Business models

Over the last few centuries, business models have undergone an incredible transformation:

  1. Medieval — guilds (i.e. smiths)
  2. 19th century — factory system (i.e. textile mills)
  3. 20th century — production line systems (i.e. Ford)
  4. 21st century — network systems (i.e. Google)

The evolution has been enabled by great inventors allowing new ways to accommodate gaps in the exchange of value. A business model consists of many components not limited to products, design, distribution, experience, partnerships, resources, value proposition, activities, cost structure, revenue generation, customer identification, and relationships. With all these moving components it is incredibly difficult to define a business model. Throughout history, technology changes what business models are possible. With the invention of the Internet and related tools, business models centered around economies of scale, global brand, lock-in, and network effects have become possible where they were incredibly difficult to attain centuries ago. Now new modalities and tools are emerging that will allow other unique business models to be created. Driven by inventors, the companies that implement these business models will have an outsized impact on society.

Throughout the history of business, ideas are reconfigured to take advantage of new tools and methods. This synthesis help drive the growth from two-way trades that defined the classical world to modern enterprises. An analogous field that underwent a similar transformation was biology — the modern evolutionary synthesis brought concepts on evolution from the 19th century with Mendelian genetics, which was rediscovered at the beginning of the 20th century.

Before the rediscovery of Mendel’s work on genetics, the prevailing theory on evolution was blended inheritance where a progeny’s traits were an intermediate between their parents. Mendel proved that genetic material did not change across generation where genes are discrete and phenotypes are not. By the early 20th century, scientists including Fisher, Haldane, Simpson, Stebbins, Dobzhansky, Mayr, and Huxley united the work of Mendel with Darwin’s evolutionary framework. The modern evolutionary synthesis posited that evolutionary forces do not only include natural selection but also genetic mutations, gene flow, and genetic drift. As genes are passed down generation to generation, mutations alter these genes overtime creating variation. Natural selection acts upon this variation to choose the altered genes with the highest fitness.

This work led to the establishment of population genetics and putting selection and adaptation at the center of biology. To the present day, the evolutionary modern synthesis is continuously being added to as new discoveries are made with better tooling. The discovery of the structure of DNA, the central dogma of molecular biology, developmental biology (i.e. evodevo), punctuated evolution (i.e. speciation), and the endosymbiotic origin of mitochondria have been incorporated into the framework. Similarly, in business old idea and combined with new ones to create unique structures. In biology, new theories are created while in business new models are used.

An easy way to have the chance to create a unique business model is to study their taxonomy. The canonical types of business can be described almost as ideal types — they are generalizations emerging from practice yet they create abstract concepts easily reused. With a business model sharing similar features to model organisms, the simple idea of identifying and engaging customers and converting payments into profits can be constantly recreated to fit the emergence of new tools. In the early days of formally studying businesses, models were “bucketed” according how they generate sales alone. As new models emerge and show success, this study is now appreciating studying an entire model similar to the shift of studying discrete genes in model organisms to understanding the entire model (i.e. systems biology). The best start is to begin to enumerate business models then observe their uses in new markets. Business model descriptors are usually not exclusive and are mixed and matched in ways that help amplify a small set of advantages. Most of the time it is not as simple to replicate a model for another product/service due to competitive dynamics, timing, or userbase. For example, the world-class customer service Zappos provides is unique to the culture and leadership. As a result, it is extremely difficult to replicate Zappos’ work for another product like shirts. A shirts company can be inspired by Zappos to provide the highest quality of service to customer but probably needs to find another model that fits the product peculiarities.

  1. Customer experience: Apple — creating a business centered around brand world-class products through vertical integration
  2. Network effects (can come in different forms such as direct, two-sided, data): Facebook — the value of the product increases as more people use it
  3. Structure: Walmart — restructuring a retail business to create stronger alignment between distribution and sales to increase operating leverage
  4. Process: Zara — implementing a take it or leave it retail business
  5. Freemium: Dropbox — offering tiers of storage services to bootstraps users and create a self-serve sales model
  6. Service: Zappos — differentiate a business on customer service
  7. Distribution: Ikea — reduce shipping of goods through making their products self-assembled
  8. Brand: Virgin — create a visible brand that can be out licensed to other businesses
  9. Customer engagement: Disney — engage customers in multiple settings, theme parks, movies, and stores, to cross-sell
  10. Economies of scale: Vale — reach a scale where production is profitable usually for a commodity
  11. Lock-in: Oracle — make a product indispensable to a customer
  12. Brokerage: Century 21 — connect buyers and sellers of a good
  13. Bundling: Comcast — combine two or more products together to increase pricing power
  14. Subscription: Salesforce — use is paid for on a recurring basis
  15. Direct sales: Dell — bring a product conventionally sold through intermediaries directly to the customer
  16. Fractionalization: NetJets — sell fractions of a good rather than the whole
  17. Razor blade: HP — offer high-margin product below cost to increase volume of sales for low-margin product
  18. Reverse razor blades: Amazon Kindle — offer low-margin product below cost to increase volume of sales for high-margin product
  19. Low cost carrier: Ryanair — most traditional services are not provided in the far resulting in lower costs and fewer comforts
  20. Royalties: Qualcomm — sells licenses on their chips without manufacturing them
  21. Licensing: Genzyme — licenses technology from the outside and then develops them in-house
  22. Pay-as-you-go: PG&E — user pay depending on their use
  23. Crowdsourcing: YouTube — aggregate content/product from users individuals and distributes them at scale
  24. Leasing: Hertz — sell use of a product for a specified amount of time
  25. Low cost, low touch: IKEA — provide low customer support to achieve lower costs
  26. Negative operating cycle: Amazon — receive payment before delivering
  27. Standardization: MinuteClinic — create a standard experience to provide low costs for a reliable experience
  28. Auction: Ebay — buyers submit the highest price they can to win a good/service provided by a seller
  29. Reverse auction: Elance — sellers submit the lowest price they can to win a buyer
  30. Sharing: Airbnb — create a marketplace for users to share a good without owning the underlying asset often effective for high volume goods/services
  31. Franchise: McDonald’s — provide the blueprint for a business model without maintaining the underlying asset
  32. Open-source: Bitcoin — developers are incentivized to improve the underlying technology through holdings or exposure to the technology itself
  33. Annual improvements: Monsanto — improve product on a recurring basis to incentivize customers for replacement not reuse
  34. Brand acquisition: Procter & Gamble — licenses and acquires products from other companies and brings them to market as Procter & Gamble brands
  35. Cooperative: Cheeseboard — creating a business owned by the employees often reliant on a strong brand to maintain profitability
  36. Platform/Tools: Red Hat — create a set of tools to maintain another product
  37. Loyalty: American Express — provide rewards to the user-base in order to lower customer churn
  38. Multi-level marketing: Amway — independent sellers distribute products to customers and also train new sellers

Old-fashioned ideas like having profits continue to matter. All companies have a choice on what business model they want to use — they can create one, transform an existing model, diversify, or just acquire one outright. Like biology, it usually is not as discrete. However, this process can create durable advantages that can last decades. Taking feedback from stakeholders can help create new sets of transactions that change the long-term viability of a business. Usually these new developments are enabled by an invention that unlocks previous constraints. It is usually a death knell when a business does not take this feedback and doubles down on a stale approach.

Special thanks to Shinya Iguchi as well as others kind enough to review and provide feedback on this piece.

Written on January 6, 2019