Business and Competitive Analysis Effective Application of New and Classic Methods Craig S. Fleisher and Babette E. Bensoussan Upper Saddle River, NJ. + New York * London San Francisco + Toronto + Sydney + Tokyo + Singapore Hong Kong * Cape Town + Madrid * Paris *’ Milan Monich + Amsterdam‘Vice President, Publisher: Tim Moore ‘Acquisitions Falter: Martha Cooley altorial Assistant: Pamela Boland Development Editor: Russ Hall “Associate Editor-in-Chief and Director of Marketing: Amy Neidlinger Publicist: Amy Fandrei Marketing Coordinator: Mogan Colvin Cover Designer Chat Praertsith Managing Faitor: Cina Kanouse Project Editor: Betsy Haris Copy Editor: Water Crost Publishing Proofreader: Language Logistics, LLC Senioe Indexer: Cheryl Lenser CCompositor: Moore Media, Ine Manufacturing Buyer: Dan Unig (©2007 by Pearson Feucation, Ine FY Press Publishing as FrPress TISEATTINE Upper Saddle Rives, New Jersey (7458 FT Press offers excellent discounts on this book when ordered in quantity for bulk purchases 0: special sales. For more information, please Zontact US. Corporate and Government Sales, 1-800-982:3119, Corpealestpearsontechgyoup.com. For sales outside the US, please contact Intemational Sales at infernational@pearsoned.com. Company and product names mentioned herein are the trademarks or registered trademarks oftheir respective owners. [All sights reserved, No part ofthis book may be reproduced, in any form or by any means, ‘vithout permission in waiting from the publisher. Printed in the United States of America Fist Printing Pebruary, 2007 ISBN 0-13.1973660 eatson Eéxcaton Singapore, Ple. Ltd Pearson Bducation North Asia, Ltd. Pearson Eacation Canad, Ld. Peatson Education de Mexico, S.A. de CV. Pearson Eaueation—Japan PPenrson Eduction Malaysia, Pte. Ld. Library of Congress Cataloging in Publication Data Mleisher, Craig S. ‘Business and competitive analysis methods: effective application of new and classic methods / Craig leisher, Babette Bensousean. prem, ISBN 0-13-1873660 (hardback ak. paper) 4. Business intelligence. 2. Competition. 1 Bersoussan, Babette BI Tie 038.7557 2007 658.4092--dee2 2006030882Business Model Analysis Short Description A business model has been defined as the “core logic by which a firm creates customer value.” Organizations that take leadership positions in their industries succeed by having an outstanding business model and executing it masterfully. Business model analysis (BMA) provides the tools to quantify the relative strength of an organization's business model to generate economic rents from a product or service. It acts as the link between the social domain, where economic rents are generated, and the cre- ative domain, where products and services are conceptualized. With a detailed examination of the components of the business model, the analyst can determine what in particular makes one business model superior to another, thus creating an effective understanding of the linkage between rents and the raw product or service. However, a business model can- not exist in isolation and must be viewed thorough the lens of competition; it is in this analysis that the superiority of one model over another may be established. ‘The elements of the business model for companies to consider are the following: @ The value proposition in the positions it adopts, The market segments it chooses to serve or avoid, 1 Its value chain and the resulting costs from the activities it performs or the resources it employs. W Its revenue model (or models) and the resulting profit potential. Its position and strength in the larger upstream and dowristream value network, including competitors and complementors. © Its competitive strategy and how it secks to gain a sustainable competitive advantage.hr Business and Competitive Analysis Understanding, the elements of a model at a detailed level allows a firm to change it to potentially generate larger economic rents, disrupt competitors, of to use it to competitive advantage. “This analysis integrates the concepts of the value proposition, market segments, value and oxtended value chains, revenue models, value migration, disruptive innovation, com- petitive strategy, and economic value Background Business models have existed since humans first traded goods in barter and have evolved to provide the means to deliver and capture superior custome ‘value, The oldest model still tied today is the shopkeeper model. Ik involves setting up shop where customers are like- i ly to be and displaying a good or service for sale. : Business models evolved from the “single-celled” shopkeeper model to more readily 5 deliver customer value and capture revenue. Such “multicelied organisms” can be cheeeved with tied products, such as the razor and blades mode} attributed to King C. Clete, where the razor is sold ata low price and the blade is sold at significant premi- . canerids model is used today to sell not only razors and blades, but also items such as ink jet printers /cartridges andl cell phones/air time. Other ‘models leverage consumer density ve Fiver value-—the telephone is an example of a network efficiency ‘model where the : Value provided to customers increases with the number of subscribers. Other well-known ; vere include a subscription business model, trace associations, co-operatives, and fran- Nises, which all may be classified as “collective” business models. “The old style auction has embraced technology and is now conducted, online with : providers like eBay, resulting in an immense increase in the number of potential buyers. : i Tt these moctls, if carefully considered, describe more how a firm will generate rev- enue-—there is no market segmentation inherent in them. ‘Other examples of recent business model innovations are MeDonald’s in the 1950s with their “Speedee Service System” for hamburgers; Toyota with is introduction of a sub Compact, the Datsun to the North American market ata time ‘when American cars were bigi sort Wal-Mart in the 19608, which provided branded high-quality products at discount prices in small towns. The 1970s saw new models from Toys “R” Us, which disrupted exist- Ing toy departments and discount department stores. The 198% sav! Dell and Intel intro- a heir business models, and in the 1990s, we had eBay and Amazon. Near