20101202 Master Thesis David Weiss - Ningapi.ning.com/.../20101202_MasterThesis_DavidWeiss.pdf ·...
Transcript of 20101202 Master Thesis David Weiss - Ningapi.ning.com/.../20101202_MasterThesis_DavidWeiss.pdf ·...
Zeppelin University
Department for Corporate Management & Economics Chair for Innovation Management
Prof. Dr. Ellen Enkel
Dipl. Ing. Annette Horváth
Business Model Innovation in Venture Capital Investment Funds: Business Model Due Diligence in Venture Appraisal
Master Thesis
David M. Weiss [email protected]
02.12.2010
Table of Contents
I
Table of Contents
Table of Contents ........................................................................................... I
List of Figures ............................................................................................... III
List of Tables ............................................................................................... IV
List of Abbreviations .................................................................................... V
1. Introduction ............................................................................................. 61.1 Problem Outline and Relevance of Business Model Innovation and
Business Model Evaluation ................................................................... 71.2 Aim and Limitations ............................................................................... 121.3 Structure of Study and Proceedings ..................................................... 15
2. Early Stage Investment Appraisal ....................................................... 162.1 Early Stage and Venture Capital ........................................................... 162.2 Screening and Due Diligence: How Much Diligence is Due ................. 18
3. Definition of Business Model and its Context .................................... 193.1 Innovation ............................................................................................. 193.2 Business Model Innovation ................................................................... 203.3 Business Model ..................................................................................... 223.4 Business Model Typologies .................................................................. 24
4. Evaluation Approaches in Theory ....................................................... 284.1 Amit and Zott ......................................................................................... 284.1.1 Evaluation Approach ........................................................................... 284.1.2 Evaluation Approach in Theory Context .............................................. 324.1.3 Appraisal ............................................................................................. 364.2 Hamel .................................................................................................... 364.2.1 Business Model ................................................................................... 364.2.2 Evaluation Approach ........................................................................... 394.2.3 Appraisal ............................................................................................. 414.3 Morris, Schindehutte, Richardson and Allen ......................................... 414.3.1 Evaluation Approach ........................................................................... 414.3.2 Appraisal ............................................................................................. 434.4 Shi and Manning ................................................................................... 434.4.1 Evaluation Approach ........................................................................... 434.4.2 Appraisal ............................................................................................. 44
Table of Contents
II
4.5 Osterwalder et al. .................................................................................. 454.5.1 Evaluation Approach ........................................................................... 464.5.2 Appraisal ............................................................................................. 49
5. Business Model Due Diligence ............................................................ 505.1 Combined Evaluation Framework ......................................................... 505.2 Evaluation Criteria ................................................................................. 565.3 Evaluation Instrument Operationalized ................................................. 57
6. Survey and Methodology ..................................................................... 606.1 Research Partner .................................................................................. 606.2 Survey Results ...................................................................................... 60
7. Conclusion ............................................................................................ 65
Appendix ...................................................................................................... VI
Bibliography .................................................................................................. X
List of Figures
III
List of Figures
Figure 1: Business Model Articles in Academic and Non-Academic Literature ......................................................................................................... 7Figure 2: Operating Margin of Business Model Innovators Compared to Product and Process Innovators ................................................................... 10Figure 3: Average Premiums with Business Model Innovators Compared to Product and Process Innovators ............................................................... 11Figure 4: Types of Due Diligence .................................................................. 15Figure 5: Venture Capital Positioned in Investment Landscape .................... 17Figure 6: Venture Capital Investment Workflow ............................................ 18Figure 7: Dual Structure of Evaluation Instrument Positioned in HTGF Investments Workflow ................................................................................... 19Figure 8: Three Types on Innovation ............................................................. 20Figure 9: Three Types of Business Model Innovation ................................... 20Figure 10: Business Model Innovation Options ............................................. 22Figure 11: Strategy, Business Model and Tactics ......................................... 23Figure 12: Business Model Framework, Hamel ............................................. 37Figure 13: Big Picture Business Model Evaluation ........................................ 47Figure 14: Business Model Adaption ............................................................. 47Figure 15: Business Model Evaluation, Detailed SWOT ............................... 49Figure 16:Extended Framework of Amit and Zott .......................................... 52Figure 17: Extended Business Model Framework of Osterwalder et al. ........ 53Figure 18: New Combinded Framework: Osterwalder’s Component Framework Identified in Amit and Zott’s Framework ..................................... 54Figure 19: New Combined Framework: Amit and Zott’s Framework Identified in Osterwalder’s Component Framework ....................................... 55Figure 20: Framework Applied to Evaluation Criteria .................................... 57Figure 21: Business Model Due Diligence Tool, Long List Ratings at Level 2 ........................................................................................................... 58Figure 22: Business Model Due Diligence Tool, Caption .............................. 59Figure 23: Business Model Due Diligence Tool, Short List Ratings at Level 1 ........................................................................................................... 59
List of Tables
IV
List of Tables
Table 1: Survey Results on VC Evaluation Criteria ....................................... 14Table 2: Business Model Typologies in General ........................................... 25Table 3: Business Model Typologies in E-Business ...................................... 26Table 4: Business Model Elements and Design Themes .............................. 32Table 5: Anchoring of Design Themes in Theory .......................................... 34Table 6: Anchoring of Business Model Framework in Theory ....................... 35Table 7: Business Model Component Comparison ....................................... 42Table 8: Risk Evaluation Framework ............................................................. 44Table 9: Merging Terminology of Osterwalder et al. and Amit and Zott ........ 54Table 10: Sources of Evaluation Criteria, Short List ...................................... 56Table 11: Criteria Rating by Investment Managers ....................................... 63Table 12: Evaluation Aggregation ................................................................. 63Table 13: Criteria Ranking ............................................................................. 64
List of Abbreviations
V
List of Abbreviations
e.g. exempli gratia
et al. et alia
HTGF High-Tech Gründerfonds
i.e. id est
R&D research and development
SWOT strengths, weaknesses, opportunities threats
VC venture capital
VCs venture capitalists
1. Introduction
6
1. Introduction
Adapt or die.
Charles Darwin is quoted to have said, “It is not the strongest species that
survive nor the most intelligent, but the ones most responsive to change”.
This also holds true for companies and the way they conduct business. In
this context you may rephrase the above statement positively to read, “adapt
and outperform”.
A business model captures the logic of how companies do business. This is
why business model innovation has received increased attention over the last
decade. Companies need to understand what Business models are and how
you can design and redesign them in order to adapt to and survive in a
changing environment. Traditionally, hopes have been placed on innovative
technology as means to ensuring a comparative advantage. This no longer
holds true. There are numerous examples of companies that do not have
innovative technology and are nevertheless extremely successful simply be-
cause of a strong business model. A case in point is T-shirt producer Thread-
less. The company has integrated the customer into all major parts of the
value creation process – from designing prints to voting on which designs
should be printed ensuring that the exact demand for each print is met in
production. Like a conductor it orchestrates the players by making use of an
internet platform that is in essence quite simple and does not represent a
technological innovation. In spite of this, Threadless produces strong margins
and has been performing well.
If this company had not yet been founded and a team of entrepreneurs
showed up at a venture capital (subsequently VC) fund to present their busi-
ness idea, how could the investors know if this concept would prove to be a
success and if he should invest?
That is the ultimate question an investor needs to answer. This study identi-
fies the business model as one important source of information hardly made
use of in business practice and provides an instrument to unlock the busi-
ness model’s potential as source of information.
1. Introduction
7
1.1 Problem Outline and Relevance of Business Model Innovation and Business Model Evaluation
With the advent of the internet in the mid 1990s it became possible to con-
duct business in new ways. Information was able to flow efficiently at increas-
ing speed and volume as technology progressed and geographic regions
around the world became connected. The World Wide Web would prove to
do its part in making the world a global village.
The concept of Business models is nothing new. Every transaction since the
beginning of humankind can be reduced to some kind of model no matter
how simple, whether or not it was explicitly stated or consciously perceived
as such. The last twenty years and most notably the last decade have seen
an increase in interest in business models. The following figure shows the
numeric increase in publication in the field of business model innovation in
the past years. A clear jump can be identified in 1995.
Figure 11: Business Model Articles in Academic and Non-Academic Literature
1 Source: Amit et al. (2010)
The graph shows trends in the number of business model articles. „PnAJ“ identifies those articles Published in non-Academic Journals. „PAJ“ identifies articles Publis-
1. Introduction
8
The vast opportunities e-businesses offered and the first success stories of
the dotcom era created interest and incentives to think systematically about
how to conduct business in this newly emerging environment. Some of to-
day’s most successful businesses have emerged from this field. Not just e-
businesses have profited from systematically designing and redesigning
business models. There are numerous examples in other industries: Stihl
have shifted from selling heavy machinery to leasing; Rolls Royce does no
longer sells airplane engines but charges for the time in use. Currently Daim-
ler is rethinking their core business of selling cars by working on their “car 2
go” concept. Adopting the cost structure of the mobile phone industry cars
can be rented ad hoc for EUR 0.19 per minute in the organization’s pilot pro-
ject city of Ulm.
