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Georg Stampfl, Zeppelin U., [email protected] Reinhard Prügl, Zeppelin U., [email protected]

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BUSINESS MODELS IN CONTEXT: CONCEPTUALIZING THE ENVIRONMENT OF BUSINESS MODELS Abstract

While prior research has contributed important insights on business models and business model design and innovation, two important aspects have been rather neglected thus far: Most of the studies see business models (1) as isolated constructs, not taking into account external factors potentially influencing a business model, i.e. not considering the interactions between a business model and its environment, (2) as rather static, not stressing the importance of re-configuring business models according to contextual changes, in order to secure survival and growth of companies. Given the vital importance of business model adaption and innovation for the survival and growth of companies, it is rather surprising that there has been hardly any research devoted to environments of business models. Several valuable concepts have been developed recently to describe and analyze the “inner context”, i.e. the business model itself; however, to the best of our knowledge, a concept to specify the environmental context of a business model is missing. Therefore, in this paper we take on this endeavor. To shed some light on the environment of business models, we conducted a review of the literature on different perspectives of business environments, conducted and analyzed interviews with leading experts on these issues, developed a business model environment framework, outlined business model innovation opportunities on the interface between a business model and its context as well as offering opportunities for further research hoping to spur further research in this thus far basically neglected stream. . Keywords: Business Model Innovation, Environment, Strategy

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INTRODUCTION In the 21st century, shorter product or design life-cycles, intra-industry competition (e.g., Apple’s iPad puts all kind of display devices, netbooks, PCs, and music players under pressure, but also increases competition for classic photo printing services – “pixel instead of paper”) and disruptions from new business models that offer whole customer experiences instead of simply products have lead to a dramatically increased pace of change (e.g., McGrath, 2011). Many micro and macro trends, such as globalization of markets, increased competition, rapid technological change (e.g., in information technology), increasing customer sophistication, changing demographics, new forms of employment, increasing rate of accumulation of knowledge, or changing societal norms have been identified as catalysts for ongoing transformation processes (e.g., Djelic & Ainamo, 1999; Volberda, 1998). In those times when an industry sees dramatic changes, many companies are confronted with increasingly turbulent, ambiguous, and highly competitive environmental conditions. Volberda (1998) identifies “hypercompetition” as a phenomenon that can be found in many industries and is characterized by companies increasingly converging through partnerships and networks as well as long-standing industry boundaries that are blurring and collapsing (Illinitch, D'Aveni, & Lewin, 1996; Smith & Zeihami, 1996). Gassmann (2007) sees industry reconfiguration as a central trend being on the way: industry boundaries are starting to blur, reorganization of whole industries on a large scale has to be expected. Petrol stations are an excellent example of this transformation process. They have developed from a mere fuel reseller to a 24-hour supermarket. New developments in technology give rise to completely new industries. For instance, the convergence of computer technology, telephone and Internet has led to the emergence of a completely new industry branch, namely the multimedia business. Another example of permeable industry boundaries is reflected in Apple’s business activities – personal 2

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computers (Mac), music player (iPod) and music services (iTunes), mobile phones (iPhone), and television (Apple TV) are increasingly converging into just one new big business by taking advantage of development of new multifunctional devices, such as smartphones or the iPad. An additional impetus for the increasing challenge of defining specific industries relies on a change of the way companies now make money. Teece (2010) identifies driving factors such as the emerging knowledge economy, the growth of the Internet, the outsourcing and offshoring of many business activities, and the restructuring of the financial service industry that lead to the development of new business models. Given the vital performance of business model innovation for the survival and growth of companies, it is surprising that academic research, with a few exceptions, has so far devoted little attention to environments of business models. Several highly valuable concepts have been developed to describe and analyze the “inner context”, i.e. the business model itself; however, to the best of our knowledge, a concept to specify the environment surrounding a business model is missing. In this paper, we, therefore, address the following research questions: (1) Which dimensions build the context of a business model, especially in times of disappearing industrial boundaries? (2) Which central environmental factors strongly influence the architecture of a business model, and how (on which dimensions) does the business model mainly interact with its environment? To answer these questions, we conducted a review of the literature on different perspectives of business environments, conducted interviews with leading experts on these issues, developed a business model environment framework and outlined business model innovation opportunities on the interface between a business model and its context.

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BACKGROUND In Need of New Business Models... Researchers argue that flexible organizational solutions are necessary in order to adapt to changing environmental conditions (Lewin & Stephens, 1993; March, 1981; Volberda, 1996). The dominant paradigm of sustainable competitive advantage is already being challenged increasingly. Transformation processes in the world’s economies call for new ways to create value. The limits of traditional organizational structures and strategies are disclosed (e.g., Djelic & Ainamo, 1999). Companies no longer have the chance of relying on a given competitive advantage during rather stable periods, but as Volberda (1996) puts it, “in the new mode of hypercompetition, […] rents do not derive from specialized routines but from adaptive capability” (Volberda, 1996: 360). Teece, Pisano, and Shuen (1997) share this view, as they argue that regimes of rapid change demand an “ability to achieve new and innovative forms of competition” (1997: 516) – also referred to as “dynamic capabilities” by the authors. In a later study Teece (2007) disaggregates these capabilities into the capacity to recognize and shape opportunities and threats, to seize opportunities, and to maintain competitiveness by reconfiguring the company. These capabilities also embrace the ability to adapt to a changing ecosystem and to design and implement viable business models: “The capacity an enterprise has to create, adjust, hone, and, if necessary, replace business models is foundational to dynamic capabilities” (Teece, 2007: 1330). Consequently, a firm’s survival and growth increasingly depends on organizational issues such as the design of new and viable business models fitting their environmental conditions (e.g., Markides, 2008; Voelpel, Leibold & Tekie, 2004).

