Categories
Business models

5 business model innovations you should know about

Business model innovations mean reconfiguring a business while it continues to deliver same products (possibly) to the same markets in a different way. Technology, such as the Internet, plays typically an important role as an enabler.

Oftentimes, business model innovations involve changes in the backend of the company. Such alterations are mostly invisible for the competitors and thus difficult to copy. Consequently, it is not a secret that managers consider business model innovation one of the best opportunities to grow their company and gain competitive advantage (click here to read more about why business models matter).

While there are a number of successful examples of business model innovations, some companies have become famous for theirs. These companies were considered important pioneers as they developed novel ways to conduct business in their respective industry, and some of them even created whole new industries.

In the following, I briefly introduce five famous business model innovations that have taken place between 1959 and today.

Famous business model innovations

Xerox: Pay per Copy

Xerox is a multinational Fortune 500 company that sells print and digital document products and services. The famous business model innovation was introduced in 1959, roughly 60 years ago, however it is one of the greatest examples how simple ideas and relatively small iterations in the revenue model can lead to immense financial implications.

Originally named Haloid and later to be renamed Xerox, the company had developed a copy machine, Model 914, that was based on novel and superior technology compared to what existed already. The problem was that the machine was about six to seven times more expensive than alternative methods ($2,000 vs. $300), which made it difficult to penetrate the market. Potential strong marketing partners weren’t willing to help either.

Instead of selling the equipment, Xerox (Haloid) decided to lease the copy machine at $95 per month and charge $0.04 per copy after the first 2,000 each month. Xerox would also take care of the service and support thus lowering the risk and burden of its customers.

Although back then the average number of copies per month a typical office machine produced was only 15-20, the new pricing model was very attractive for customers. The technology turned out to be convenient and working well, and Xerox found out that customers were soon making 2,000 copies per day! Over the next 12 years, the company grew its revenues from $30 million to $2.5 billion in 19721 .

Rolls-Royce: Power-by-the-Hour

Rolls-Royce was founded in 1904 when Charles Rolls and Henry Royce established a collaboration to develop and produce the “best cars in the world”. The World Wars brought them into manufacturing engines for aircrafts and the famous business model innovation was introduced in 19622.

The company was exclusively selling the ownership of its engines to aircraft manufacturers. Aircrafts were purchased by airlines who then paid Rolls Royce for the reparations and maintenance of the engines. This was a very risky business for the airlines, in particular smaller ones, since engine breakdowns could be extremely costly and result in grounding a plane for weeks.

Rolls Royce then introduced a new business model that didn’t sell engines to the aircraft manufacturers but thrust hours to the airlines. This reduced the airlines’ risk significantly and encouraged Rolls Royce to develop even better engines as more flight hours would mean more income while more resources spent on repairing the engines would mean less income. The business model innovation resulted in a completely new value creation dynamic for the industry.

Dell: Made-to-Order

Dell is one of the largest technology companies today and an interesting example of a business model innovation. Michael Dell started the company in 1984 and generated $6 million in sales the next year and $25 billion 15 years later. How is that even possible?

Dell started out as a provider of hard-drive upgrades. Soon after its founding, the company changed its business model to offer personal computers directly to the end customer without the retail middleman. The purpose of this made-to-order design was to cut both the reseller markup and the cost of carrying inventory. This became known as the direct business model3.

The direct business model enabled Dell to sell customized PCs at a low cost. As opposed to most of its competitors, the company was able to focus on configuring its supply chain and distribution to best match the market’s expectations without having to deal with retailers. In addition, Dell could be closer to its customers and collect data directly to anticipate demand and develop better products. All these innovations together, supported by smart technological solutions, made Dell one of the largest global players in the PC industry.

Nespresso: Exclusive pod coffee

Nespresso was founded in 1986 although the system (machine, pod) was patented already in 1976 by a Nestlé employee. The original business model was to sell coffee machines and espresso coffee contained in small pods made of aluminum. The business was not very successful initially and the company almost went bankrupt.

It wasn’t until Nespresso introduced the “Le Club” in the 1990’s that the company started to become more successful. The concept of customers belonging to an exclusive club that offered personalized service became the third part of the Nespresso system (machine, pod, service). The pods were initially sold online but in 2000 Nespresso opened its first concept store in Paris followed by hundreds of similar stores around the world.

By establishing a strong brand and customer relationships through direct sales involving exclusive and personalized service, Nespresso was (is) able to charge a premium price for its products and grow to a company with $4 billion in sales today.

Nespresso revolutionized the way coffee is sold to consumers. It created a business with recurring revenues from direct sales (pods) and imposed high customer switching costs (the machine would take only Nespresso pods) that prevented existing customers from changing to a competitor. This helped Nespresso sustain its business when its 1,700 patents started to expire around 2011-2012 and the company had to find ways to pre-empt competition4.

Netflix’s streaming service

Netflix was founded in 1997 as an online DVD rental store where the DVDs were delivered to the users via mail. This business model was an innovation per se as it disrupted existing brick-and-mortar competitors. Since then, the company has introduced a series of changes in its business model.

Soon after its founding, the company started offering subscription-based DVD rentals. In 2005, Netflix was debating whether it should expand by providing online streaming service or a hardware device designed to help download movies overnight. At the same time, Youtube was gaining immense popularity despite the lack of high-definition content. Consequently, Netflix rejected the idea of a “Netflix box” and opted for video-on-demand and online streaming service, which it introduced in 2007.

Over the course of its rapid growth, Netflix separated its DVD rental business from the streaming service (still having 3 million subscribers to the service), introduced a powerful recommendation algorithm, and integrated backward into content production5. As we all know, it is today by far the best-known online streaming service with a vast library of content that about 167 million subscribers around the world use to binge-watch movies and TV shows.

Conclusion

It is important to note that coming up with business model innovations is extremely difficult. Some of the examples given in this article may seem to have been easy little changes in the companies’ business model that resulted in huge success.

Behind the scenes though, Rolls-Royce and Nespresso for example, were struggling with their business and almost ceased to exist. Their business model innovations are long stories involving multiple experiments, trial-and-error phases, and moments of despair.

Also, “innovation” doesn’t automatically mean successful changes. A novel business model can, of course, also end up being nothing but a test or an interesting (and possibly sad) story to tell. One of my favorite examples of an innovative business model that first appeared pointless and impossible, then smart and potentially successful, and finally foolish, is that of MoviePass.

Yet, due to the potential that successful business model innovations hold, they have become an important part of companies’ strategic planning and corporate entrepreneurship.


References

1Chesbrough, H. & Rosenbloom, R. S. 2002. The role of the business model in capturing value from innovation: Evidence from Xerox Corporation’s technology spin-off companies. Industrial and Corporate Change.
2Rolls-Royce press release from October 2012: “Rolls-Royce celebrates 50th anniversary of Power-by-the-Hour“, https://www.rolls-royce.com/media/press-releases-archive/yr-2012/121030-the-hour.aspx.
3Magretta, J. 1998. The power of virtual integration: An interview with Dell Computer’s Michael Dell. Harvard Business Review, March-April issue.
4Matzler, K., Bailom, F., Friedrich von den Eichen, S. & Kohler, T. 2013. Business model innovation: Coffee triumphs for Nespresso. Journal of Business Strategy.
5Rothaermel, F. & Guenther, A. 2017. Netflix, Inc. Case studies published by McGraw-Hill Education.

Leave a comment