Apple’s success in recent years is credited to its ability to define a workable
business model for downloading music. “The combination of product innova-
tion and business model innovation (…) put Apple at the center of a market
approximately 30 times larger than its original market” (Lindgardt et al.,
2009).
Even investment funds acknowledge the importance of the business model
towards the success of a venture. This study is conducted in cooperation with
the praxis partner High-Tech Gründerfonds (subsequently HTGF). HTGF has
been traditionally focusing on investing into ventures with strong technology
USPs and has experienced that a considerable amount of portfolio compa-
nies with less interesting technology outperform technology-based firms. This
observation has lead to the idea of having a closer look at business models
and coming up with an instrument that would allow to make an ex ante
statement concerning its potential for success.
In literature there a numerous statements and findings that point to the fact
that the business model is indeed an important object of analysis and that
there is a need to expand research in this field. Chesbrough sums it up in his
hed in Academic Journals. Literature source employed: Business Source Complete EBSCOhost Database. Period: Ja-nuary 1975–December 2009.
1. Introduction
9
publication entitled “Business model innovation: it’s not just about technology
anymore” (Chesbrough, 2007). The days of focusing solely on innovative
technology as source of comparative advantage are long gone. “Today, inno-
vation must include business models, rather than just technology and R&D.
(…) A better business model often will beat a better idea or technology”
(Chesbrough, 2007). Competing on technology alone is increasingly difficult
with ever decreasing product life cycles and increasing costs of R&D. In fact
Casadeus-Masanell and Ricart (2010) point to the fact that firms compete
through their business model and that therefore the business model itself is a
source of comparative advantage. A disruptively innovative business model
can create such a comparative advantage in the same vain and become the
key asset and USP itself of the company. This does not mean that technolog-
ical innovation has become irrelevant. It means keeping pace with both these
elements: technological and business model innovation.
Rivette and Kline (2000) and Rappa (2001) point to the patentability of Busi-
ness models. It is only possible to patent Business models in the USA, how-
ever. That is a limiting factor. But to ventures operating in an industry that
cannot exclude the USA as market a patent only in the USA may present a
key asset.
Results of a study conducted by IBM in 2006 clearly show the relevance of
business model innovation. In figure (2) the right bar represents business
model innovators, the left bar product, service, market innovators and the
middle bar process innovators. Measured in cumulative annual growth rate
over five years in percent business model innovators clearly outperform
product and process innovators.
1. Introduction
10
Figure 22: Operating Margin of Business Model Innovators Compared to Prod-
uct and Process Innovators
In a similar vein, a survey conducted by The Boston Consulting Group and
BusinessWeek compare a company cluster of process and product innova-
tors with a company cluster of business model innovators. They find that a)
business innovators earn a considerable higher average premium and b) re-
turns are more sustainable so that business model innovators still outper-
formed product and process innovators even in the 10-year category.
2 Source: IBM (2006)
1. Introduction
11
Figure 33: Average Premiums with Business Model Innovators Compared to
Product and Process Innovators
Why is there a need for a business model evaluation instrument?
A standardized process is useful because it ensures that important aspects
are not overlooked. It also allows a third party to retrace the logic of an in-
vestment decision or refusal. This is especially important to VC funds that
operate according to the four-eye principle. Franke and Gruber found that on
average 55% of all investment proposals are read only by one investment
manager, before a refusal or an invitation to a personal meeting is given
(Franke and Gruber, 2004). They argue that subjective influences play a ma-
jor role. This is also supported by the argument of “similarity biases” Franke
et al find in their publication on VC funds’ investment criteria that summarizes
the message in the title: “What You Are Is What You Like” (Franke et al.,
2003).
Currently much of the decision making process is subjected to personal
judgment and the experience of the investment manager in charge. This can
work well for experienced investment managers in a majority of cases. An
inexperienced investment manager will not have these tools at his/her dis-
posal. And even experienced investors make mistakes. In light of these as-
3 Source: Lingardt et al. (2009)
1. Introduction
12
pects, a standardized process for the evaluation of business model’s can
prove to be a useful tool for all VC funds.
Besides the points of reliability and accuracy, efficiency is a further benefit of
an evaluation instrument. Larger VC funds receive between 1000-2000 in-
vestment requests per year. For these VC funds a standardized process
would save resources in the screening phase, which would allow an expan-
sion of the scope, of ventures that can be screened.
Especially in early stage investments where information is scarce, every
source of information is to be exploited to its maximum. It is argued here that
there is potential to unlock towards this aim by developing a reliable process
for business model evaluation that does not exist as of today. There are ap-
proaches towards evaluating business models in literature, however none of
them can be considered comprehensive and moreover none of them is oper-
ationalized in a way that corresponds to the logic of existing workflows, and
that is satisfactory in terms of content and user friendly in terms of applicabil-
ity.
1.2 Aim and Limitations
A literature review has lead to the work of Franke, Gruber, Harhoff, and Hen-
kel (2008) who analyze investment criteria of VC funds. They find that the
team is the most important criteria and find significant differences in evalua-
tion results originating from novice or from experienced venture capitalists. In
their implications for future research they suggest “it may be fruitful to ex-tend this line of research by investigating whether experience also has a significant impact on the evaluation of other aspects of venture pro-posals. For example it may well be that the assessment of business models (e.g. Amit & Zott, 2000) could be subject to experience effects.
Whereas novice VCs [ i.e. venture capitalists] may look at simple com-
ponents of business models (…), experienced VCs may place more weight on the fit of the various components, and thus may arrive at a better understanding of the overall value creation of the proposed ven-ture.”
From this, two implications are deducted for this study. First, the business
model is a relevant unit of analysis as VC investment criterion and there is a
1. Introduction
13
need for an adequate instrument that can be used for business model evalu-
ation. Secondly an hypothesis is suggested to be tested, namely:
„Novice VCs tend to analyze single components where as experienced VCs tend to analyze the fit of linkage between the components“.
The aim of this study is to develop such an evaluation instrument for busi-
ness model evaluation and to test the proposed hypothesis. Since the first
aim poses a greater challenge it constitutes the main part of this study.
The ultimate aim for a VC is to be able to gauge ex ante whether a venture
has the potential to be successful. There are many factors that contribute to
success in the end and the business model is just one of them amongst other
objects of interest analyzed during due diligence as shown in figure (4). Of
course, the business model could be great but fail because of being imple-
mented at the wrong time, in the wrong environment or executed poorly by
the people driving it. These are important factors determining the success or
failure of a venture. However, in order to focus on the specific importance of
the business model, these other factors will not be taken into consideration.
In literature, there is not sufficient research on business models as source of
information for investment decision-making. A survey of literature conducted
by Franke, Gruber, Harhoff and Henkel sums up investment criteria that are
usually employed during the due diligence process:
1. Introduction
14
Table 14: Survey Results on VC Evaluation Criteria
They find that in essence all criteria can be „collated into four major groups,
namely criteria related to (1) the product service offering; (2) the mar-
ket/industry; (3) the start-up team; and (4) the financial returns to be ex-
pected“ (Franke et al., 2008). Striking is the fact that in none of these studies
the business model as unit of analysis is mentioned among the top three cri-
teria. This could mean that it nevertheless is a unit of analysis, however nev-
er ranks among top three or it is not seen explicitly as unit of analysis. Inter-
views with investment managers have pointed to the fact that is indeed ana-
lyzed in business practice – but not explicitly or as a structured process but
4 Source: Franke et al. (2008)
1. Introduction
15
rather in a way that overlaps with other units of analysis. In VC due diligence
you typically find six areas of the venture that are analyzed: team, technolo-
gy, market, finance, legal and tax. This study aims at contributing towards
establishing business model due diligence as new form of due diligence next
to existing forms displayed in figure 4. It is argued that the business model
contains valuable information that are currently unsufficiently exploited. This
is especially relevant for early stage investments since information is scarce
and every information source is to be made use of to maximum extent.
Figure 4: Types of Due Diligence
1.3 Structure of Study and Proceedings
Working towards these aims at first in chapter 2 relevant aspects of the VC
industry are presented to set the scene for the results this study aims at pro-
ducing. Chapter 3 defines how the term business model is used in this study
and elaborates on business model innovation and innovation as its context.