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… Meeting Contextual Characteristics Structural changes within entire industries or the emergence of new industries create threats, but innovation opportunities as well. Thus, if companies do not react to changes in their environment, they are likely to fail (Tucker, 2001). The music industry is a perfect example of how environments change and consequently find themselves in need of new business models. The Internet enabled consumers to (illegally) download copies of their favorite commercial copyrighted recordings. Online platforms such as YouTube allow people to access music for free from anywhere in the world, anytime. However, the Internet is also a new distribution channel that enables downloads of digital music to compete with traditional (i.e. physical) product sales. In 2008, the online music store “iTunes” made Apple the biggest music retailer in the U.S.1 The convergence of industries (i.e. entertainment and mobile communications) is beautifully depicted by the current boom of so called “smartphones”: By combining the functions of a traditional mobile phone with those of a photo and video camera, a MP3 player, a personal computer and a personal digital assistant (PDA), different industries meet on one small handset. The need for a continuous business model innovation process has been identified, because new market conditions simply frequently require new business models that account for the altered context (Mitchell & Bruckner-Coles, 2004). Companies that blindly continue to rely solely on what has always worked for them in the past, without considering the dynamics of the competitive environment, can often be rudely awakened by a reduction in their market share. In other words, the business model must match ever changing environmental conditions. The influence of the external environment on the business model has quite recently been recognized in the literature: Zott and Amit (2007) see environmental conditions as an important moderator of the relationship between business model design and the performance of a company. 1

According to NPD MusicWatch Survey, January 2008

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In a similar vein, Demil and Lecocq (2010) underscore that the environment has the potential to influence the core components of a business model. Consequently, the specific components of a business model must be designed with reference to the environment of the business model (Teece 2010). In transforming conditions, business models are far from being stable. In fact they are provisional in the sense that, as parts of the business model (or even the whole business model) they might be replaced by new parts (or models), which better fit the altered external environment (Shirky 2008). In this context, the business model has three functions: find a business model, test it, and adapt it to its environment. By anticipating, mirroring and adopting future trends in the business model, a company should be able to differentiate itself effectively from competition through a unique way of adding value for the customer. If the company succeeds in developing a differentiated, effective, and efficient business model, this can be a pathway to a major competitive advantage. As the company must continuously monitor if the business model still fits the respective environment (Morris, Schindehutte, & Allen, 2005), the question is raised as to which dimensions build the context of a business model? What factors influence a business model, and on which dimensions does the business model interact with its environment?

Scanning the Environment of Business Models In the literature, scanning the environment is described as an important process of strategic management: “scanning is the first link in the chain of perceptions and actions that permit an organization to adapt to its environment” (Jennings & Lumpkin, 1992: 791). In a similar vein, Hambrick (1982) sees environmental scanning as a key step towards organizational adaption. The business environment has been identified as an important contingency for 6

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competitive strategy and supply chain management (Chi, Kilduff & Gargeya, 2009). In strategic management, the importance of a structured approach for monitoring a firm’s environment has been recognized, and, consequently, organizations scan their environment to understand external forces of change (Hagen, Haile & Maghrabi, 2003).

The literature on environmental scanning defines the latter as the analysis of “information about every sector of the external environment that can help management to plan for the organization’s future. Scanning covers not only competitors, suppliers and customers, but also includes technology, economic conditions, political and regulatory environment, and social and demographic trends” (Choo, 1999: 21).

Environmental scanning plays an important role in strategy development and also influences corporate performance: Murphay, Smith, and Daley (1992) observed that firms involved in environmental scanning activities were significantly larger and more profitable than non-scanning firms. These findings are consistent with the results of a study from Subramanian, Fernandes, and Harper (1993), indicating a strong relationship between the performance of a firm (in terms of profitability and growth) and the existence of scanning systems. Environmental scanning can be conceived of as a key step in achieving alignment between a firm’s strategy and its outside environment (e.g., Beal, 2000; Hagen et al., 2003). Taking up the notion outlined above, that the selection or configuration of a powerful business model is a major task of strategy work, it seems obvious that environmental scanning is a prerequisite for anticipating changes in the environment in the business model. Organizations thus seem to benefit from scanning the environment of a business model. They can identify or

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clarify the external forces of change that influence it, and thereby develop adjustments or reconfigurations for the existing business model needed to secure or improve performance.

As Hagen et al. (2003) outline, profound environmental analysis is not only about gathering information about the environment, but also classifying the significance for the organization, monitoring high priority issues and forecasting future developments. As remarked by Smircich and Stubbart (1985), strategists must be able to “access, organize and evaluate data without mistakes. Strategists overcome the problem of deciding what information is worth bothering about by using frameworks or lists” (1985: 725). Consequently, a first step towards a framework for the analysis of environmental factors that significantly affect a firm’s business model seems to be a good starting point..

Literature Review: State of Research on Business Models and Business Model Innovation Due to growing R&D costs on the one side and steadily shortening product life cycles that limit revenues on the other side, innovation pressure has been rising constantly over the last decades. Many companies try to master this challenge by aiming at the development of breakthrough products and services that promise higher returns on investment (e.g., Lilien, Morrison, Searls, Sonnack, & von Hippel, 2002; von Hippel, 2005). An alternative strategy, which has gained increasing attention from management field quite recently, both within scholarly debate as well as within business practice, is to come up with innovative business model designs (e.g., Johnson, Christensen, & Kagermann, 2008; Markides 2006, 2008; Osterwalder, Pigneur & Tucci, 2005; Teece, 2007, Zott & Amit, 2008), i.e. an innovative and often game changing approach towards value creation and towards the related architecture of a company. 8

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In a recent study conducted by Zott, Amit & Massa (2010), the authors note that academics’ interest in the business model concept has “virtually exploded” (2010: 8) since 1995. From that time on, business model research has developed in very different directions. The literature on business models can be roughly divided in five tracks: (1) definitions, typologies, and taxonomies, (2) elements and components of business models, (3) reference models and frameworks, (4) the relationship between the business model concept and strategy, and (5) the performance relevance of business model(s) (innovation) (see table 1). This already emphasizes that thus far the business model and its context, i.e. its interaction with environmental dimensions could be so far rather neglected but promising track in literature on business models. --------------------------------Insert Table 1 about here --------------------------------Business model research has been criticized for its conceptual ambiguity (Porter, 2001), resulting in “an invitation for faulty thinking and self-delusion” (2001: 77). Chesbrough and Rosenbloom (2002) note that the concept “draws from and integrates a variety of academic and functional disciplines, gaining prominence in none” (2002: 553). However, it seems that at least some common ground has been reached so far, as elaborated by Zott, Massa & Amit (2010). The business model has been established as a new unit of analysis, providing the possibility of gaining a holistic view on how companies do business. Furthermore the business model concept focuses on organizational activities, and in business model research the emphasis lies on how companies create and appropriate value. Research has so far devoted great efforts to describe the “inner context”, i.e. how a business model can be defined, what constitutes a business model, how the business model influences corporate performance and how the construct is related to strategy. 9

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While all prior research on business models has contributed to our knowledge of business models and business model innovation, the following three important aspects are missing: (1) Most of the studies see business models as isolated constructs. Thus they are not taking into account external factors influencing a business model. (2) Consequently business models are seen as rather static, not considering the interactions between a business model and its environment, which in turn often result in regularly required adjustments made to a business model. (3) Given the ample research on the importance of re-configuring business models according to contextual changes for the survival and growth of companies, it is rather surprising that there is paltry research on business model environments.