business models are being introduced with great frequency, such a5 the technolo- gy of voice over Internet protocol (VOIP or voice over 1D), which delivers telephone calls Pring the Intemet, and threatens traditional telephone companies ‘and their associated busi- Using Hodels, Nunerous carriers are competing for VOIP business offering fo 5a voice etn morose the Internet for a fraction of the cost of the traditional switched networks. Sqowever as magical as this technology seems, its widespread implementation will only Y ae eced when a firm leveraging this techmology as@ disruptive force adopts 4 viable model H “These introductions represent more than just the emergence of new ‘competitors—the new iq concepls andl new technologies embodied in these models will disrupt existing business, : ‘The examples discussed previously represent only a small sample of well-known busi- nose medls and represent a fraction of those in use today. Hach successful new model hasBusiness Model Analysis found a way to deliver greater value to customers and, equally importantly, successfully capture that value for the firm, Business models are not static constructs but undergo fre- quent changes in response to competition, the macro environment, and the introduction of new models. ‘The end of the twentieth century saw the rise of business models that leveraged tech- nology offered by the Internet. These dot-coms were virtual companies, many existing only in cyberspace. Others followed what was known as a “bricks and clicks” model. Companies that used the bricks and clicks model had a physical location but looked to the Internet as another channel to generate sales. ‘The twenty-first century ushered in the “dot-com bust,” where thousands of compa- nies that described their business model as being “Internet-based” simply ceased to exist, in turn losing billions of dollars in venture capital. The pundits and the media told us that the old rules did not apply to these dot-coms. Stock valuations with price to earnings mul- tiples that were unheard of 10 years previously were okay because of the rules of the “new economy.” Critical examination of the models of “Intemet” companies was often poor, with attempts at separating the “model” from “strategy.” In fact, there was no alchemical trans- mutation to change the laws of business. The.pundits were wrong! Until the dot-com bust of 2000/2001, the term “business model” was poorly understood and poorly applied. Since then, academics and researchers have worked to understand, analyze, and clari- fy the definition of business models and study their respective components. Strategic Rationale and Implications ‘The dynamism of the business world must be translated to the model for a firm to remain in a leadership position. Technology disrupts existing businesses, markets, and the macro environment. New business models are a source of disruption as well. These disruptions can be harmful not only to existing firms, but to entire industries and even nations. The model a firm uses must adapt to meet the challenge of competition and the opportunities and threats posed. It must also provide the means for a firm to act on opportunities and leverage strengths. A superior business model will allow the firm to maintain or gain a leadership position in its industry, while an inferior model can spell disaster—hence, it is imperative to understand the relative strengths and weaknesses of the firm's own business ‘model through the lens of competition. This analysis allows the firm to determine its value proposition, targeted market seg- ments, value chain, relative position in the value network, and revenue model and place it in a superior position to deliver value to the customer. The firm can determine if it has a temporary or sustainable competitive advantage with its model and if the model lends itself to delivering factors critical to the firm’s success. Moreover, the same analysis applied toa competitor’s model will provide a broad understanding of the competition's strengths that can be neutralized and weaknesses that can be leveraged. The Business Model Definitions of business models range from “an organization’s core logic for creating, value” to “a story that explains how an enterprise works.” Some researchers consider how the pieces of a business fit together, but these approaches typically lack the critical aspects of 121E i‘ i , : Business and Competitive Anal strategy, which considers competition. Others view the business model as the missing link between strategy and business processes. Alan Afuah! provides a more complete definition of a business model, as follows: “A business model is the set of which activities a firm performs, how it performs them, and when it performs them, as it uses its resources to perform activities, given its industry to create superior customer value and put itself in a position to appropriate that value.” “There is, however, no real consensus of what a business model and its components are. ‘The purpose of every business is to satisfy a customer's need, This can only be done by looking at the business from the outside—from the point of view of the customer and the market, Chesborough and Rosenbloom? proposed the definition of a business model as a link between products, services, and economic rents earned by the firm utilizing the model ‘They propose that a business model incorporates the following six elements: 1, Value proposition——The value of the product or service from the customer's per- spective and how the product addresses customer's needs. 2. Market segment—With the recognition that consumers in different segments have diverse needs and will value the product or service in distinct ways, the value may only be unlocked if the right segment is targeted. 