The following chapters presents the evaluation approached found as result of
a literature review. These evaluation approaches are critically appraised and
compared in order to select two approaches that would be suitable for a
combined new approach serving as underlying framework for the evaluation
TypesofDueDiligence
1)Team
2)Technology
4)Finance
5)Legal
6)Tax
7)BusinessModel
2. Early Stage Investment Appraisal
16
instrument being developed. Chapters 6 and 7 are concerned with develop-
ing the evaluation instrument. Once the underlying framework has been de-
veloped, it is filled with evaluation criteria. These have been collected from a
literature review and replenished with criteria gained from interviews with in-
vestment managers. This list of criteria is then presented to investment man-
agers asking them to rate them according to importance. The result is an
evaluation instrument that is built on a combined framework that is well an-
chored in theory and that offers high usability in business practice. It consists
of criteria collected from literature and investment managers and is opera-
tionalized as a tool for business model due diligence reflecting requirements
in VC investment processes in its dual structure.
2. Early Stage Investment Appraisal
2.1 Early Stage and Venture Capital
Early stage investment is characterized by information scarcity and high risk.
Typically you would find a team with a business idea expressed in some kind
of business plan that ranges from a chaotic PowerPoint presentation to a well
reflected, structured and elaborated business proposal and execution plan.
Some may have already passed the phase of prototyping and have first ex-
periences from field tests which allow them to verify and support the assump-
tions made in the business plan. Others have experience from operations
and may already have managed to achieve first revenues.
In contrast to this, later stage investments provide a history of revenues,
sales performance and market feedback. Therefore, during a due diligence
process there is plenty of information that can be analyzed and a valid esti-
mation of market, operational and financial risk can be made.
Since there is not much information available during early stage every source
of information needs to be exploited to its best.
It is argued here that the business model is one of the few available sources
of information in early stage. Currently it is not exploited to its best. Much of
the evaluation process pertaining to it is subject to intuitive judgment depend-
ing in its accuracy on the experience of the respective investment manager in
2. Early Stage Investment Appraisal
17
charge instead of being subject to a structured process that is objective and
well reflected. There is a need for such a process since it increases the in-
formation volume investment decisions are based on and improves the accu-
racy of this information base.
There are different opinions and definitions as to what “early stage” and “ven-
ture capital” means with regards to venture maturity and the investment
amount. Some scholars further differentiate early stage into seed, start-up,
first stage and later stage, which will not be further elaborated given the focus
of this survey. To give an overview and position the focus of this survey, the
following graph illustrates a common understanding of investment stages in
entrepreneurial finance:
Figure 5: Venture Capital Positioned in Investment Landscape
Other countries such as the USA are known to be less risk averse than the
country this survey has been conducted in which is also reflected in invest-
ment volumes and timing. You will hardly find any VC fund in Germany that
invests in an extremely early stage. Therefore founders usually start off alone
or are pre-financed by so-called friends/fools/family often followed by a busi-
ness angel round later on. However, business angels usually invest only be-
tween EUR 20.000 and EUR 200.000. Therefore any venture that needs
funding above that would need to start off with the mentioned pre-financing
stages and produce results in order to reduce investment risk, increase cred-
ibility and subsequently receive funding from a VC fund. Bank loans are not
an option unless taken privately due to conservative risk assessment. Ac-
cording to its political mandate to support start up companies, High-Tech
Gründerfonds as the leading German early stage VC fund invests into ven-
tures that are not older that 1 year with an investment of EUR 0.5 million in a
Founder(s)Friends,Fools,Family
BusinessAngels
VentureCapital
PrivateEquity
GrowthFinancingby
Banks
Exit:IPO,AqcuisiRon
2. Early Stage Investment Appraisal
18
standardized process. The total investment amount can vary upwards de-
pending on how many investors join the round pari passu.
2.2 Screening and Due Diligence: How Much Diligence is Due
Franke and Gruber classify the investment process into two phases: screen-
ing and due diligence (Franke and Gruber, 2004). The first being a rough
analysis of the venture proposals and the second a more precise analysis.
They map the different detailed stages in the investment process against the
survival rate at which business plans drop out of the process (figure ...): in-
coming business plans, screening, initial screening, second screening, per-
sonal contact, due diligence, negotiations, closing. Of 100 business plans
only 1-4 manage to achieve investment.
Figure 6: Venture Capital Investment Workflow
This proportion is in line with the situation at HTGF: after 5 years of opera-
tions about 4000 business plans have been received of which about 200
3. Definition of Business Model and its Context
19
have received investments. In HTGF processes the screening phase is to be
placed before a term sheet is signed and the due diligence phase thereafter.
Figure 7: Dual Structure of Evaluation Instrument Positioned in HTGF Invest-
ments Workflow
The evaluation tool developed in this study is designed in a way that one part
is optimized for use during screening and another for use during due dili-
gence. Illustrated in form of a sieve the first part serves to sieve proposals in
search of promising ventures with a minimum of time invested into a rough
estimate that is made up of a short list of 14 criteria identified as relevant.
The second part illustrated in form of a lens serves the purpose of a detailed
analysis. A newly developed framework is operationalized in a way that it
extends these 14 criteria and gives detailed measurable statements concern-
ing different aspects of the business model. This dual structure of the instru-
ment accommodates the tradeoff between time and accuracy allowing an
adequate response to the question of how much diligence is due at a particu-
lar stage of the process.
3. Definition of Business Model and its Context
3.1 Innovation
Innovation has traditionally been understood as product and process innova-
tion. The business model concept has recently been increasingly addressed
in the domains of innovation and technology management. In these literature
3. Definition of Business Model and its Context
20
streams, „the business model represents a new dimension of
tion“ (Amit et al., 2010) that enables companies to commercialize innovative
ideas and technologies. It is seen both as a source of innovation and a vehi-
cle facilitating innovation.
Figure 8: Three Types on Innovation
3.2 Business Model Innovation
Moving on from Innovation to business model innovation, Giesen, Berman,
Bell and Biltz (2007) suggest a categorization identifying three types of busi-
ness model innovation: industry models, revenue models and enterprise
models. The first explains innovation in supply chain, the second describes
innovative ways how companies create value and the third defines the inno-
vation within the firm’s structure and its contribution to value chains.
Figure 9: Three Types of Business Model Innovation
Business model innovation needs to be distinguished from business model
invention. The first term refers to a business model that exists and has been
reshaped. The later term refers to a new business model that has not yet
been executed.
InnovaRon
ProductInnovaRon
ProcessInnovaRon
BusinessModel
InnovaRon
BusinessModel
InnovaRon
Industrymodels
Revenuemodels
Enterprisemodels
3. Definition of Business Model and its Context
21
Henderson and Clark (1990) make a distinction between a component and
architecture level pertaining to products:
"[The] distinction between the product as a whole - the system - and the
product in its parts - the components - has a long history in the design litera-
ture ( ... ) The overall architecture of the product lays out how the compo-
nents will work together ( ... ) A component is defined here as a physically
distinct portion of the product that embodies a core design concept and per-
forms a well defined function ( ... ) The distinction between the product as a
system and the product as a set of components underscores the idea that
successful product development requires two types of knowledge. First, it
requires component knowledge, or knowledge about each of the core design
concepts and the way in which they are implemented in a particular compo-
nent. Second, it requires architectural knowledge or knowledge about the
ways in which the components are integrated and linked together into a co-
herent whole“
This approach is transferred to the concept of Business models and business
model innovation by Zollenkop (2006) and summarized in figure (10). It dis-
plays three dimensions of business model innovation. The first dimension
and axis refer to business model innovation occurring on the structural level.
It ranges from principally innovated to gradually innovated. The second di-
mension and axis depicts business model innovation pertaining to the com-
ponents of a business model also ranging from principally innovated to grad-
ually innovated. Thirdly, range or number of affected elements is a dimension
and axis spanning from high to low. This results in four types of business
model innovation: architectural business model innovation (upper left quad-
rant), gradual business model innovation (lower left quadrant), principal busi-
ness model innovation (upper right quadrant) and modular business model
innovation (lower right quadrant).
3. Definition of Business Model and its Context
22
Figure 105: Business Model Innovation Options
3.3 Business Model
Moving from business model innovation to business model, it is insightful to
first clarify what a business model is not. A business model is not a business
plan, it is not strategy and it is not to be confused with typologies.
A business model is to be found in a business plan. However the business
plan stresses its execution and provides information encompassing every-
thing that pertains to the business – not just its business model.
„Today, „business model“ and „strategy“ are among the most sloppily used
terms in business; they are often stretched to mean everything – and end up
meaning nothing “ (Magretta 2002). Cassadeus-Masanell and Ricart (2010)
describe the difference between Business models, strategy and tactics using
the analogy of an automobile. Their underlying understanding of a business
model is not normative. It does not imply that a business model has to con-
sider certain aspects such as containing certain elements. It is simply a set of
choices. Based on this idea and coming back to the analogy of a car, strate-
gy is the choice what type of car you choose. A fouy-by-four will allow the
driver to move well in off-road terrain and will limit him in terms of maximum
5 Source: Zollekop (2006)
3. Definition of Business Model and its Context
23
speed, whereas a roadster will present the opposite picture of potential and
limitations. The car itself is the business model offering a certain set of op-
tions to act due to its configuration in potential and limitations. The driving of
the car is the available set of actions, or tactics as the authors call it.