As elaborated above, every business model must be adjusted properly to specific environmental circumstances. Thus, it is not enough only to consider the business model as an isolated phenomenon, but the external factors influencing the business model must be monitored as well. Teece (2010) perfectly brings it to the point: “A business model cannot be assessed in the abstract; its suitability can only be determined against a particular business environment or context. Neither business strategies, business structures nor business models can be properly calibrated absent assessment of the business environment; and of course the business environment itself is, in part, a choice variable; i.e. firms can both select a business environment, and be selected by it: and they can also shape their environment” (2010: 191).

Thus, in the following section we try to make a first step towards the conceptualization of the environment surrounding a business model.

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METHOD The applied method in this paper is inductive and exploratory in nature. The reason for the specified methodical grounding is that the current stock of knowledge on this topic is quite limited. The results emerging from this study deliver first insights on what business model environments might look like and what dimensions of the environment potentially interact with the business model. The findings build a starting point for further research on the topic of business model environments and on options for business model innovation. --------------------------------Insert Figure 1 about here --------------------------------To conduct this study, we followed a multi-step approach (see figure 1). First, we reviewed articles published in leading academic and practitioner-oriented management journals dealing with issues such as general strategic management, environmental scanning, industry analysis, organizational environments, strategic fit, strategizing by analogies, cross-industry innovation and, of course, business models, to collect factors that are generally used to specify all kinds of business environments. In the second step, we conducted a first round of expert interviews. Although this method is criticized for its subjective nature and the potential for false statements (e.g, Meuser & Nagel, 1991), expert interviews are appropriate to access specialized expert knowledge for theorizing in fields previously hardly researched (Bogner & Menz, 2005). In these interviews the experts identified from the list of factors derived from the literature review those factors that are specifically relevant for defining business model contexts. Third, we synthesized dimensions by grouping similar factors (previously selected by the experts). In doing so we received 13 dimensions that constitute the environment of a business model. In the fourth step, we conducted a second round of interviews where the experts assessed which dimensions 11

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show a more direct and stronger impact on a business model. The fifth (and last) step was to build layers which aggregate dimensions that have been rated as being on a similar interaction level with the business model.

Expert Sample The expert status is being attributed to people who have deep and accessible knowledge on a specific topic (Meuser & Nagel, 1991). For the purpose of this study, knowledge regarding business models and business model innovation was used as primary selection criterion. Furthermore, it was necessary that the interviewees were experienced in working with business models on an analytical and conceptual level. In our sample, one half of the experts come from the field of external and internal strategy consulting, and the other half come from venture capital companies. We chose these two groups because consultants and investors are usually confronted with an abundance of business cases, have foci on different industries and therefore gained broad knowledge regarding business models and different business environments. The 10 experts in our sample vary regarding their educational background and professional experience. This allowed for different perspectives on the topic of business models in our study (see Table 2). --------------------------------Insert Table 2 about here ---------------------------------

CONCEPTUALZING THE BUSINESS MODEL ENVIRONMENT Perspectives on “Business Environments” Although management literature agrees that environmental characteristics have implications for all aspects of the management of organizations (e.g., Boyd, Dess & Rasheed 12

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1993; Prescott, 1986) and acknowledges the high importance of monitoring changes in the environment, it is rather surprising that in scholarly debate “only little agreement exists on what the environment is and how to apprehend it” (Frishammar, 2006: 22). So far, there is no set of constructs and measures of business environments widely accepted. Sharfman, Dean, Dess and Rasheed (1991) underline that research has been unable to build a comprehensive and coherent literature about business environments due to the fact that no single approach to conceptualizing or measuring environments has gained widespread acceptance. Even though the extreme degree of theoretical and empirical diversity regarding research on business environments seems to impede the development of more unified theory and research, one of the strengths of this multiplicity of approaches is the provision of richer insights and an increased number of alternatives (Sharfman et al., 1991). Frishammar (2006) revisits research on organizational environments and identifies the following four different schools of thought: the adaptive, the resource-dependence, the cognitive, and the population-ecology perspective. He concludes that the seemingly dominant adaptiveperspective is not enough to capture environmental complexity, as the sole reliance on one perspective might lead to a too narrow approach. Consequently, he calls for a broader perspective on the environment, accounting for the idea that environment is partly enacted by its participants. A similar approach towards the relationship between business environment and the players within is proposed by Teece (2010). The author sees business environments as a choice variable, being partly shaped by the firms acting within. We build on this research in developing our business model environment framework. Thus, we see business models and business model environments as partly interacting phenomena. In line with Frishammar (2006) we use the term “perspectives” as a conceptual umbrella to gather related views and approaches regarding the characterization of business environments. 13

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To give an overview on the main characteristics of different concepts of business environments, we differentiate the following business environment perspectives: industry environments, organizational environments, and business model environments (see Table 3). --------------------------------Insert Table 3 about here --------------------------------The industry environment perspective has been dominated by the structure-conduct-performance paradigm, most prominently represented by Porter’s Five Forces Framework (Porter, 1980). It is unquestioned that the Five Forces Model has put industry analysis to the next level. However, in times of dynamic business environments “the concept of an industry is itself of questionable value” as outlined by Teece (2007: 1324) in a recent study. The author outlines that the Five Forces Model “is compromised because it has insufficient appreciation (a) for the importance of and nature of innovation and other factors that change the “rules of the game”, (b) for factors inside the business enterprise that constrain choices, (c) for factors that impact imitation and appropriability issues, (d) for the role of supporting institutions, complementary assets, cospecialization, and network externalities, or (e) for the blurred nature of industry boundaries” (Teece, 2007: 1325). Furthermore, research indicates that industry effects on firm performance have been overrated so far: industry specific effects are a much less important source for economic rents and are outweighed by business specific effects (such as the business model) (e.g., Short, Ketchen, Palmer & Hult, 2007; Zott & Amit 2007). In today’s dynamic business environments, where industry boundaries are faint to an increasing extent (see above), the notion of stable business models within clearly defined industry boundaries is more and more challenged. Hence, there is a need for a new perspective on business environments besides the organizational environment perspective. Business models 14

