of app development—as we saw earlier—is another example.
In Chapter 7, I give crowdsourcing the full attention that it deserves, pointing out the role
that it can play in value creation.
Disruptive Innovations
Another concept that can be useful in explaining and making predictions about firm perfor-
mances is disruptive innovations.21 Many of the super-performers listed in Table 1.1 achieved
their prominence by disrupting established firms, or are in the process of disrupting estab-
lished firms in some industry. For example, Apple is often said to have “disrupted” the “dumb”
phone industry with its iPhone. Microsoft’s Windows operating system played a major role in
the disruption of minicomputers and mainframe computers by the PC. Importantly, history
suggests that these super-performers still run the risk of being disrupted in the future. In
fact, some scholars think that the unicorns of Table 1.2 and many others are in the process of
disrupting many industries. Therefore, in Chapter 8, I examine the opportunities and threats
that disruptive innovations can create for organizations and their business models—I provide
the background information for exploring disruption questions.
Complementary Assets
One interesting, but often ignored observation in the study of disruptive innovations, is that
not all the incumbent firms that are attacked by disruptors fail. Incumbent firms with access
to tightly-held difficult-to-imitate complementary assets often profit from disruptive inno-
vations.22 Complementary assets are the resources needed to commercialize an invention
or discovery.23 They include brands, distribution channels, marketing, manufacturing, shelf
space at stores, and complementary technologies. Complementary assets can be critical
to profiting from an invention. For example, RC Cola invented diet cola but Coke and Pepsi
made most of the money from it because they had the superior brands, shelf space, distri-
bution channels, and other scarce but important complementary assets.24 In Chapter 9, I
examine the role that complementary assets play in the performance of firms in the face of
innovation.
Long Tails
An interesting observation during the dot.com boom came from the business models of two
of the top market cap performers of Table 1.1. Professors Erik Brynjolfsson, Jeffrey Hu, and
Michael Smith observed that a significant portion of Amazon.com’s sales, at the time, came
from obscure book titles that were not found in brick-and-mortar stores, rather than from
the national bestsellers.25 After reading the MIT working paper about this interesting obser-
vation, Chris Anderson also observed that a lot of Google’s revenues at the time came from
the millions of obscure customers who each spent very small amounts of money on adver-
tising rather than from a few very large advertisers each of which spent huge amounts.26
14 Part I: Introduction
These observations led Chris Anderson to use the phrase the long tail in business and wrote
the book explaining the role that long tails or “market niches” can play in business models—
how aggregating the many niches of a market can, in a digital economy, be more lucrative
than focusing on a few larger markets or hits.27 In Chapter 10, I look further into the role that
long tails play in the performance of firms such as the overachievers of Table 1.1.
Relationship Between Business Models and Strategy
Finally, as hinted earlier in this chapter, there is a strong relationship between an organiza-
tion’s business model and its strategy—a relationship that can be crucial to understanding
why some firms attain and maintain a competitive advantage better than others. Because of
the significance of this relationship, I have dedicated Appendix A to it. The appendix also dis-
tinguishes between strategy as an attribute of a firm, and strategy as a discipline or subject
taught in business schools. I clarify the distinction by tracing the evolution of strategy as a
subject taught in business schools. Readers with no prior knowledge of strategy may want
to read Appendix A before proceeding to Chapter 2.
Concluding Remarks
The overarching responsibility of many managers and entrepreneurs is the performance of
their organizations. The analytical techniques and core business model innovation concepts
introduced in this chapter, and to be explored in more detail in later chapters, can help such
managers and entrepreneurs (1) perform the analyses to arrive at more informed decisions,
(2) explain to stakeholders how and why they arrived at decisions, (3) lend credibility to
decisions and the people behind them, and (4) better explain and make predictions about
the performances of firms, especially in a digital or sharing economy. The question is: How?
To see how, consider someone who has just been appointed to a position that is new to
him or her—for example, the position of CEO, member of the board of directors, general
manager, and so on—in which he or she has overarching responsibility for the performance
of the firm (e.g., in early 2018, Uber, SoFi, and numerous others welcomed new CEOs and
other executives). Because the strategic decisions that such an executive takes have a
huge effect on performance, it is crucial that the executive understands the firm’s business
model, strategy, and their impact on performance. Importantly, the resulting impact of any
potential strategic decision on the firm’s performance needs to be examined very carefully.
The following five steps—that are rooted in the analytical techniques and core concepts of
this book—can help the executive with decision-making.
Step 1: Identify the Business Model
Because human beings are cognitively limited, it is not always obvious to everyone what
a firm’s business model really is. That is, the set of activities that a firm performs to build
resources and use them to generate, deliver, and monetize benefits to customers are not
always very obvious to everyone. Thus, the first thing for the new manager to do is to
piece together the firm’s business model. Because business model frameworks are shared
Introduction to Business Model Innovation 15
languages that people can wrap their minds around, they can be used to describe how the
firm builds resources and use them to generate, deliver, and monetize benefits to custom-
ers. Therefore, the first step for a new executive is to use the business model builder (BMB)
framework to piece together the firm’s business model. Chapter 2 is about the BMB and how
to use it to paint a portrait of a business model and more.