Figure 116: Strategy, Business Model and Tactics
Business models should also not be confused with typologies. Typologies are
Business models that have been grouped to different clusters. Since this is
an important insight into understanding Business models an extensive list of
examples is provided in the next chapter.
But what exactly is a business model?
„At a general level the business model has been referred to as a statement
(Stewart & Zhao, 2000), a description (Applegate, 2000; Weill & Vitale,
2001), a representation (Morris, Schindehutte, & Allen, 2005; Shafer, Smith,
& Linder, 2005), an architecture (Dubosson-Torbay, Osterwalder, & Pigneur,
2002; Timmers, 1998), a conceptual tool or model (Osterwalder, 2004; Os-
terwalder, Pigneur, & Tucci, 2005; Teece, 2010), a structural template (Amit
& Zott, 2001), a method (Afuah & Tucci, 2001), a framework (Afuah, 2004), a
6 Source: Casadeus-Masanell and Ricart (2010)
3. Definition of Business Model and its Context
24
pattern (Brousseau & Penard, 2006), and as a set (Seelos & Mair, 2007).
“This lack of definitional consistency and clarity represents a potential source
of confusion, promoting dispersion rather than convergence of perspectives,
and obstructing cumulative research progress on business models.“ (Amit et
al., 2010)
There a numerous definitions of what a business model is. Amit et al. have
compiled the most referenced to definitions in a list that is provided in the
appendix for further reference.
The definition this study is based on revolves around the idea of transactions.
It is argued in this paper that this pinpoints the core of a business model.
Cambridge online dictionary7 defines business as „the activity of buying and
selling goods, services, or a particular company that does this, or work you
do to earn money“. The idea of buying and selling is also covered by the
word trade, defined in its form as a verb as „to buy and sell goods or ser-
vices, especially between countries“. In its form as a noun it is defined as „to
exchange something, or to stop using or doing something and start using or
doing something else instead“. This definition features the notion of exchang-
ing something which is core to the idea of transaction defined as „when
someone buys or sells something, or when money is exchanged“.
Based on these considerations, the definition of Amit and Zott (2001) has
been selected to work with in this study:
“The business model depicts the content, structure, and governance of transactions designed so as to create value through the exploitation of business opportunities.”
3.4 Business Model Typologies
The term business model is often confused with the term business model
typologies. Some scholars also refer to typologies as taxonomies or patterns.
To make this distinction clear, detailed examples of different typologies are
given in this chapter. Since this is a way of clustering business models into
different groups it provides a useful overview and is fruitful in gaining under-
standing about business models. Two compilations are presented that can be
7 Source: http://dictionary.cambridge.org
3. Definition of Business Model and its Context
25
found in literature. The first is taken from Johnson (2010) and is more gen-
eral. The second is taken from Amit et al. (2010) and features business mod-
el typologies from the field of e-business.
Table 28: Business Model Typologies in General
Type
Examples Description
Auction
Sotheby’s, Priceline, eBay
Customers name their own price for a product/service. Unwanted products are sold to a large customer base
Alter the usual formula
Amazon Amazon generates high profits on its positive working capital, because it holds little inventory and yet enjoys long payables like traditional booksellers do
Bricks + Clicks Home Depot, Tesco, REI
Integrate both an online (clicks) and an offline (bricks) presence to browse, order, and pick up products.
Bundle elements to-gether
iPod and iTunes, fast food value meals
Make purchasing simple and more complete by packaging related products together.
Create user communi-ties
Angie’s List Grant members access to network of quality information about services or goods; generate revenue through mem-bership fees and advertisements.
Cell phone Sprint, Better Place Give away the “cell phone” for little to no cost but gain high margins by selling the “minutes” on a per-usage fee.
Develop unique partner-ships
MinuteClinic MinuteClinic enables CVS to make money in ways other than visit fees (i.e., it gets customers into stores and ex-poses them to other CVS products).
Dial down features Motofone Target less-demanding consumers with products or ser-vices that may not be superior but are adequate and per-haps more convenient, simple, etc.
Do more to address the job
UPS Look beyond your typical offering and address other jobs your customers are trying to get done.
Disintermediation Dell Deliver your standard product or service more directly to the customer through a new, non-standard channel.
Freemium LinkedIn, Skype, Pandora
Offer basic services for free but charge for upgraded or premium services.
Lease instead of sell Xerox Allow customers the opportunity to pay for performance.
Leverage new influenc-ers
Hindustan, Unilever Identify new influencers that make the delivery of your offering more convenient, far-reaching, or affordable.
Low-touch approach Xiameter Offer standardized, low-price version of a product or ser-vice that is traditionally customized and higher priced.
Multi-level marketing Amway, Avon, NuSkin
Market and sell products or services direct to consumers, outside of retail locations.
Own the undesirable
AllLife Seek to serve segments of the market that may not appear to be immediately attractive.
Razors/blades Gillette, personal printers
Give away the “razors” for essentially no cost but make profits by selling higher-margin “blades.”
Reverse razors/blades iPod/iTunes Give away the “blades” (iTunes) for essentially no cost but make profits by selling higher-margin “razors” (iPod).
Servitzation of products IBM Provide not only a one-time product offering but also an ongoing service-offering attendant to the product.
Subscription Magazines, Netflix, BabyPlays
Consumer pays a subscription price to gain access to the product or service.
8 Source: Johnson (2010)
3. Definition of Business Model and its Context
26
Table 39: Business Model Typologies in E-Business
Timmers, 1998
e-Shops Stands for the Web marketing and promotion of a company or a shop and increasingly includes the possibility to order and to pay.
e-Procurement Describes electronic tendering and procurement of goods and services.
e-Malls Consists of a collection of e-shops, usually enhanced by a common umbrella, for example a well-known brand.
e-Auctions Stands for the electronic implementation of the bidding mechanism also known from traditional auctions.
Virtual
Communities
This model brings together virtual communities that contribute value in a basic environment provided by the virtual community operator. Membership fees and advertising generate revenues. It can also be found as an add-on to other marketing operations for customer feedback or loyalty building.
Collaboration
Platforms
Companies of this group provide a set of tools and information environ-ment for collaboration between enterprises.
Third-Party Marketplaces
A model that is suitable when a company wishes to leave the Web marketing to a third party (possibly as an add-on to their other channels). Third-party marketplaces offer a user interface to the supplier's product catalogue
Value Chain Integrators
Represents the companies that focus on integrating multiple steps of the value chain, with the potential to exploit the information flow between those steps as further added value.
Value Chain Service Providers
Stands for companies that specialize in a specific function for the value chain, such as electronic payment or logistics.
Information
Brokerage
Embraces a whole range of new information services that are emerging to add value to the huge amounts of data available on the open networks or coming from integrated business operations.
Trust and Other Third Parties
Stands for trust services, such as certification authorities and electronic notaries and other trusted third parties.
Tapscott, Lowy, & Ticoll, 2000
Agora Applies to markets where buyers and sellers meet to freely negotiate and assign value to goods. An Agora facilitates exchange between buyers and sellers, who jointly "discover" a price. Because sellers may offer a wide and often unpredictable variety or quantity of goods, value integration is low.
Aggregation In Aggregation b-webs there is a leader that takes responsibility for selecting products and services, targeting market segments, setting prices, and ensuring fulfillment. This leader typically sets prices in advance and offers a diverse variety of products and services, with zero to limited value integration.
Value Chain In a Value Chain, the so-called context provider structures and directs a b-web network to produce a highly integrated value proposition. The seller has the final say in pricing.
Alliance An Alliance strives for high value integration without hierarchical control. Its participants design goods or services, create knowledge, or simply produce dynamic, shared experiences. Alliances typically depend on rules and standards that govern interaction, acceptable participant behavior, and the determination of value.
Distributive
Network
Distributive Networks are b-webs that keep the economy alive and mobile. They play a vital role in ensuring the healthy balance of the systems that they support. Distributive Networks service the other types of b-webs by allocating and delivering goods.
Applegate, 2001
Focused Provide products and services within specific industry or market niche. There are five types of focused distributors business models—retailers,
9 Source: Amit et al. (2010)
3. Definition of Business Model and its Context
27
Distributors marketplaces, aggregators, infomediaries, and exchanges.
Portals Not defined. They include horizontal portals, vertical portals, and affinity portals. These are differentiated on the basis of the gateway access, affinity group focus, revenues source, and costs structure.
Infrastructure
Distributors
Enable technology buyers and sellers to perform business transactions. There are three categories of focused distributors: infrastructure retailers, infrastructure marketplace, and infrastructure exchange, which are differentiated on the basis of control inventory, online selling presence, online pricing, revenues source, and costs structure.
Infrastructure Portals Enables consumers and businesses to access online services and information. They are further classified into horizontal infrastructure portals (Internet service providers, network service providers and web hosting) and vertical infrastructure portals (producers and distributor application service providers, or ASPs).