3, Value chain and cost models—This is the structure required to create and distribute the product ot service and the resulting cost models from performing activities and utilizing resources to deliver its value proposition to its target market. Revenue models—The revenue model and resulting profit potential. Value network—This is the firm’s position in the chain linking upstream and down- stream activities to the final consumer of the product. It should include suppliers, competitors, complementors, and other downstream activities 6. Competitive strategy—How the firm seeks to gain a sustainable competitive advan- tage. Figure 8.1 defines the various elements of a business model and how they fit together. It considers competition, or the relative ability and activities of the firm to create and deliver superior value in satisfying, a customer need or want, and it should justify the financial cap- ital needed to realize the model. Chesborough and Rosenbloom contrast the business model to strategy and suggest that there are three distinctions, as follows: 1. A business model's focus is on creating and capturing value. It seeks to define how that value will be created and the structure and method by which it will be captured. ‘The strategic layer goes further by attempting to define how a firm seeks to gener ate a competitive advantage. 2. A business model is a construct for converting the product or service into economic value, but it does not consider how to deliver that value to the shareholders that must be considered by the strategic layerBusiness Model Analysis 3. Strategy depends on knowledge of the wider environment the firm is to operate in. The business model does not require such knowledge and requires only a limited ‘understanding of its surroundings. From a practical perspective, the business model needs to understand its target market and the web that makes up its value network, ‘Business Model Value Proposition Paes Target Market ‘and Value Chain <> Services Costs and Revenue Value Network Competitive Strategy Economic Rents. Figure 8.1 The Business model Source: Adapted from Chesborough and Rosenbloom. "The role of the business model in capturing value from innovation: evidence from Xerox Corporation's technology spin-off companies," Industrial and Corporate Change, Volume 11, Number 3, pp. 529-555. Classification of Business Models Business models occur in an inestimable variety of shapes and sizes: One small disparity between two models—for example, with the target market and the value proposition~and they become substantially different. Extensive research has been directed at classifying the -vast array of existing business models. With the boom of the Internet economy, one focus has been classifying models that use the Internet; another has attempted to determine if one business model sharing a set of common characteristics is superior to another, ‘Two general approaches to model classification can be found. ‘The first approach attempts to group like models based on a set of shared characteristics. The resulting struc- ture is most often a two-dimensional construct: with position in the value chain, source of revenue, core profit-making activities, pricing policy, value integration, degree of econom- ie control, and others being considered along x and y axes. Following are two examples of such schemes. ‘Timmer’s? 11 e-business models use the degree of innovation and the degree of inte- gration as the characterizing dimensions, describing architecture for the product, service, and information flows. Linder and Canirell* propose a classification scheme based on a model's core profit- making activity and its relative position on the value chain, Linder and Cantrell’s scheme is broader in scope and does not limit itself to e-models. In determining the superiority of one business model concept over another, Linder and Cantrell concluded there is “no silver bullet,” and one model in their classification system ‘was not superior to another. Researchers from MIT classified models based on the type of asset and the rights to the asset being sold. Their classification and analysis of the 1000 largest US. firms along those dimensions state, “some business models do indeed perform better 123124 Business and Compatitive Analy than others.” The results from researchers are mixed; however, we do know some firms con sistently produce better results than others in the same industry—for example, Southwest in. the airline industry and Bristol Meyers Squibb in the pharmaceutical industry. In general, the profitability of a firm is determined by both firm- and industry-specific factors. Innovative integrative Less |More Tess |More Eshop |v. v E Procurement |v x E-Mall |v. v E-Auction Collaborative Platform Taformation Brokerage Third-Party Marketplace: Trust Services Value Chain Integrator Value Chain Servioe Virtual Community Z Figure 8.2 E-business models Source: Adapted from Timmer's Classification Scheme (1998). Win Ara Wo One Organization? Ho we aac and tan customers? Home ( courtnencad * ow do we deter Yat cur orguo vale proposition? ‘snare nine? “whet 0 our unique “Sing sesouren ond Sito ‘spablion? Intargas Figure 8.3. Operating model framework Source: Adapted from Linder, J., and S. Cantrell (2000), "Changing Business Models: Surveying the Landscape,” Accenture Institute for Strategic Change._Business Model Analysis BMA provides a means for bridging the gap between a firm's prosperity and its prod- ucts and services. For some firms, familiar business models cannot be applied, and new models must be devised. Adapting the models themselves serves to change the economic value of the products or service. In fact, changing any one of the elements of a model serves to change the economic rent derived from the good or service. Take, for example, the seg- ment served in the airline industry~the business traveler versus the tourist. Consider the activities in that value chain and the costs and the revenue-generation models. Continental and Southwest have different structures in their value chain, yet they basically start with the same raw material. Theit revenue generation models differ. They occupy the same location in the value chain. The various parts of the value net have differing ability to generate eco- nomic rents; for example, suppliers of aircraft based on the forces at work in that segment of the value net capture a differing level of economic rent from air travel than the airlines themselves. In order to generate superior rents, the organization must create superior value and avoid commoditization of its supply chain and distribution network to prevent value migration. Finally, competitive strategy determines how a firm creates a competitive strate- gic advantage over rivals. A superior