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transcend blurring industry boundaries, and the analogous application of business models from other domains has been identified as valuable source for generating business model innovation options (e.g., Gavetti, Levinthal & Rivkin 2005). Consider, for instance, the “bait and hook” business model, a business model “characterized by an attractive, inexpensive, or free initial offer that encourages continuing future purchases of related products or services” (Osterwalder & Pygneur, 2009: 104). Frequently, the initial offer is a loss-leader or is subsidized by the company, in anticipation that later purchases of related products will eventually generate offsetting profits. This business model has become highly popular and has been applied in many sectors, such as telecommunications (mobile handsets), consumer goods (razors), electronics (printers), or in the aviation business (aircraft engines).

The Business Model Environment Framework The concept behind the business model environment framework (BME framework) is based on the seminal work of Duncan (1972). The author states “if a theory of organizationenvironment interaction is to be developed to facilitate empirical research, it is necessary that the […] dimensions of the environment be more clearly defined” (1972: 313). The BME framework consists of 13 dimensions (see Table 4 and Table 5). Each dimension is specified through factors, representing a non-exhaustive enumeration.

--------------------------------Insert Table 5 about here ---------------------------------

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According to Johnson, Scholes and Whittington (2006), the simple identification of influences is not enough. In fact, the challenge for strategists lies in understanding the impact of these forces. This is necessary because dimensions of the environment differ in importance (Garg, Walters & Priem, 2003). Consequently, dimensions with similar impact on the business model are grouped to one layer (see Table 5).

The Business Model Environment Map The closer the layer is to the business model, the higher the influence is on it. In some cases, this relationship seems to be bidirectional, so that a closer layer also means a higher level of interaction. Of course, the intensity of influence or interaction depends on the business model environment in consideration, but some dimensions are – one a general level – more closely linked to the business model and thus more relevant when adapting, re-configuring, or creating business models. This relationship is indicated in the business model environment map (BME map, see Figure 2). --------------------------------Insert Figure 2 about here --------------------------------In the suggested BME framework, we analyzed the environment from a business model perspective. In other words, the environment is not seen from an organizational point of view as has been done so far in the literature on business environments. Instead, the business model is the entity from which the environmental scanning process is conducted. As the scanning initiates from the business model, it builds the core of the map. To assess the impact of different environmental factors on the business model, it is necessary, at first, to achieve a sound understanding of what the latter is like: what components it is made of and what is included in the 16

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business model concept. Only after a common understanding of the business model construct has been established, can a scanning process of the environment be initiated. Different researchers are giving the term “business model” different connotations, ranging from a company’s cost structure to complex analysis of organizational structures. Hitherto, no common classification scheme for business models has emerged in academic literature. There are more than 20 studies (see Osterwalder 2004: 24 for details) offering different definitions of the term “business model”. For the purpose of this research we define – in line with the definition proposed in recent studies (e.g., Baden-Fuller, MacMillan, Demil & Lecocq, 2006; CasadesusMasanell & Ricart 2010) – the business model as the logic of a firm, the way it operates and how it creates value for its stakeholders. In defining the link to strategy, we follow the idea of Ammar (2006) and Casadesus-Masanell and Ricart (2010). These authors see the experimentation with different business models and the choice of a specific model through which the company competes in the market as a central task of strategy.

THE DIMENSIONS OF THE BUSINESS MODEL ENVIRONMENT As we have already elaborated, the factors deemed relevant for the context of business models by the experts in our study were aggregated to 13 dimensions (see Table 5). We discuss the dimensions of the “interface layer” in the following section in more detail. Many of the other dimensions are well known either from traditional “organizational environment” or “industry” analysis and are fairly straightforward. This does not come as a surprise, as the three perspectives on business environments identified are partially overlapping (see Table 3). The dimension “other business models” accounts for the fact that the business model which best meets the requirements of the relevant ecosystem is one of the major sources of competitive advantage in dynamic environments. We assume that there is no single best business 17

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model. Instead, the “fit” might depend on a variety of issues, for instance, the specific resource configuration of a company operating the business model. Hence, a business model is in competition with other business models, be it from within the company (e.g. from other business units), from other business models within the same business environment (but incorporated from a different institution), or even from completely different contexts. The dimension “micro & macro trends” describe forces that a motors for change. Whereas, for the purpose of this study, micro trends are seen as business model environment specific, macro trends are ubiquitous. For example, a micro trend is a technological development (e.g., increased mobility of computing devices), resulting in a change of lifestyles (e.g., increased flexibility regarding work forms in terms of time and location), which then alters consumer behaviors and finally result in new customer needs to be addressed in a new business model. This source of dynamism of business model environments is partly countered by “forces of inertia”. This dimension covers those factors that result in a resistance to change. Naturally, these are very context specific. In the development of smart grids, for instance, these forces could be: lack of energy storage capacity, low economies of scale for renewable energy generation, strong market position of power suppliers and stock market pressure to perform, conventional thinking and behavior of power users, or complexity of existing power distribution network.