Infrastructure Producers
Design, build, market, and sell technology hardware, software, solutions, and services. Four types of infrastructure producers are: equipment component manufacturers, software firms, customer software and integration, infrastructure service firms.
Rappa, 2001
Brokerage Model They bring buyers and sellers together and facilitate transactions. Usually, a broker charges a fee or commission for each transaction it enables. Subcategories are: Marketplace Exchange, Business Trading Community, Buy/Sell Fulfillment, Demand Collection System, Auction Broker, Transaction Broker, Bounty Broker, Distributor, Search Agent, Virtual Mall.
Advertising
Model
The broadcaster, in this case a web site, provides content (usually for free) and services (like email, chat, forums) mixed with advertising messages in the form of banner ads. The banner ads may be the major or sole source of revenue for the broadcaster. The broadcaster may be a content creator or a distributor of content created elsewhere. Subcategories are: Portal, Personalized Portal, Niche Portal, Classifieds, Registered Users, Query-based Paid Placement, Contextual Advertising.
Infomediary Model Some firms function as infomediaries (information intermediaries) by either collecting data about consumers or collecting data about producers and their products and then selling it to firms which in turn can mine it for important patterns and other useful information to better serve their clients. Examples are: Advertising Networks, Audience Measurement Services, Incentive Marketing, Metamediary.
Merchant Model Wholesalers and retailers of goods and services sold over the Internet. These include: Virtual Merchant, Catalog Merchant, Click and Mortar, Bit Vendor
Manufacturer Model Manufacturers can reach buyers directly through the Internet and thereby compress the distribution channel.
Affiliate Model The affiliate model provides purchase opportunities wherever people may be surfing. It does this by offering financial incentives (in the form of a percentage of revenue) to affiliated partner sites. The affiliates provide purchase-point click-through to the merchant via their web sites.
Community Model The community model is based on user loyalty. Users have a high investment in time and emotion in the site. In some cases, users are regular contributors of content and/or money. Examples are Voluntary Contributor Models and Knowledge Networks.
Subscription Model Users are charged a periodic—daily, monthly or annual—fee to subscribe to a service. Examples are Content Services, Person-to- Person Networking Services, Trust Services, Internet Service Providers.
Utility Model The utility model is based on metering usage, or a pay-as-you-go approach. Unlike subscriber services, metered services are based on actual usage rates.
Weill & Vitale, 2001
Content Providers Provides content (information, digital products, and services) via intermediaries.
Direct to Customer Provides goods or services directly to the customer, often bypassing traditional channel members.
Full-Service Provider Provides a full range of services in one domain (e.g., financial, health,
4. Evaluation Approaches in Theory
28
industrial chemicals) directly via allies, attempting to own the primary consumer relationship.
Full-Service Provider Provides a full range of services in one domain (e.g., financial, health, industrial chemicals) directly via allies, attempting to own the primary consumer relationship.
Intermediary Brings together buyers and sellers by concentrating information.
Shared
Infrastructure
Brings together multiple competitors to cooperate by sharing common IT infrastructure.
Value Net
Integrators
Coordinate activities across the value net by gathering, synthesizing, and distributing information.
Virtual
Community
Creates and facilitates an online community of people with a common interest, enabling interaction and service provision.
Direct to Customer Provides goods or services directly to the customer, often bypassing traditional channel members.
Whole-of- Enterprise/Government
Provides a firm-wide single point of contact, consolidating all services provided by a large multi-unit organization.
4. Evaluation Approaches in Theory
Comprehensive business model innovation literature overviews already exist.
In this regard I would like to point to the review of Amit, Zott and Massa
(2010). Anders Sundelin has visualized a timeline of publications from 2000-
2010 that includes business model frameworks where provided by the au-
thors. This constitutes an excellent chronologic overview of business model
innovation literature and is referred to for means of orientation.
Given the focus of our topic this chapter on theory specifically highlights
evaluation approaches found in literature. A literature a review was conduct-
ed in search of evaluation approaches and with regards to specific evaluation
criteria that could later be used as items for evaluation. Presented to an in-
vestment manager, five of these approaches could be identified as having
potential toward informing an evaluation instrument that would be of use for
business practice. These approaches are discussed in detail in this chapter.
4.1 Amit and Zott
4.1.1 Evaluation Approach
Amit and Zott define a Business model as follows:
“The business model depicts the content, structure, and governance of
transactions designed so as to create value through the exploitation of busi-
ness opportunities.” (Amit and Zott 2001)
4. Evaluation Approaches in Theory
29
In this definition a business model at its core is all about capturing and ex-
plaining the nature of transactions that occur. The authors suggest three per-
spectives from which to approach this effort: content, structure and govern-
ance and name them business model “design elements”.
In addition they propose four sources of value: novelty, lock-in, complemen-
tarities, efficiency. They name these sources “design themes” of a business
model. Business models contain all three design elements and all four design
themes. Different businesses will focus on different themes of this cluster.
They find that novelty-centered and efficiency-centered Business models
have a positive impact on entrepreneurial firms (Amit and Zott, 2007). The
following passage summarizes these three design elements and four design
themes.
Design Elements
Content
Transaction content refers to the goods or information that are being ex-
changed, and to the resources and capabilities that are required to enable
the exchange.
Structure
Transaction structure refers to the parties that participate in the exchange
and the ways in which these parties are linked. It also includes the order in
which exchanges take place (i.e., their sequencing), and the adopted ex-
change mechanism for enabling transactions. The choice of transaction
structure influences the flexibility, adaptability, and scalability of the actual
transactions.
Governance
Transaction governance refers to the ways in which flows of information, re-
sources, and goods are controlled by the relevant parties. It also refers to the
legal form of organization, and to the incentives for the participants in trans-
actions.
In their activity system approach content refers to what activities are select-
ed, structure refers to how activities are linked and governance to who per-
4. Evaluation Approaches in Theory
30
forms activities. In addition to these design elements the authors suggest four
design themes and define them as follows:
Design Themes
Efficiency:
Efficiency refers to transaction efficiency. According to transaction theory
transaction efficiency increases as the cost per transaction decreases. Spe-
cifically, it encompasses the completeness and quality of information and the
efficiency of its flow and the efficiency of processes such as production and
distribution. A transaction is efficient if costs per transaction are considerably
lower than what you could consider as industry standard.
In short: A business model is efficient, when transactions are cheaper, faster,
of better quality and more simple than the average.
Complementarities:
Complementarities refer to the bundles of goods that provide more value
than the total separate value of each single good. You want to serve custom-
er needs and wants as good as possible thinking in a job-to-be-done mentali-
ty. You thus integrate products and services from partners to create that all-
encompassing solution. Combination of online and offline (click-and-mortar),
vertical and horizontal complementarities and cross-selling are core themes.
In resource based view theory complementarities are considered strategic
assets and a source of value creation. Network theory emphasizes the im-
portance of complementarities among network participants. Complementari-
ties increase value by enabling revenue increase. Complementarities are
given when product value is enhanced and additional products or services
are provides in a way the works towards providing a solution to a customer’s
needs and wants.
In short a business model performs well in terms of complementarities when
products and/or services are complementarily combined (alone or with part-
nering companies) to bundles in a "job-to-be-done" mentality, meeting needs
and wants of customers extremely well.
4. Evaluation Approaches in Theory
31
Lock-In:
Lock-In prevents customers and strategic partners to switch to competitors.
Repeat purchases, switching costs, personalization, customization, affiliate
programs, loyalty programs, transaction safety, reputation built by transaction
history and rating systems are core themes. According to resource based
view theory assets such as brand name or byer-seller trust contribute to lock-
in. It refers to effective ways of motivating customers to engage in repeat
transactions and to ways of incentivizing partners to improve their associa-
tions.
In short a business model performs well in terms of lock-in when customers
stay loyal because they love the product/service or because it's cumbersome
or painful to leave or switch.
Novelty
Novelty refers to innovation in terms of new ways to structure transactions as
opposed to value creation potential of innovation in the Schumpeterian view
which traditionally encompasses introduction of new products and services,
new production, distribution or marketing methods and accessing new mar-
kets. There are no core themes to be mentioned since novelty refers to spe-
cific individually unique ideas a company comes up with in terms of mainly
the structure of transactions. Value is created by connecting previously un-
connected parties, eliminating inefficiencies in the buying and selling process
through adopting innovative transaction methods, capturing latent consumer
needs or by creating entirely new markets. The vast possibilities in virtual
markets enable vast opportunities for novel Business models.
There are links between novelty and lock-in to be pointed out. Firstly, when
an e-business has a strong brand, it can attract and retain customers easily.
Secondly, according to network theory, first movers can create positive feed-
back loops easily and achieve critical mass. This is especially important in
winner-takes-most markets. Between novelty and complementarities the link
is caused by the fact that the main innovation of some e-businesses lies in
their complementary elements they combine such as resources.