business model will also ensure the value the firm appropriates from the customer is greater-than the costs of the activities undertaken, resources employed, and positions adopted in delivering that value. : BMA provides a holistic framework to combine all the activities of the firm in the pux~ suit of competitive advantage and to maximize the value delivered to the targeted cus- tomer. It then becomes possible to deliver superior value propositions to the target market and receive higher prices for the product or service delivered. The Dow Jones Industrial Average (DJIA) was introduced in 1896 to create an index from the leading firms of the day. Only one firm has survived to this day—General Electric. ‘The mortality of firms is well understood, estimates for first-year failure is an astonishing 70-80%; however, more interesting is the fall-ont rate from the S&P 500 and the Fortune 500, which is estimated to be between 2-6%. This effectively means that between 10 and 30 companies depart their leadership positions every year. Innovative business model intro- ductions have caused the disruption of established firms. Kmart, whose business models sustained it for 103 years, filed for Chapter 11 bankruptcy protection early in 2002. Railroads, which were the basis of the Dow prior to the turn of the twentiéth century, are minor players today. They saw their value migrate to other forms of transportation and their value proposition diminish along with their leadership positions, Jn 1994, Japan had 149 corporations listed in the Global 500 with $3.8 trillion in total ievenue; this fell to 82 corporations with $2.2 trillion in total revenue in 2004. This indicat- ed that the business models they employed no longer allowed them to occupy leadership positions. In the same timeframe, 1994 to 2004, the total revenue generated by the Global 500 increased from $10.3 trillion to $14.9 trillion. The inability to adapt business models to changing competitive and macro-economic conditions can spell disaster for firms, indus- tries, and nations. As a result of this history, there are two subtly distinct philosophical directions regard- ing business models, Christensen and Raynor® focus on technological evolution disrupting business models. Mitchell and Coles® suggest, “Improved business models will replace technology as the most frequent and most powerful source of business disruptions.” This is 8 powerful proposition—where the business model itself becomes a competitive weapon. It v5126 Business and Competitive Analysis stands to reason that the ability to modify or construct a business model to disrupt come | pelitors and avoid disruption can provide a significant advantage to a firm. BMA will determine the viability of any business model for any type of concern, including those organizations using multiple business models. Those organizations that do engage multiple models will benefit by understanding which part of their business is driv- ing revenue and which models need improvement. Additionally, conducting a BMA will alow a firm to understand its weaknesses and extend its advantages. BMA may also be used to disaggregate a competitor's position and understand where it is most vuinerable. Strengths and Advantages : Comprehensive BMA verifies the relationship of the firm's model—that is its strategy, positions, activities, land resources-—to the larger macro-environment, the industry, and its competitors. The Value delivery mechanisms of the firm and their interaction with the customer and the envi- Torment are made evident with this analysis. BMA provides a comprehensive approach beyond strategic and operational effectiveness in describing why a firm is profitable or unprofitable. Detailed Understanding BMA allows a detailed understanding of the advantages and disadvantages of the firm's value delivery systems, This understanding makes it possible to modify part or all of a busi- ‘hess model to create a competitive advantage. Those firms employing multiple models in multiple industries can quantify their relative strengths. ‘As a corollary, it is possible fo examine the relative position of competitors by using BMA and to use the insights from this analysis to disrupt their business models, Integration of Value Delivery Mechanism BMA delivers the ability to integrate the value delivery mechanism of the model and charge superior prices for the valute delivered. This in turn will lead to maximizing revenue gen- eration and consequently increased profitability for the firm being analyzed. Innovation BMA can provide an impetus to innovate within the organization, either with the model itself, the services and products that the firm provides to customers, or along any dimen- sion of the value delivery mechanisms of the firm. Identification of advantages at the target firm or identification of competitor weaknesses could enhance the innovation process. Weaknesses and Limitations } ye Disruption from Outside the Industry Firms may become blind to rivals offering innovative solutions or to those companies that are not considered direct competitors—this is a position detailed by Christensen and Raynor? as the primary means of business disruption. Firms must then consider not onlyie 7 Business Model Analysis 127 direct competitors, as emphasized in this analysis, but must also avoid being blindsided by firms and industries that are not considered direct rivals. Innovation Although this technique may be used to correct business model inconsistencies, it does not necessarily provide the means to innovate and consequently to provide additional value to customers. If a firm defines its leadership position too closely with that of current rivals, it may become a follower by adopting models that are easily duplicated, Market Orientation This technique will only be useful to a firm that has a market orientation. Its irrelevant for a firm that is producing a product and trying to sell it by targeting a heterogeneous market with a homogeneous marketing strategy. Process for Applying the Technique Step 1; Articulate the Value Proposition Value is determined by the customer—the firm needs to define the product or service it will provide and the forms in which a customer may use it, The value proposition will change depending on the target market specified, and there may he an iterative process between Steps 1 and 2, with a different proposition specified for each target segment. ‘The firm, through its value proposition, may choose to position its products or servic- esas low cost, differentiated, or niche-focused, Low-cost provider strategies work best in cases where: 1B Price competition is especially vigorous. 