Business Model Innovation Opportunities at the Interface Business Model to Business Model Environment Johnson et al. (2008) suggest that established companies cannot succeed with new offerings as long as they do not understand how the business opportunity is related to the business model. Following this notion, it is necessary to learn more about the customer, the product and the company in the first place. These three dimensions are closely enmeshed with the 18

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concept of the business model, sometimes even seen as part of the business model itself (e.g., Osterwalder & Pigneur, 2009), and hence referred to as “interface layer”. Customer. When designing, re-configuring or adapting the business model, the value proposition is a central aspect. In the literature it is emphasized that satisfying real customer needs by developing a strong value proposition is a key to corporate success. The basic question is: What kind of needs can be identified in a given environment? Learning more about the needs of people helps to detect groups of potential customers: assessing the homogeneity / heterogeneity of needs leads to a natural segmentation process. After identifying segments of (potential) customers, a firm can decide which group(s) of customers it wants to target and, depending on the extent of heterogeneity, whether one business model or different business models are necessary to fulfill customer needs. The power of customers determines the leeway in several decisions regarding the business model. For instance, in food retailing, the suppliers of foods usually have very limited room for negotiations with their customers, the big supermarket chains. The latter often threaten with delisting, i.e., removing products from the shelves in order to apply pressure in pricing negotiations (the options regarding the revenue model are tremendously reduced in this case). In specific environments, it is possible to circumvent or ease off the great power of customers by tapping additional customer segments, resulting in reduced dependency on a specific customer segment. The power of customers is often a consequence of their loyalty, the existence of switching costs or a lock-in mechanism in the environment. Customer loyalty is increased when switching costs are high. For instance when changing from one software system to another, a company is likely to run into high costs for installing the new system and for training employees. Customer lock-in and switching costs are a great example of the interplay between business model and business model environment. Both can be determined either by the environment or by 19

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the business model, as the following example shows: In the 1970s, retailing in the consumer electronics industry was characterized by many small retailers offering only a limited selection of products, and consumers that had more commitment to national brands than to retailers – either of which would result in low switching costs. Circuit City (a consumer electronics reseller; bankruptcy in 2008) invested in large stores (offering a wide selection of brands and products), in automated distribution centers (increasing availability of products) and in brand building measures. As a consequence, the attractiveness for customers to switch from one retailer to another was significantly reduced. In some environments, corporate success is based primarily on a strong brand. In the case of high brand relevance, purchasing decisions are based primarily on the fit between the values and the message the brand stands and tempered by the customer’s personal preferences. In such environments, the brand building process builds the basis for a powerful business model. However, even in environments where brands are very important, such as the fashion business, some innovative business models can be successful although the firm cannot rely on a strong brand, as the following example shows. Threadless is a fashion company with a completely disruptive business model compared to the conventional apparel industry. The cornerstones of Threadless’ business model are brilliantly summarized in a study from Ogawa and Piller (2006, p. 66): “Threadless focuses on a well-known fashion item: T-shirts with colorful graphics. This type of product is typically hit or miss, with success contingent on a company’s ability to identify fast changing trends and the ability to develop a hip and trendy brand. Despite neither having a strong brand, nor sophisticated market research, nor forecasting capabilities, none of Threadless’ hundreds of products has ever flopped. Rather, Threadless relies on a community of customers, including hobbyists as well as professional graphic designers, who submit, inspect, 20

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and approve all designs. In this way, Threadless can exploit a pool of talent and ideas that is much larger than the company could possibly afford if it relied instead on an internal process. Moreover, Threadless will manufacture only those designs that have garnered the necessary number of preorders from interested customers, thereby ensuring each product’s success. Each week on the Threadless website, customers can evaluate between 400 and 600 new submissions on a scale from zero to five. On average, each design is rated by 1,500 people. In addition, customers can express their desire to purchase a submission, and Threadless uses that information to determine which products should be developed and manufactured.” The Threadless example clearly demonstrates the value of questioning the current role of customers in helping to create new business models. For a long time, the prevailing strategic approach saw the company and the customer as two different and separated entities, resulting in the basic assumption that the firm strives to create value, whereas the exogenous customer is only seen as the passive recipient of the company’s value creation efforts. In several environments, companies are increasingly intensifying relationships and cooperation with resources located outside the firm. One possibility is to use innovative users and customers as a resource; this idea is referred to as community sourcing. In a recent study by Schau, Muniz, and Arnould (2009), it was shown that users and customers are able to be active co-creators of value (Payne, Storbacka & Frow 2008), co-create competitive strategy and collaborate in the firm’s innovation process (e.g., Pruegl & Schreier, 2006; von Hippel, 2005). The systematic integration of the customer in the process of value creation has triggered the development of game-changing business models. Communities of users have taken centre stage in media and entertainment businesses where usergenerated content is increasingly replacing that of traditional providers (e.g., YouTube or Wikipedia). Similarly, products in both high-tech industries (e.g., medical equipment, biotechnology, nanotechnology) and low-tech industries (e.g., sports equipment) increasingly are 21

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being developed by communities of users, either independently or in collaboration with incumbent firms (e.g., Pruegl & Schreier, 2006; von Hippel, 2005). Last, but not least, it is important to know how people react to changes in the prices of a product, which is expressed as the price elasticity. In inelastic environments, i.e. when the absolute value of price elasticity is less than one, changes in the price of a product or service result in relatively small changes in the quantity of goods demanded. In elastic environments, i.e. when the absolute value of price elasticity is greater than one, changes in price have a relatively strong effect on the demand for a product or service. Assessing the price elasticity of a business model environment helps to construct or adapt a revenue model that meets the requirements of the environment. Price sensitive environments boost business models that reduce costs in the value creation process (e.g., by establishing partnerships with other companies, entering jointventures or shortening the value-chain through new distribution channels). Product. An important differentiation has to be made at this point. In business model literature, it seems that the terms “product” and “value proposition” are often used interchangeably. We deem this synonymous use erroneous. We see the value proposition as part of the business model as it describes the benefit of the offer the company makes to its customers, what problems are solved and which needs are satisfied. The products are the means to achieve this value proposition. In a business model environment, there are usually different products available to fulfill the same value proposition. In the current discussion on the future of the automotive industry, electric cars are playing an increasingly important role and are high on the agenda of every big car manufacturer’s priority list. E-mobility nurtures the re-thinking of mobility concepts. The value proposition could be to offer the customer comfortable, environmentally friendly mobility at a fair price. In this case, different products might be able to deliver this value: e-cars, conventional eco-friendly diesel or gasoline powered cars, or 22