4. Evaluation Approaches in Theory
32
In short, a business model is novel when something in the business model is
new, be it components or connections or innovatively new combinations
thereof.
Amit and Zott sum up all four design themes at their three elementary levels
of content, structure and governance as follows:
Table 410: Business Model Elements and Design Themes
4.1.2 Evaluation Approach in Theory Context
Amit and Zott review contributions of several theories to the notion of busi-
ness models including value chain analysis, Schumpeterian innovation, re-
source-based view, theory of strategic networks and transaction cost eco-
nomics. While none of them completely explain the notion of the business
model and its function of value creation, they argue that each theoretical
framework contributes elements towards that aim and is reflected in each
design theme to a different degree as summarized in the table below. Their
10 Source: Amit and Zott (2001)
4. Evaluation Approaches in Theory
33
proof of theoretical anchoring is summarized in this chapter and in detail in
their 2001 publication for further reference.
Value chain analysis contributes to the notion of Business models since it
describes value creation at the firm level as suggested by Porter (1985). All
four aspects of this analysis are relevant to a comprehensive business mod-
el: defining the strategic business unit, identifying critical activities, defining
products, and determining the value of an activity. Central to this theory is the
idea of value creation by differentiation along every step oft he value chain.
Schumpeterian innovation revolves around the idea that innovation is the
source of value. Sources for innovation in turn can be new goods, new mar-
kets, new production methods, new supply sources, and reorganization of
industries. This is why this value source „novelty“ is mainly traced back to this
theory line. Schumpeter coined the term „creative destruction“ describing a
technological innovation that changes practices in economic life and enables
the entrepreneur to achieve so-called Schumpeterian rents until this technol-
ogy becomes established in the market. This change caused by technologi-
cal innovation is also referred to as disruption or Schumpeterian shock.
Resource based view of the firm ascribes the firm’s value creation to its
unique bundle of resources and capabilities. It states that uniquely combining
a set of resources and capabilities creates value especially if they are com-
plementary, specialized, heterogeneous within an industry, durable, scarce,
not easily imitated and not easily traded. Stressing the idea of resource com-
binations, especially the value source „complementarities“ is rooted in this
theory line.
Strategic network theory is especially relevant for e-businesses in the virtual
market space. The Internet enhances transaction efficiency, reduces asym-
metries of information and thereby improves coordination between the parties
involved in the transaction. Value creation by lock-in draws mainly on these
aspects in terms of theoretical background.
Transaction cost economics identifies transaction efficiency as a major
source of value creation. Efficiency is understood in a sense that costs are
reduces for participating parties in the transaction. Therefore efficiency as a
source of value is derived mainly from transaction cost theory.
4. Evaluation Approaches in Theory
34
Theoretical anchoring of sources of value (design themes) in e-businesses
are summarized by the authors in the following table:
Table 511: Anchoring of Design Themes in Theory
The above stated business model definition by Amit and Zott contains the
business model elements content, structure and governance. He authors
claim that „this definition of a business model is consistent with the im-
portance of transaction efficiency (emphasized by transaction cost econom-
ics), novelty in transaction content, structure and governance (Schumpeteri-
an innovation), complementarities among resources and capabilities (advo-
cated by resource-based view theory), and network effects (inherent in stra-
tegic networks). It captures the sources of value in e-businesses identified in
this paper and is hence applicable in virtual markets in general“ (Amit and
Zott, 2001). They support this model with five arguments.
1) Innovation in the context of business model not only refers to products
and, processes, distribution channels and markets but also to ex-
change mechanisms and transaction architectures. Therefore this
business model definition is consistent with Schumpeter’s idea of in-
novation being an act of „creative destruction“.
2) The definition’s consistency with the value chain framework is justified
by highlighting the fact that elements such as processes and sources
of value are core to this theory. A higher level of consistency is
achieved if the idea of value chain is extended to a process that ena-
11 Source: Amit and Zott (2001)
Table entries describe the degree to which the identified sources of value in e-businesses are viewed, directly or indirectly by different theoretical frameworks in strategic and ent-repreneurship as important for value creation.
4. Evaluation Approaches in Theory
35
bles transaction instead of following a flow of goods from creation to
sale.
3) The value oft he business model increases as the bundle of products
and services become „more difficult to imitate, less transferrable, less
substitutable, more complementary and more productive with
use“ (Amit and Zott 2001). With resources and their combinations at
the core of this notion the definition is consistent with resource based
view theory.
4) Consistency with network theory is derived from the link between net-
work configuration and value creation and the fact that the locus of
value creation is seen as the network and not necessarily the firm.
5) Rooted in Williamson’s (1975) focus on the efficiency of alternative
governance structures mediating transaction it is argued that in addi-
tion to efficiency enhancements there are other factors that contribute
to value creation, namely novelty, lock-in and complementarities.
Business model elements content, structure and governance are argued
to be rooted in strategic network theory. Therefore the business model
construct can be seen as extension of strategic network theory. The au-
thors support this finding with the following table.
Table 612: Anchoring of Business Model Framework in Theory
12 Source: Amit and Zott (2001)
4. Evaluation Approaches in Theory
36
4.1.3 Appraisal
According to journal rank and references in literature the approach of Amit
and Zott can be considered the most accepted in this field. They have con-
tinuously published well-accepted papers in this field for almost 10 years. It
was decided to significantly build this study on their approach because it is
simply the best approach to be found. It is theoretically well grounded and
applicable to business practice. The fact that the business model definition
focuses on transaction allows enough flexibility to apply it to different indus-
tries and stages of venture maturity. Since innovation is something that dis-
rupts existing structures it is necessary to work with concepts that are open
enough to incorporate innovative elements. This points to a shortcoming of
the widely accepted component models. While they have a wide range of
uses and portray simplicity, they lack an openness of concept that would al-
low for innovation.
The focus of Amit and Zott on e-business is limiting on the one hand. On the
other hand it allows accurate results in this field while all-encompassing ap-
proaches tend to be blurry and too unspecific when applied to the task at
hand.
According to my opinion, their approach lacks especially one important as-
pect: process. My suggestion, as elaborated in Chapter 5.1 is to extend the
approach with this element. Having worked with the detailed level of the ap-
proach, I find that hardly any items presented on “sequence” as part of struc-
ture and “legal forms” as part of governance are suggested. Furthermore it is
not so clear what is meant by “exchange mechanisms” and what the differ-
ence is to “nature of linkages”. It is also unclear how to handle the financial
model, since it is unclear where it fits into content-structure-governance-
framework.
Nevertheless this approach is by far the best I could find in literature.
4.2 Hamel
4.2.1 Business Model
To understand the evaluation approach of Hamel one needs to grasp the
business model it is based on. It consists of four key elements (customer in-
4. Evaluation Approaches in Theory
37
terface, core strategy, strategic resources and value network) that are linked
by three bridges (customer benefit, configurations and company boundaries).
The quality of this business model can be measured by four criteria, namely
efficiency, uniqueness, fit and profit boosters.
Figure 1213: Business Model Framework, Hamel
Core strategy consists of three elements: business mission, product and
market scope and basis for differentiation.
Business Mission captures the overall objective of the strategy and encom-
passes value proposition, strategic intent, “big, hairy, audacious goals” (Ha-
mel 2000), purpose, and overall performance objectives. Product and market
scope describe the essence of where the firm competes: which customers,
which locations, what product segments, and where it doesn’t compete. Ba-
sis for differentiation depicts the essence of how the firm competes and in
specific how it competes differently from its competitors.
Strategic resources comprise core competencies, strategic assets and core
processes.
Core competencies means what the firm knows. It encompasses skills and
unique capabilities. Strategic assets are what the firm owns and include:
brands, patents, infrastructure, proprietary standards, customer data, and
anything else that is both rare and valuable. Core processes are what people
13 Source: Hamel (2000)
4. Evaluation Approaches in Theory
38
in the firm actually do. It refers to methodologies and routines used in trans-
forming inputs into outputs. Core processes are activities, rather than assets
or skills that are used in translating competencies, assets, and other inputs
into value for customers.
Configuration refers to the unique way in which competencies, assets and
processes are combined and interrelated in support of a particular strategy. It
explains the linkages between competencies, assets and processes and how
these linkages are managed. To be successful strategies and business mod-
els need to rest on a unique blending of competencies, assets and process-
es.
Customer interface includes the four elements fulfillment & support, infor-
mation & insight, relationship dynamics and pricing structure.
Fulfillment & support describes how the firm reaches customers – which
channels it uses, what kind of customer support it offers, and what level of
service it provides. Information & insight is knowledge collected from and uti-
lized on behalf of customers. It is the information content of the customer in-
terface. It also refers to the ability to extract insights from this information that
can help the firm to do novel things for customers. Furthermore, it covers the
information that is made available to customers before and after purchase.