1 Competitive products are essentially identical. 1 There are few ways to achieve product differentiation that are meaningful to buyers. 8 Buyers incur low switching costs. Buyers are large and have significant power to bargain down prices. Differentiation allows a firm to command a premium price for its product and /or increase ‘unit sales. A firm can employ several differentiation themes; these can be based on product features, although they are the easiest for competitors to copy. Differentiation themes that ate difficult for competitors to copy can provide a sustainable competitive advantage, Bases for differentiation that are more difficult to imitate include the following: 8 Brand name or reputation. Coke, for example, is the best-known brand in the world. 1 Where the good or service is available. An extensive and well-configured distribu- tion network makes the product widely available to customers. 1 Extreme positioning in levels of quality or delivery—a six-sigma or beyond level of quality may be difficult to imitate. ‘The situation may be complicated by the fact that a firm supplies multiple products or serv- ices, and the question is whether the firm is operating multiple models or a single model.i 128 Business and Competitive Analysis Consider the case ofa bicycle shop: The basic business ofthis shop is to retail bicycles, accessories such as clothing, and bicycle parts, and to service bicycles. Bicycle service HY aeounl for 35-50% of revenue. Should this bicycle shop be considered two distinet busi- nesses, a service business, and a retail business? Or is ita single business model with a sustainable competitive advantage in service over an online retailer who sells bicycles sasramncesyories? What about General Hlectric, which is in the business of supplying i power systems as well as aiteraft engines? The technology in these two industries may well Be traneferable, partially answering the question: “Why are we one busi ness?” However, the question of disaggzegating a business model is best answered from a customer's per- \ spective, A customer for a bicycle would definitely consider how their bicycle would be 7 serviced when making their purchase decision. ‘The customer, in defining value, also provides guidance in the consideration of mod- cls. Ifthe customer sees the business offering as a whole, the separate activities undertaken bya firm should be considered as sources of aclvantage, OF where they are not offered, and should be, as sources of disadvantage. | Step 2: Specify the Target Segment Unless the firm is a very specific niche player, it may serve multiple segments of the mar- ket, and it may need to specify the changing propositions for each segment it chooses to wee ane d from whom it will derive economic tents, Quite often, a business provices more than one service of product; our bicycle shop, for example, provides bicycles, clothing, accessories, and service. For somebody seeking to purchase a nev’ bicycle, these may be SNewed as a bundle of services offered by the whole firm, and the proposition presented to them may be quite different than to an individual already owning a bicycle who wishes to have it serviced. Ie Segments can be broken down broadly by: (a) customer characteristics unrelated to the 5 product, generally known as demographics (Le,, geographic span, socioeconomics, etc.) Pd (6) product and/or service-related approaches that define user types, USES: and ben- fits generally known as psychographics. The analyst should pursue 8 detailed analysis of cae aeanket segments served by the firm-—edditional examples of segmentation bases 3 widely available!—and te the value proposition to customers who may desire different aspects of the product or service. “The objective is that customers’ needs must be understood, along with their growth potential; for exemple, with airline flights, ‘business consumers demand frequent, inexpen- bive flights with minimal delays, no lost baggage, and polite courteous service. If a cus- tomer’s needs are not well understood, analytical tools using customer focus groups, Kano model analysis, or quality function deployment (QFD) may ‘be especially useful. Step 3: Determine Competitors ‘Afiem exists within its industry because it serves those customers who see its value propo- ‘ition as superior to its competitors. Typically firms serving the same customer segments ; sith the same product or sexvice are perceived as “the competition.” These firms will i dccupy a similar position along the industry value chain and may have similar resourceBusiness Model Analysis 129 characteristics. However, there may be firms that provide substitute products; companies :that operate in niche markets; and suppliers or customers that have a credible threat of for- ward or backward integration. Firms that cause companies to forfeit their leadership posi; tions are rarely obvious and do not attempt to compete directly against established rivals; instead, they find new ways to deliver value to customers. Firms often surrender segments that have become unprofitable due to commoditization and later discover that those same competitors have moved up the experience and learning curves and now threaten another segment. Interviews with customers and sales staff and systematic, regular competitor analysis conducted by the firm will help identify current and future competition. ‘The analyst, after determining who the competitors are, will need to articulate the value propositions of those competitors and the target markets served by those firms. Step 4: Evaluate the Value Chain and the Cost Model With the ultimate goal of delivering value to, and capturing economic value from, the cus- tomer, itis imperative that the value chain be understood. To deliver the right value to the appropriate market segments, price it correctly, and position itself properly, a firm must undertake a specific