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comfortable public transportation services. The variety of products with the same value proposition, in turn, leads to different business models. For e-mobility, this could be car-sharing, a combination of power supply contracts and ownership of e-cars subsidized by utilities, the lease of e-cars, or short-term rentals. Many companies have invested heavily in the development of a specific product (in this context, the term “product” is used for physical products as well as services). Thus, the product and its properties influence the choices regarding the business model. High quality products, for instance, often can (or must) be combined with additional services related to the product as customers are expecting a more comprehensive product experience. A low quality product, on the other hand, might require more attention regarding the cost structure of the financial model as it is supposed to be relatively inexpensive. The former is particularly influenced by resources needed (“operating resources” dimension), potential of economies of scale (“general market attributes” dimension) and size of the company (“institutional” dimension). When companies are developing new business models or want to transfer existing business models from other domains, it is particularly important to assess if these business models reflect product involvement and the emotionality regarding their own products. A business model based on a “no-frills” concept will be effective in rather commoditized areas, such as airline flights, train tickets or car rentals. Such an approach would likely fail for personal services such as wedding planning. Involvement and emotionality regarding a product may change over time. In a recent pan-European study, 4 out of 10 car owners consider getting rid of at least one of their cars or consider doing so in the next 12 months.2 Their decision is based primarily on economic and ecological reasons. Kruse (2009) concludes in one of his studies that whereas the car was the principal status symbol of recent decades, it has now lost its pole position in the 2

„European Transportation & Mobility Observatory 2009”, Ipsos Market Research

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emotional space. Ownership of a car is constantly losing importance in favor of car-rental or carsharing concepts. A product’s complexity and functionality respectively are factors that have similar impact on the appropriateness of a business model. A highly sophisticated product needs more interaction with the customer; this results, for instance, in the need for better trained and more sales staff, in a reduced number of options regarding the distribution channels, or in possibilities to sell additional services for customers, such as trainings or workshops. When a product is complementary or supplementary to other products, this definitely has to be taken into account. The success story of Apple’s iTunes and iPod, often named as a perfect example for business model innovation, clearly depicts the value of a business model that is tailored around “linked” products. As a product runs through the different phases of its lifecycle, the business model has to be adapted accordingly. During the development/R&D phase, the emphasis is likely to be on the development of a suitable production model that allows capitalizing, for example, a new technology. During the implementation/roll-out phase, the business model should allow entry into the market quickly and to receive prompt feedback from customers as early as possible. This is especially true for new businesses engaged in bringing a new product to the market. They often revise their business model four times until they finally reach profitability (Johnson et al. 2008). Especially when a product is on the declining path of its life cycle, an improved business model could guarantee constant revenues. The latter is something that products with great demand variability rarely deliver. If sales depend on external factors, like the seasons or the weather, the business model must deal with volatile revenue streams. Substitutes are often seen as a threat. However, they can be a source or driver for business model innovation, as well. Postal services are currently threatened by increased use of e-mails 24

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instead of conventional mailings, and by electronic media in general. New offers, such as the epostcards, combine the advantages of both worlds. The user creates individual postcards by uploading a digital picture, either via computer or directly from a smartphone. The postcards are subsequently printed and delivered by the postal service company. The Internet and related technological developments led to a decrease in the relevance of physical distance. This factor describes how important it is for a company to position its value-creating efforts close to the customer’s location. In many environments, physical proximity has become almost irrelevant (e.g., service centers or call centers are outsourced to low cost countries). In other environments, though, open innovation, a more integrated value-creation process, joint R&D efforts, and organizational networks require low physical distance (e.g., automotive clusters), networked business models, and new business models on the inter-organizational level (Provan, Fish & Sydow, 2007). Institution. This dimension characterizes the organization that incorporates the business model. In most cases that are profit-oriented businesses or not-for-profit organizations, but the factors are also applicable to asses an association, a government or any other entity that creates and captures value. Markides and Oyon (2010) outline that the attractiveness of a new market space, which has been created by a new business model, depends on factors such as the size or the competencies of a firm. The authors state accordingly (2010: 7): “This might seem like an obvious point but it is amazing how many established firms plunge into the new markets without giving careful consideration to whether the new market is right for them.” Of course, the selection and design of a business model is materially impacted by corporate size, market share and multinationality, i.e., managing production or delivering services in more than one country. Some business models can be operated only by big companies 25

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as they demand, for instance, specific assets and hence challenge the ability to access required resources. Big multinationals eventually gain advantage through greater bargaining power and more possibilities to realize economies of scale. Some business models, though, require high organizational flexibility and consequently are especially relevant for small companies or startups. Amor All, a company offering tire shining products, managed to reach 300 million dollars of revenue with only five employees. By assigning third parties with all tasks that did not belong to its core business, Amor All, kept its flexibility high and payroll costs low – resulting in a business model easily scalable up and down as outlined by Jim Muehlhausen from the Business Model Institute3. A factor that has become even more important in the last couple of years is the network in which a firm is embedded. New business models are increasingly based on a corporate environment where networking, sharing, and acting globally are at the center stage of value creation. As many different actors (suppliers, business partners, alliances, and customers) are involved in the co-creation of value, mastering the design and management of interconnected, coproductive offerings become a central aspect of the business model. This also involves the reconfiguration of roles, relationships, and structures. Traditionally, in Porter’s value chain theory (1985), value activities are regarded as linear. However, the notion that a linear configuration does not suffice to explain value creation efforts in dynamic environments has gained more and more attention in academic literature (e.g., Weitzel, Wendt & Westarp, 2000; Wirtz 2010). New business models result in more than one-way value chains, starting with suppliers and ending at customers: The complicated linkages of value chains between firms, customers, and suppliers constitute a value network, where all the value creation and capture activities happen. 3