Relationship dynamics, describes the nature of the interaction between pro-
ducer and customer. It can be face-to-face or indirect, sporadic or continu-
ous. Relevant aspects are how the customer can interact with the producer
and what feelings these interactions invoke on the part of the customer. It
enables ways to create a sense of loyalty by the pattern of interactions. And
finally the pricing structure describes if you charge for a product or for a ser-
vice, if you charge directly or indirectly via a third party, if you can bundle
components or price them separately, if you charge a flat rate or charge for
time or distance and if you have set prices or market-based prices.
Customer benefits refer to a customer-derived definition of the basic needs
and wants that are being satisfied. They link the core strategy to the needs of
the customer. It is important to decide what benefits are going to be included.
Value network includes suppliers, partners and coalitions.
4. Evaluation Approaches in Theory
39
Suppliers are to be found at the top of the producer’s value chain. Privileged
access to or a good relationship with suppliers can be a key element of a
novel business model. Partners supply curtail complements to a product or
solution. Where relationships with suppliers are vertical relationship with pro-
ducers are more horizontal. A creative configuration of partners can be the
key to a successful business model. Coalitions with like-minded competitors
can be of advantage where investment or technology hurdles are high or
where there is a high risk of ending up on the losing side of a winner-take-all
market. Coalition members are more than partners; they share directly in the
risk and rewards of industry revolution.
Company boundaries describe the link between strategic resources and the
value network. They are decisions that have been made about what the firm
does in-house and what it outsources out to the value network.
4.2.2 Evaluation Approach
Hamel offers an approach to evaluate the performance of the above de-
scribed business model. Four evaluation criteria are proposed toward that
aim: efficiency, uniqueness, fit and profit boosters.
Efficiency the way Hamel understands it means that the value customers
place on the benefits delivered must exceed the costs of producing those
benefits. This differs from Amit and Zott’s definition of efficiency that aims at
transaction efficiency measured in the costs that are reduced for participating
parties.
Uniqueness is given when above average profits can be realized because
the business model differentiates itself from others in the market. The aim is
to create a business model that is unique in its conception and execution. A
business model must be unique in ways that are valued by customers.
Fit between business model elements allows a firm to generate healthy prof-
its. This is the case when all its elements are mutually reinforcing and the
business model can be considers internally consistent because all its parts
work together for the same end goal.
Profit boosters is a criterion well elaborated by Hamel and supported by
subcategories, namely network effects, positive feedback effects, learning
4. Evaluation Approaches in Theory
40
effects, pre-emption, choke points, customer lock-in, scale, focus, scope,
portfolio breadth, operating agility and lower breakeven.
Network effects: the value of a network increases with increasing amount of
network members. Positive feedback effects refer to the way the firm makes
use of market feedback to turn an initial lead into an „unbridgeable
chasm“ (Hamel, 2000) for competitors. A firm with a large user base, and a
way of rapidly extracting feedback from users, may be able to improve its
products and services faster than its competitors can. Therefore its products
improve and capture even more customers, which can become a virtuous
cycle. Learning effects, firms that manage to get an early start in accumulat-
ing knowledge, and that are able to learn faster than their rivals, can build an
unattainable lead. Pre-emption means that merely being first may be enough
to keep competitors out of the game. It requires a great product and a capaci-
ty to learn rapidly. Choke points are what keep competitors at a distance. It
could be a technical standard, control of some infrastructure, preferential ac-
cess to partners or customers, a patent, or a prime location. Customer lock-in
keeps the customer loyal because he loves the product or service or because
it is cumbersome or painful for him to leave or switch. Customer lock-in can
be achieved by long-term supply contracts, proprietary product designs that
keep them coming back for upgrades and add-ons, control over a local mo-
nopoly or high switching costs.
There is a trade-off to be considered between strategic economies comprised
of scale, scope and focus and strategic flexibility comprised of portfolio
breadth, operating agility and lower breakeven. Scale improves efficiencies in
ways such as better plant utilization, greater purchasing power or the ability
to enforce industry wide price discipline. It has proved to be a successful
strategy to consolidate fragmented industries where possible. A high degree
of focus and specialization may allow a firm to perform better than competi-
tors with a more diffused business mission and a less coherent mix of ser-
vices or products. Scope is the inverse of focus and comes from sharing re-
sources such as brands, IT infrastructure, facilities, scarce talent and best
practice across business units and countries. Portfolio breadth may render a
firm more resilient in the face of rapidly shifting customer priorities than a nar-
rowly focused competitor. Portfolio is defined in terms of countries, products,
4. Evaluation Approaches in Theory
41
businesses, competencies, or customer types. Operating agility means that a
company is able to quickly refocus its efforts to respond to changes in de-
mand and can thereby even out profit fluctuations. Low breakeven makes a
company more flexible. Capital intensity, debt and high fixed costs reduce the
financial flexibility of a business model.
4.2.3 Appraisal
This approach in one of the few that have a suggestion on how to evaluate a
business model with its four evaluation criteria efficiency, uniqueness, fit and
profitability. The bridges connect the business model elements and allow a
discussion about business models that incorporates the relationship among
elements and their fit, which is rare to find in business model innovation liter-
ature. Usually component models describe elements in a static way. It is a
powerful tool provided with detailed explanations of each mentioned item,
which makes it extremely useful for business practice and is therefore highly
recommendable.
Based on this it could have been used as the single basis for this study.
However, it did not prove to be sufficiently explanatory to serve the purpose
of this thesis on its own. For this reason the decision was made to combine
two models that each perform well in explaining a different aspect: the com-
ponent side on the one hand and the linkages on the other.
4.3 Morris, Schindehutte, Richardson and Allen
4.3.1 Evaluation Approach
Morris, Schindehutte, Richardson and Allen state, “Limited progress has
been made in establishing criteria for evaluating models or their underlying
components” (Morris et al., 2006). They suggest the following criteria for
evaluating the overall business model:
- Uniqueness
- Profit potential
- Internal consistency
- Comprehensiveness
- Imitability
- Robustness
4. Evaluation Approaches in Theory
42
- Adaptability
- Sustainability
However, “Methods for quantifying and applying such criteria have not been
proposed. Alternatively, numerous criteria exist for evaluating the individual
model components” (Morris et al., 2006).
As short as the authors’ contribution to the topic evaluation may be, they
nevertheless pinpoint the status quo adequately and make a suggestion of
useful criteria.
By mapping and quantifying the components of the business model the au-
thors propose a method to evaluate two of the suggested criteria: compre-
hensiveness and internal consistency. With this approach it is possible to
compare the business model of different companies as shown in figure (…)
exemplary with the two companies Dove Data and Operations Associations.
Table 714: Business Model Component Comparison
Furthermore, the authors point to the importance of the relationship between
business model and strategy and state that a “good business model captures
the core logic and dominant strategy of a venture” (Morris et al., 2006).
14 Source: Morris et al. (2006)
4. Evaluation Approaches in Theory
43
4.3.2 Appraisal
The authors state themselves, that “Methods for quantifying and applying
such criteria have not been proposed.” However the criteria they suggest are
relevant and an important contribution towards an evaluation instrument de-
veloped in this study.
4.4 Shi and Manning
4.4.1 Evaluation Approach
Shi and Manning present an evaluation approach by giving insight into busi-
ness model risk. They categorize three levels: elementary risk, compatibility
risk and system risk. Each of these levels has three dimensions: value mar-
ket firm share and competitive sustainability. These items can be reformulat-
ed positively to measure how well a business model performs in an evalua-
tion.
4. Evaluation Approaches in Theory
44
Table 815: Risk Evaluation Framework
4.4.2 Appraisal
There was moderate feedback from practitioners concerning usability and
plausibility when interviewed. They found the choice of dimensions “value
market”, “firm share” and “competitive sustainability” random and difficult to
15 Source: Shi and Manning (2009)
4. Evaluation Approaches in Theory
45
follow why explicitly these dimensions were chosen. There was disagreement
on the fact that competition is desirable and that it should even be actively
promoted as suggested by this approach. It was perceived as unclear how
the four proposed sub models (financial model, resource model, exchange
model, organizational model) fit together with the level/dimension framework
in figure (…). Therefore this approach was not used for this study. However,
it does propose a way of measuring model performance by its risk evaluation
and therefore is to be mentioned.
4.5 Osterwalder et al.
Business Model Generation (2010), a book authored by Alexander Osterwal-
der, Yves Pigneur and group of 478 researchers and practitioners, ap-
proaches the topic of evaluation by providing a tool to evaluate both the busi-
ness model environment on the one side and the business model itself on the
other. The environmental analysis comprises 18 items grouped into the fol-
lowing 4 categories:
- Key Trends
o Technological trends
o Regulatory trends
o Societal & cultural trends
o Socio-economic trends
- Market Forces
o Market segments
o Needs & demand
o Market issues
o Switching costs
o Revenue attractiveness
- Macro Economic Forces
o Economic infrastructure
o Commodities & other resources
o Capital markets
o Global market conditions
- Industry Forces
o Substitute products & services
o New entrants (insurgents)
4. Evaluation Approaches in Theory
46
o Competitors (incumbents)
o Stakeholders
o Suppliers & other value chain actors
For each of these 18 items questions are suggested with which one can ex-
plore dimensions of these items.