set of activities. Using valtie chain analysis, these activities can be ana- lyzed to identify which step o steps provide economic advantage. A value chain identifies a series of activities that must be undertaken to transform inputs into a product or service delivered to customers, Figure 84 identifies the activities of a classic value chain. > > inbound Operations ‘Outbound Sales and Service and Logistics Logistics Marketing Aer Themoans by The means by The mavernent—-Marketing— ‘The dotivory of wich wich the of fished Identiication, _pro- and post- - components, enterprise products targeting, and sales services. £ = material and transforms raw through the satisfaction of a supplies move inputs into distribution customers? : from suppliers finished channels tothe needs. ‘ to the focal products or end customers __Sales—Reaching 5) Mfim’s site for Services. or users. customers, h uso in developing ni subsequent relationships 7 operations. with them, : delaling ° products, and order taking. Suppor Actvtios Research, Development, and Innovation ‘ Is Mm Human Resources Facets ‘Administration (Communications, Government Relations, Legal, Publi Affairs, otc.) Figure 8.4 Classic value chainBusiness and Competitive An: On the other hand, a customer-focused activity value chain (AVC) emphasizes the activities thata firm engages in to learn about customer's needs and the work required with customers in design, development, delivery testing, and installation of the product or serv- ice. This type of value chain is better suited to firms that provide intangible products or services. The two value chains are complementary, and both may be used. Perform Customer Conceptualize Creating Evaluating Research Solutions Prototypes Solutions. How the firm Ways the firm. Processes employed —_Predscision ‘dentifes and determines by firm to develop practices the fem assimilates today's alternative actual solution ‘employs to assess and tomorrow's producvservice models, ‘solutions under “real- customer needs. solutions. world” conditions. [operating Features ‘Marketing and Delivery Post-sales /and Production Selling Servico and Fotlow-up. What the firm does How the firm goes. Ways the firm Post-sales options to create the ‘about communicating Installs the product the firm employs to product/service. lis solutions to or solution to deliver added value current and potential customers and/or tocustomers alter ‘customers, sites-tocations. solution delivery Figure 8.5 Activity value chain Source: Adapted from Fahey, L. (1999). Competitors. New York, NY: John Wiley & Sons, p. 175. ‘The classic value chain facilitates an overview of what a firm does to access suppliers, its manufacturing, and service. A firm will pursue activities and employ resources to achieve its desired position and, as a result, will incur costs. Value chain analysis allows the analyst fo determine the current advantage or disadvantage of the firm along each segment oof the value chain and the resulting cost structure. The customer-focused AVC, on the other ‘hand, identifies all the direct and indirect interaction with customers, Conduct a classic value chain and/ox AVC analysis of the target firm. Compare the two value chains to the firm's direct competitors, as determined from competitive positioning analysis. Firms that are competing using radically different positions may not pursue simi: lar activities, Add the dimension of time to the value chain and AVC for both direct com- petitors and the target firm if appropriate, Use this analysis to extract where the firm has a competitive advantage or a competitive disadvantage. ‘The time dimension should elso include an understanding of experience curve effects. For the business model being analyzed, determine which resources a firm is leveraging to deliver value to the customer, The resources may be tangible, such as plant and equip: ‘ment, or intangible, such as patents, brands, or copyrights. They can be human, structural, or based on RED. A firin’s ability to turn its assets into customer value for different market segments is part of its competence or capability.ng Business Model Analysis Experience, Sis, Coste, at. Pant, Pry Esqipment Inventory. to Figure 8.6 Asset categories Source: Adapted from Fahey, L. (1999). Competitors. New York, NY: John Wiley & Sons, p. 300. Using the six asset categories identified in Figure 8.6, evaluate the assets the firm is using. The analyst should look beyond the firm’s own assets; it is not necessary for a firm to control or own the assets it leverages in pursuit of its model, Alliances, relationships, and networks may provide an organization with a competitive advantage by using, assets that are owned or controlled by another entity. Assets vary between the following five attributes: B Availability—Not all assets are equally available; capital, for example, is not avail- able in unlimited quantities. # Specificity —An asset is specific to place, tirhe, and space. An asset physically locat- ed in North America may provide little to no advantage in the Chinese environment, The range of application technology is typically limited; for exemple, technology designed to improve the hardness of rubber tires cannot suddenly be used in elec- tronics. @ Sustainability—Performance, for example, can increase the stock of capital avail- able, and poor quality may diminish the brand of the firm. @ Replicability—Organizational culture, knowledge, and other attributes may be dif ficult to reproduce. These may provide a source of great competitive advantage. 1 Substitutability—Can a given asset be trumped by another asset, thus reducing the value of that asset? 