Step 2: Identify Strategy
Recall that a strategy is a plan to achieve goals in the face of uncertainty. Because firms
do not always reveal their plans, may not know what their plans are, or may not have any,
a firm’s strategy is not always obvious—not even to all seasoned executives of the same
company. Therefore, the second step for the new manager is to identify his or her firm’s
strategy. Chapter 2 shows how a firm’s strategy can be identified, starting with a portrait of
the firm’s business model (painted using the BMB).
Step 3: Determine Performance
Because the overarching responsibility of the executive is the performance of the firm, the
third step is to determine whether the firm is performing well or not. This is easily and quickly
determined using financial data such as share prices, revenues, profits, assets, liabilities, and
costs, as well as other data such as customer satisfaction and so on.
Step 4: Determine What Drives the Performance
After determining whether a firm is performing well or not, the next step is to determine
what about the business model and strategy makes the firm perform well or not so well.
This is a crucial step. Making the connection from a business model and a strategy to perfor-
mance often involves using core concepts such as network effects and multisided platforms
(Chapter 6), crowdsourcing (Chapter 7), disruptive technologies (Chapter 8), complemen-
tary assets (Chapter 9), and long tail (Chapter 10). Making the connection may also involve
using analytical techniques such as business valuation techniques (Chapter 3), breakeven
frameworks such as the Margin-SalesRate matrix (Chapter 4), and business model appraisal
frameworks such as the VARIM framework (Chapter 5).
Step 5: Brainstorm About the Impact of Decisions on Performance
Before taking strategic decisions, it is crucial for a manager to brainstorm about how
the decision is likely to impact the performance, given the business model, strategy, and,
importantly, how the latter two drive performance. The following sample questions can
guide the brainstorming: Is the decision consistent with what has enabled the firm to
perform so well? Given that the firm’s performance is poor, how can one be sure that the
decision will help improve performance? Depending on the context, many other questions
may need to be examined. Again, the concepts and frameworks of the book are critical to
the brainstorming.
16 Part I: Introduction
Notes
1 See the following for more definitions of business models: Massa, L., Tucci, C., & Afuah, A. (2017).
A critical assessment of business model research. Academy of Management Annals, 11(1), 73–104.
Magretta, J. (2002). Why business models matter. Harvard Business Review, 80(5), 86–92.
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models as models. Long Range Planning, 43(2–3), 156–171. Timmers, P. (1998). Business models for
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2 For more on business model innovation, please see: Amit, R., & Zott, C. (2012). Creating value
through business model innovation. MIT Sloan Management Review, 53(3), 41. Chesbrough, H.
W. (2010). Business model innovation: Opportunities and barriers. Long Range Planning, 43(2–3):
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3 Chesbrough, H. W., & Rosenbloom, R. S. (2002). The role of the business model in capturing value
from innovation: Evidence from Xerox Corporation’s technology spin-off companies. Industrial and
Corporate Change, 11(3), 529–555.
4 Stabell, C. B., & Fjeldstad, O. D. (1998). Configuring value for competitive advantage: On chains,
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5 Ghemawat, P. (1986). Wal-Mart Stores’ Discount Operations. Boston: Harvard Business School
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6 Chesbrough, H. W., & Rosenbloom, R. S. (2002). The role of the business model in capturing value
from innovation: Evidence from Xerox Corporation’s technology spin-off companies. Industrial and
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7 Afuah, A. N. (2004). Business Models: A Strategic Management Approach. New York: McGraw-Hill.
8 McMullen, J. S., & Shepherd, D. A. (2006). Entrepreneurial action and the role of uncertainty in the
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10 Morrison, A., & Wensley, R. (1991). Boxing up or boxed in?: A short history of the Boston Consulting
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11 Kaplan, R. S., & Norton, D. P. (1993). Putting the balanced scorecard to work. Harvard Business
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12 Afuah, A. N. (2004). Business Models: A Strategic Management Approach. New York: McGraw-
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13 Osterwalder, A., & Pigneur, Y. (2010). Business Model Generation. New York: Wiley.
14 See also Osterwalder, A., & Pigneur, Y. (2010). Business Model Generation. New York: Wiley.
15 Priem, R. L. (2007). A consumer perspective on value creation. Academy of Management
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16 Osterwalder, A., & Pigneur, Y. (2010). Business Model Generation. New York: Wiley.
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18 Parker, G. G., & Van Alstyne, M. W. (2005). Two-sided network effects: A theory of information
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19 Eisenmann, T. R., Parker, G., & Alstyne, M. (2006). Strategies for two-sided markets. Harvard
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27 Anderson, C. (2006). The Long Tail: Why the Future of Business Is Selling the Less of More. New
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