http://businessmodelinstitute.com

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The case of Nespresso shows that organizational structure and corporate culture define whether a business model works in a specific company. The basic idea behind Nespresso – selling Coffee as a luxury good – met with resistance and reluctance of Nestlé’s managers. As they had a fast moving consumer good (FMCG) background, they didn’t see the point of selling coffee at a high price with an expensive machine, and that all through mail order (later complemented with high-end retail stores at premium locations) – a disruptive business model for selling coffee. Nestlé is tailored to sell mass market products (e.g, Nescafé) – and this was entrenched in its corporate culture. Selling a luxury good was completely new to the company and its employees. Nestlé and Nespresso had very different business models: Nescafé focuses on instant coffee sold through mass-market retailers, while Nespresso concentrates on direct sales in the premium segment. As the potential of the Nespresso concept had been recognized, the company decided to create a separate unit to solve these incompatibilities (Markides & Oyon 2000). When Nestlé introduced Dolce Gusto (a rather low-priced coffee compared to Nespresso), however, it decided to house it within the existing Nescafé division, using the Nescafé business model. The success of many companies originates in their ability to exploit the relevant technologies in their specific environment. By investing in new technologies, the firm reaches a higher level of technological development, which in turn, results in new business model opportunities. Consider the Circuit City example above. One of the advantages that Circuit City offered to its customers, in comparison to small retailers back in the 1970s, was the availability of a great variety of products (contrary to small retailers offering only a limited selection of products and brands with many items often not available). To realize this advantage, the company had to invest in information technology that allowed sales tracking (recognition of sales patterns), in combination with automated distribution centers. Tracking information allowed another company 27

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to gain competitive advantage. By making information on parcel tracking available to customers on its website, UPS was able to significantly reduce customer service costs to a few cents, compared to a couple of dollars for an incoming phone call at the UPS customer service center. In the BME framework, several groups of stakeholders (e.g., suppliers, customers, and employees) are represented. Suppliers are part of a company’s value network, customers build one of the most important dimensions, and employees influence organizational culture and are a key resource. One group that particularly influences the business models of start-ups or young companies are the shareholders. The expectations of shareholders must be considered when defining a business model. What does an investor expect from a company? Are investors willing to invest further in a specific business model? Is the short-term financial success a major goal of the investment or is it sustainable long-term growth?

DISCUSSION Research suggests that the business environment is an important issue that has to be considered in order to make companies fit for the future, even though there is no widely accepted definition of what a constitutes “business environment”. In increasingly dynamic business contexts, a business model that accounts for the changes in the environment has been identified as a primary source for competitive advantage. Despite the recent increase in business model research and the notion that a business model can never be assessed in abstract, there is no pioneering research on what constitutes the business model environment. Consequently, we took a first step in developing a business model environment framework. Instead of developing a model, we decided to build a framework, as the latter is less rigorous than the former and thus accounts for the inductive and exploratory nature of our research. However, a framework encompasses many variables and seeks to capture complexity. In identifying relevant dimensions, 28

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which must be considered when assessing business models environments, the framework provides a basis for further studies and might serve as a catalyst for a unified research on the interaction between business models and their respective environments. Furthermore, the framework suggested in this paper might help managers analyze the links between a business model and its environment in a structured manner. It could be used to identify business model innovation opportunities, as it allows for comparability of trends and developments beyond the boundaries of industries. It also serves as a basis for the development of scenarios describing future conditions potentially requiring tremendous shifts in the current business model of a company. As argued by Thorngate (1976), there is no research in social sciences that can simultaneously achieve the goals of generalizability, accuracy, and simplicity. Also, our research comes with several limitations. The factors describing business environments in our study have been derived from a wide array of literature streams. The literature is widely divergent. Hence, it is quite challenging to make sense of it in the context of the business model environment. The studies take either an industry or an organization-environment perspective. Consequently, there is a considerable potential that there are factors influencing business model environment that have not yet been discussed in the literature4. Furthermore, a considerable part of the literature dates back 30 years or more. The method of expert interviews we used to synthesize factors specifically relevant to business model contexts is inclined to yield false statements and criticized for its subjective nature. The factors attributed to the dimensions must be considered as a nonexhaustive enumeration. The developed framework is generic in nature and therefore the layers indicating the different degrees of interaction with the business model might differ widely,

4

We tried to address this problem by conducting interviews with 10 leading experts in the field of business model innovation

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depending on the business model environment in consideration. Finally, the concept of the business model itself has, up to now, remained theoretically underdeveloped (Teece, 2010). Future research should address these limitations. Scholars need to develop theoretical foundations of the dimensions constituting the “outer context” of business models, i.e. the business model environment. As the identification of dimensions, in turn, facilitates the identification of different types of environments, future research needs to shed light on the particularities of specific business model environments (e.g., in the field of social entrepreneurship or pro poor business models). Clarity needs to be established on how specific environments are changing, where this dynamism comes from and how it could be transformed in business model innovation opportunities. With this first effort we would like to encourage researchers to join us on this endeavor as the business model in its context as well as interdependencies between specific business models and environmental dimensions is from our point of view to date far from being fully understood.

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APPENDIX TABLE 1 Overview - Research on Business Models Topic definitions, typologies, and taxonomies elements and components of business models reference models and frameworks the relationship between the business model concept and strategy the performance relevance of business model(s) (innovation)

Literature e.g., Lecocq, Demil & Warnier, 2006; Linder & Cantrell, 2000; Magretta, 2002; Osterwalder, Pigneur & Tucci, 2005; Perkman & Spicer, 2010; Rappa, 2002; Schweizer 2005; Timmers, 1998 e.g., Afuah & Tucci, 2003; Amit & Zott, 2001; Casadesus-Masanell & Ricart, 2007; Linder & Catrell, 2000; Magretta, 2002 e.g., Gordijn, 2002; Greiner, 2006; Osterwalder & Pigneur, 2009; Shi & Manning, 2009 e.g., Ammar, 2006; Casadesus-Masanell & Ricart, 2010; LehmannOrtega & Schoettel, 2005; Morris & Schindehutte, 2005; Seddon & Lewis, 2003; Teece, 2010 e.g., Chesbrough & Rosenbloom, 2002; Malone et al. 2006, Zott & Amit, 2007, 2008

TABLE 2 Expert Sample Interviewee 1 2 3 4 5 6 7 8 9 10

Profession Investor Consultant Investor Consultant Consultant Investor Investor Consultant Consultant Investor

Level Associate Associate Principal Partner Partner Senior Executive Senior Executive Principal CEO Associate Principal CEO

Focus Consumer goods, e-commerce Chemistry Internet based companies Various Telecommunications Telecommunications New media Various Telecommunications Life science, software

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TABLE 3 Perspectives on Business Environments Industry Environments

Organizational Environments how the micro- & macro environment affects the organization