131132, 133 and Competitive Anal Step 5: Evaluate the Value Network Itis important to consider the value the firm is capable of capturing in its extended value chain or its relative position to its customers, suppliers, and rivals. The relative positioning of a product or service is critical. Ifa firm produces a product or service that it can supply to only one customer, it will be in an inferior position as its customer will have significant bargaining power. ‘A firm may have developed a value network that is capable of competing in dimen- sions where it has not been able to before; for example, Sony, to compete in the game con- sole market, established relationships with both IBM and Toshiba to produce multi-core processor architecture for Playstation in order to compete with the Microsoft-Intel team, ‘who had a clear lead in technical expertise. “This value network analysis should include suppliers, customers, complementors, and competitors. Step 6: Determine the Revenue Model for the Firm ‘The ability to appropriate value will depend on the revenue model the business uses. Txamples are: a subscription model commonly used with magazines; fee for service commonly used by realtors and agents; direct sales to end users; and so on. It is impor- tant to ensure that revenues are greater than costs. Analysis of the firm’s and competi- tors’ financial statements over time will reveal if the target firm enjoys an advantage over its competitors. “The reventie model should describe each revenue stream and how each stream brings in revenue; for example, a newspaper may have streams from direct newsstand sales, paper box sales, subscription, advertising, classifieds, and the Internet, and each of these revenue streams will incur a different cost. The evaluation of the revenue model should include an understanding of price compared to the competition, the value proposition, product qualt- ty, service, and the value customers perceive in the model. “The analyst should also be able to determine if the revenue /cost model at this stage is superior to that of the competition and is likely to produce better profits, The key here is also profit potential, and this may be determined from actual financial results, although they ean be misleading if viewed from a point in time—a firm may not have matured and ray be in its startup stage; the more important measure then becomes profit potential. Step 7: Determine the Critical Success Factors for the Industry Critical success factors (CSPs) are a limited set of aspects that are necessary to secure and gain a competitive advantage. CSIs tepresent those areas that are critical to fim’ success, providing a direct link to organizational performance (see Chapter 3, “Avoiding Analytical Pitfalls”) John F. Rockart! defined four basic sources of CSFs, as follows: @ Specific industry characteristics —The airline industry, for example, must provide frequent, on-time flights to successfully target business customers. i ‘Those arising from the chosen strategy of the business—High level of technical service is an important factor for companies secking to differentiate themselves in the welding industry.Business Model Analysis 133 B Favironmental characteristics or those resulting from economic or technological ‘change—For example, a telecommunications firm taking advantage of deregulation in the industry. 1 Those arising from the internal needs of the firm—An organic structure may be ctitical to a firm that has to compete in a highly innovative environment. Critical success factors that relate to position, activities, resources, and costs will be used to determine the strength of the business model. Sources that may be useful in determining CSFs are management tools such as the balanced scorecard and benchmarking, Other tools, e such as environmental analysis, industry structure analysis, internal analysis, competitor ee analysis, or using industry and business experts, are other sources for determining, CSEs. a Step 8: Complete an Analysis Grid Detailing Each Element of the Business Model ‘The objective of this analysis is to detail where in its business model a firm is capable of pro- . ducing a superior result. To complete the analysis, each element of the business model is . placed ina grid, as shown in Table 8.1. Bach element is ranked from 1 to 5 (superior) for the target firm and its competitors on an analysis grid, Table 8.1 Business Model Analysis Grid 3s er \ ca Value Proposition 4 in tie TRIE) target Markets 1 ‘Value Chain Analysis and Cost Model is eee feeceee reer eee is Value Network 3h sal Revenue Model and Profit Potential Strategy ad ‘This grid should, at a glance, allow the analyst to-determine which part of the business %, model is superior or inferior to its competitors. val Ultimately, the strength of firm's business model will be determined by its ability to convert the product/service domain to economic rents for the firm. The true value of this analysis lies in the ability of the firm to achieve a detailed understanding of the components i of its business model and to make improvements in components of the model design. The firm may find ways to innovate along its revenue model, its value chain, or some other ele- i ment, or disrupt its competition and generate greater economic rents. Because business models are not static constructs, the analyst will find it useful to generate both a current state and future state analysis and to review the analysis on a regular basis.Case Study: Dell Computer and the Printer Market ‘Dell Computer has been the darling of the petsonal computer industry, gaining market share—-reported at 18.2% of all units shipped worldwide in 2004—and reporting revenue growth in double digits, outstripping its rivals year after year. Dell is a competitor to IBM, HIP, and other firms, not only in computers but also in areas such as printers, storage, hand- held devices, and increasingly in consumer electronics. Dell has entered the low-end printer business using its direct model and threatens mar- et leer HP. Can Del's printer model propel to success allowing ito capture sufficient market share to disrupt FIP? Dell's competitors in the printer market are HP (the market leader), Epson, Lexmark, and Canon, HP by far has the largest share, with 60% of the existing market, Epson has 16% and Lexmark 12%, Dell has approximately 3% of the current market, selling‘a small num- ber of printers to businesses while its most active market is the ‘home consumer market, HP excels at RED, rolls out new product lines to remain competitive, and expects to introduce digital printing, which could save corporations up to 30% in costs each year. HP earns 70% of its profits from sales of ink and printers ‘Low-cost, high-quality, easy to use, readily available products win in the marketplace, and printers are no exception. However, innovative nev printers that produce better pic- wel se maltiznedia cards directly, and interface to other devices also sell. Highly differ- sntiated products as a result of R&D, brand, and widespread distribution appear be the driving CSPs for the printer industry, and Dell's brand cannot compete with HP’s and Lexmark’s. Dell has adopted a low-cost direct sales approach to target business customers, Which comprises 80% of its personal computer sales. ‘Dell has licensed products from Lexmark, which it sells under its own ‘brand name, that meet the needs: of business customers. HP tar- gets a larger spectrum of business printing, with a broader range of products than Dell—for example, high-end color laser printers. Lexmark and Epson, ‘while competing in the same range of products as Dell,offer customers dot matrix printers. HP and Lexmark have strong, distribution networks and are readily available. Dell has a well understood, sustainable competitive advantage along its activity chain that ithas atlized to dominate the personal computer industry. Its cash conversion c¥ete because of efficiencies, especially in inventory, has improved from minus 18 days in 2000 to minus 36 days in 2004. HP, however, has an advantage in R&D and the ability to launch now innovative products far more quickly than Dell. Del! must work with Lexmark, who manufactures its product. However, Dell could match this R&D capability by acquiring technology from a printer manufacturer and entering the market with product it manufac- tures directly and sustain its momentum by investing in R&D. ‘Both companies use the razor and blades model to generate revenuc, However, Dell sells using its electronic model, while HP uses ‘conventional distribution, which is signifi: tantly more difficult to manage. The advantage must go to Dell here Using an abbreviated form of the BMA, analysts can quickly determine where weak- nesses or advantages might lie by comparing each element of the ‘Dell and HP printer busi- ness models, as follows:Business Model Analysis 135 Value proposition—Dell is competing on price with limited high-end printers avail able to large business that allows centralized management. It does not provide large printers with robust duty cycles. Advantage: HP. 1 Target markets—The result of the value proposition and the product offering is that Dell’s active market segment is the home consumer. In 2004, Dell sold some 31,000 laser printers, compared to over 2,000,000 for HP. Advantage: HP. Value chain analysis and cost structure—With Dell’s value chain and cost structure and the complexity HP has in shipping product actoss the country for distribution, the advantage lies with Dell here. Value network—Dell purchases a number of its printers from Lexmark; however, both have a PC business and make storage devices. Consequently, neither have an advantage. 4 Revenue model—Both companies use the razor and blades model, with neither having a 5 Strategy—Dell has a sustainable competitive advantage with its revenue model; however, this does not seem to be Well aligned in printers with the CSFs for the industry, HP printers are readily available for demonstration at stores and to dis- tributors. Printers, in fact, may not lend themselves to Internet selling or distribu- tion. Advantage: HP. In examining the BMA grid in Table 8.2, we can see that HP indeed has an overall advan- tage with its business model, and Dell needs to seek a new value proposition, target mar- ket, and strategy if it is going to succeed. The printer market is extremely competitive, char- acterized by low prices and razor-thin margins. At this point in time, Dell has not been able to penetrate this market aggressively because of issues with its positioning, active market segments, and strategy. Table 8.2 Business Model Analysis Grid—Dell Versus HP. Velue Proposition Target Markets Value Chain Analysis and Cost Model Velue Network Revenue Model and Profit Potential Strategy Darker » SuperiorB FAROUT Summary FAROUT SUMMARY 1 2 3 4 8 F A A ° U T Figure 8.7 Business model analysis FAROUT summary Enture orientation—Medium. BMA provides a medium orientation, giving the target 'n business model and its integration with the industry ted forward-looking view is mitigated by the erosion petitor offerings, or disruptive industry firm a comprehensive view of its ow! and macro environment. This integral of customer value by potentially superior comy forces. “Accuracy--Meediuim. While the analysis is somewhat subjective, its accuracy is deter- mined by the accuracy and skill of the analyst: This has been rated as “medium” but, depending, on the quality of the analyst, this can vary. “Resource efciency—Meedium to high. Analysis of a firm can be completed rapicly; the research required and the complexity of tools used are limited. Medium-high resource effi- Giency should be expected. Onjetivily— Medium. ‘The detailed nature ofthe analysis, while allowing for some sub- jectivity, forces structure on the analyst. Usefulness—Mediuum to high. The analysis provides # comprehensive view of the busi- ness model and an opportunity to correct model irregularities and attack competitor's weaknesses. ‘Tineliness--Medium, Analysis can be completed readily but contingent on the detail required; in contrast to other analysis techniques, this is high. Related Tools and-Techniques Activity value chain analysis 3 Competitor profiling 1 Competitor segmentation analysis B Customer value analysis @ Financial ratio analysisFunctional capability and resource analysis © Thdustry analysis 1 Kano model analysis @ Quality function deployment @ STEEP analysi 8 Strategic funds programming Strategic group maps @ Value chain analysis References Aaker, D. (2005). Strategic Market Management, Hoboken, NJ: John Wiley & Sons. ‘Afuah, A. (2004). Business Models: A Strategic Management Approach. New York, NY: McGraw-Hill Irwin, pp. 3,5, 12, 173-209, Chesbrough, H., and R. Rosenbloom (2002). "The role of the business model in capturing value from innovation: Evidence from Xerox Corporation's technology spin-off com- panies," Industrial and Corporate Change, Volume 11, Number 3, pp. 529-555. Christensen, C.M., and M.E. Raynor (2003). The Innovators Solution. Boston, MA: Harvard Business School Press, pp. 56-65. Drucker, PE. (2001). 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