Business Model Environments how the business model and its environment interact

Focus of inquiry

how the industry affects the organization

Frame of reference

industry

ecosystem

ecosystem

Assumption regarding industry boundaries

strict

strict

blurring

industry environment

stable business models

dynamic business models

Source for economic rents

TABLE 4 Dimensions of the Business Model Environment Dimension

Relevant Publications

Customer

Beal, 2000; Burgeois, 1980; Choo, 1999; Duncan, 1972; Kast, 1980; Jauch, Osborn & Glueck, 1980; McCann, 1985; Nadkarni & Narayanan, 2007; Nadkarni & Barr, 2008 Beal, 2000; Nadkarni & Narayanan, 2007; Naesens, Gelders & Pintelon, 2007 Boyd, Dess & Rasheed, 1993; Choo, 1999; Dess & Rasheed, 1991; Duncan, 1972; Jelinek & Burstein, 1982; Johnson, Scholes & Whittington, 2007; McCann, 1985; Naesens, Gelders & Pintelon, 2007 Beal, 2000; Choo, 1999; Duncan, 1972; Dutton, Walton & Abrahamson ,1989; Duncan, 1972; Jauch, Osborn & Glueck, 1980; Jelinek & Burstein, 1982; Kast, 1980; Nadkarni & Barr, 2008; Neubauer & Solomon, 1977; Subramanian, Fernandes & Harper, 1993; Teece, 2010

Product Institution Key Technologies Operating Resources Competitors Other Business Models General Market Attributes Social Dimension Political Dimension Legal Micro & Macro Trends Forces of Inertia

Beal, 2000; Dill, 1958; McCann, 1985; Kast, 1980; Nadkarni & Narayanan, 2007; Nadkarni & Barr, 2008 Beal, 2000; Burgeois, 1980; Demil & Lecocq, 2010; Dill, 1958; Duncan, 1972; Dutton, Walton & Abrahamson, 1989; Jauch, Osborn & Glueck, 1980; Johnson, Scholes & Whittington, 2007; Kast, 1980; McCann, 1985; Nadkarni & Barr, 2008; Nadkarni & Narayanan, 2007 Johnson, Christensen & Kagerman, 2008; Nadkarni & Narayanan, 2007; Markides, 2009; McGrath, 2011 Choo, 1999; Dill, 1958; Huffmann, 2001; Jelinek & Burstein, 1982; Johnson, Scholes & Whittington, 2007; Nadkarni & Barr, 2008; Nadkarni & Narayanan, 2007; Neubauer & Solomon, 1977 Beal, 2000; Burgeois, 1980; Choo, 1999; Demil & Lecocq, 2010; Duncan, 1972; Dutton, Walton & Abrahamson, 1989; Huffmann, 2001; Jauch, Osborn & Glueck, 1980; Johnson, Scholes & Whittington, 2007; Kast, 1980; Neubauer & Solomon, 1977; Subramanian, Fernandes & Harper, 1993 Beal, 2000; Burgeois, 1980; Dill, 1958; Duncan, 1972; Dutton, Walton & Abrahamson, 1989; Jauch, Osborn & Glueck, 1980; Kast, 1980; Johnson, Scholes & Whittington, 2007; McCann, 1985; Nadkarni & Barr, 2008; Neubauer & Solomon, 1977; Subramanian, Fernandes & Harper, 1993 Beal, 2000; Burgeois, 1980; Dill, 1958; Duncan, 1972; Jauch, Osborn & Glueck, 1980; Kast, 1980; Johnson, Scholes & Whittington, 2007; McCann, 1985; Nadkarni & Barr, 2008; Neubauer & Solomon, 1977; Subramanian, Fernandes & Harper, 1993 Burgeois, 1980; Demil & Lecocq 2010; Huffmann, 2001; Lenz, 1978; Neubauer & Solomon, 1977; Osterwalder & Pigneur, 2009; Teece, 2010 Self & Schraeder, 2009; Trader-Leigh 2000, Tripsas & Gavetti, 2000; Markides, 2009; Fosfuri & Ronde, 2009; Smith, Binns & Tushman, 2010; Sommerlatte, 2005

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TABLE 5 BUSINESS MODEL ENVIRONMENT FRAMEWORK

high / low quality

size

segmentation

involvement / emotionality

market share

power of customer:

multinationality complexity / functionality complementary / supplementary

 lock-in

life cycle (duration of, position on) state of available technology

core competencies ability to access required resources

 loyalty  switching costs

technological standards

resource intensity cost of resources access to resources

number of competitors risk of new competitors cost structure

dominant designs life cycle (duration of, position on)

flexibility

demand variability

organizational structure

substitutes

corporate culture

relevance of physical distance

technological development level

margins

Legal Dimension

Political Dimension

Social Dimension

other BM inside firms using the respective BM

market size

culture

political stability

(de-)regulation

entry barriers

demographics

single markets

litigations

BM external to the company but in the specific environment

fragmentation

income distribution

subsidies

certifications / accreditations

BM from other environments

growth potential potential for economies of scale

pricing patents

value network

Society Layer General Market Attributes

Competitors competitive pressure

Other Business Models

Market Layer (financial, human, natural)

Operating Resources

Key Technologies

Institution

needs

homogeneity / heterogeneity

Factors

Asset Layer

Product

Customer

Dimensions

Interface Layer

moral suasion level of education

IPR

moral suasion

tax employment laws

market transparency

health & safety laws compliance

brand relevance role of customer price elasticity stakeholders

Forces Layer Micro & Macro Trends Forces of Inertia

Driving forces on a micro level (=depending on environment in consideration): e.g., increased importance of social networks or technological convergence; mega trends (=independent of environment in consideration) such as aging society, urbanization, connectivity, new work forms, increased mobility etc. Forces that result in resistance and reluctance to changes in the current environment, e.g., technology lacking behind, current business model is still successful, bureaucracy, inflexible organizational architectures etc.

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FIGURE 1 Research Design 1

2 Collection of environmental factors based on literature review

3 1st round of expert interviews for identification of relevant factors

4 Synthesis of factors to generate dimensions of the BM environment

5 2nd round of expert interviews to assess interaction of dimensions with BM

Aggregation of dimensions (with similar level of interaction) to layers

*BM = business model

FIGURE 2 Business Model Environment Map

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