This is mentioned to point to future research implications since the analysis
of the business model environment is an important aspect, which is excluded
in this study in order to focus on the business model itself.
4.5.1 Evaluation Approach
This evaluation is based on a 9-component business model framework. In a
complementary two-fold approach, the SWOT analysis is applied first to the
business model as a whole in a big picture analysis. As the example of ama-
zon in figure (13) shows, positive and negative aspects are marked directly
on the business model template. Compared to figure (14) showing amazon’s
business model adoption made from 2005 to 2006, one can retrace how the
awareness of strengths and weaknesses can enable a company to amelio-
rate its business model. Therefore, „like seeing the doctor for an annual ex-
am, regularly assessing a business model (...) [is seen as] an important ac-
tivity that allows an organization to evaluate the health of it’s market position
and adopt accordingly” (Osterwalder et al, 2010).
4. Evaluation Approaches in Theory
47
Figure 1316: Big Picture Business Model Evaluation
Figure 1417: Business Model Adaption
In this example amazon was able to tap into new revenue streams with high-
er margins, namely utility computing fees and fulfillment handling fees. By
16 Source: Osterwalder et al. (2009) 17 Source: Osterwalder et al. (2009)
4. Evaluation Approaches in Theory
48
making use of its excellent IT infrastructure and large product range, amazon
was able to address developers and companies as well as individuals and
companies that need order fulfillment as two new customer segments by ex-
tending its value proposition to offering a service called fulfillment as well as
web services such as S3, EC2 and SQS.
Amazon’s fulfillment service stores a seller’s inventory in its warehouse and
takes care of packaging and shipping. Individuals and companies are able to
sell through amazon’s fulfillment infrastructure at a fee and can thereby make
use of a further distribution channel in a convenient way.
With amazon web services, developers can rent on-demand server capacity
to run their own applications.
After a big picture evaluation, the SWOT is applied to each component in
detail. This is done in 3 steps:
First of all each component is evaluated by rating several items concerning
internal strengths and weaknesses on a scale from – 5 to +5.
Secondly each component is evaluated by rating items concerning external
opportunities on a scale from +1 to +5.
Thirdly each component is evaluated by rating items concerning external
threats on a scale from -1 to -5.
The first step is aimed at evaluation of internal factors in a combined manner.
The second and third steps target external factors separately. Throughout,
several items are provided to “help jumpstart” (Osterwalder et al., 2010) ones
own evaluation as figure (15) shows.
4. Evaluation Approaches in Theory
49
Figure 1518: Business Model Evaluation, Detailed SWOT
4.5.2 Appraisal
This approach has its strengths, especially due to its underlying business
model. This is well accepted in business practice. Comparing Alexander Os-
terwalder’s dissertation19 of 2004 with the book Business Model Generation
of 2010 this is a good example of scientifically sound work turned into some-
thing practitioners can use beneficially. Judging by the resonance in the mar-
ket, this translation effort is much appreciated as complex topics have been
organized, put in simple words and presented in a graphically aesthetic way
that is easy to read and lends itself to application.
Concerning the evaluation approach I believe this can be improved. Remark-
ing that you can do a SWOT and list certain evaluation criteria seems to be
stating the obvious and not thoroughly worked through. Even though the au-
thors state that it is a “non-exhaustive set of questions”, this list of evaluation
criteria is exactly the point of interest. There is an overlap concerning the el-
ements “opportunity” and “threats” which appear both in the environment
evaluation and the internal SWOT. Finally, the advantage of having an under-
lying component model should be exploited not just by performing SWOT
18 Source: Osterwalder et al. (2009) 19 The business model ontology – a proposition in a design science approach
5. Business Model Due Diligence
50
analysis but by working out how the components interact and how one can
measure internal consistency and fit.
In summary, this approach is valuable due to its underlying component model
that is widely accepted with practitioners and is easy to use. However, the
evaluation approach has potential to be ameliorated.
5. Business Model Due Diligence
The aim of this study is to develop an evaluation instrument that would facili-
tate business model due diligence during venture appraisal. To that aim a
suitable framework is needed that is well founded in theory on the one hand
and that lends itself to use in business practice due to high level of relevance
and ease of use on the other hand.
This framework is subsequently to be equipped with evaluation criteria that
allow users to measure how well a business model performs.
5.1 Combined Evaluation Framework
As stated in numerous publications there is confusion and lack of clarity in
business model innovation literature with a plurality of frameworks and termi-
nology. Amit, Zott and Massa aptly point to the fact that a kind of silo thinking
has lead to „dispersion rather than convergence of perspectives, (...) ob-
structing cumulative research progress on business models“ (Amit et al.,
2010). With no ambition to come up with yet another fancy new framework
that would hopefully become the top dog oft he game, in this study it was re-
solved to working with existing frameworks and to combining them in a way
that is practical.
After comparing the approaches available in literature, the approach of Amit
and Zott and the approach of Osterwalder et al. have been selected. This is
because they have strengths and limitations in different areas and comple-
ment each other well when combined.
5. Business Model Due Diligence
51
Let us revisit Amit and Zott’s definition:
“The business model depicts the content, structure, and governance of
transactions designed so as to create value through the exploitation of busi-
ness opportunities.” (Amit and Zott, 2001)
This definition is first and foremost accurate. It points to the core of what a
business model is: it is all about transaction, exchanging one thing for anoth-
er. That is what business is - its essence is trade. It would even make sense
to argue that this is a „trade model“ rather than a „business model“. However,
to not create more confusion we will continue working with the term business
model.
Beyond it’s accuracy the above definition is also simple. The content, struc-
ture and governance organizing principle allows a simple structuring of dis-
cussion around business models. As illustrated above this structure is well
anchored in theory and can therefore furthermore be considered well in-
formed and comprehensive. Since this approach revolves around transac-
tion, it is a dynamic approach as opposed to component models hat are of
more static in nature.
Next to a theoretically well-grounded framework Osterwalder’s framework
was chosen to cover usability and relevance for business practice. Published
in 2010 it is the latest framework available in the business model innovation
landscape and apparently the most popular one. Developed in a crowdsourc-
ing project and having enjoyed viral marketing it has received quite some
attention in a burgeoning community of practitioners. Attractive design and
simplicity in illustration make it an appealing tool to use.
Talking to practitioners, they do not find value in many of the presented sci-
entific publications since they lack practical application and do not pull to-
gether a critical mass of people agreeing on the language presented. Busi-
ness Model Generation has gathered a remarkable group of people accept-
ing its language. The upcoming iPad application is likely to allow this ap-
proach to spread even further so that it may become a kind of standard in
business model thinking. Allowing a common language, this is a positive de-
velopment for the community interested in business model innovation, which
is hopefully further supported by partly building on this approach in this study.
5. Business Model Due Diligence
52
There are other component models found in literature. Amit et al. have com-
piled a summary that is provided in the appendix for further reference. Com-
pared to the other approaches the Osterwalder framework was selected for
the above-mentioned reasons.
These two models are believed to represent a useful framework when com-
bined. To that aim one amendment has been made on each approach: Amit
and Zott’s framework has been extended by one element allowing it to cap-
ture processes. Their approach has been visualized and the new element
market in red in figure (16).
Figure 1620: Extended Framework of Amit and Zott
Osterwalder’s framework also needs an amendment to be compatible with
the one above. Including „Governance Instruments“ as new building block it
is now able to correspond with the structure-content-governance framework
appreciated in Amit and Zott’s approach. This extension is visualized in figure
(17).
20 Own visualization based on Amit and Zott (2001)
5. Business Model Due Diligence
53
Figure 1721: Extended Business Model Framework of Osterwalder et al.
With these amendments made it is now possible to merge the extended
frameworks. The following table faces both extended models and makes a
suggestion towards merging terminology.
21 Own visualization based on Osterwalder et al. (2010)
5. Business Model Due Diligence
54
Table 922: Merging Terminology of Osterwalder et al. and Amit and Zott
Osterwalder et al. (extended)
Amit and Zott (extended)
Value Proposition Content
Goods Key Activities Processes Key Resources Resources Key Partners
Structure
Participating Parties Customer Segments Participating Parties Customer Relationships Nature of Linkages Channels Exchange Mechanisms Revenue Streams Goods Exchanged Cost Structure Goods Exchanged Governance Instruments Governance Control Methods, Legal Forms,
Incentive Schemes
That said we are finally able to incorporate the extended Osterwalder frame-
work into the Amit and Zott framework - or the other way around depending
on the user’s preference, as displayed in figure (18) and (19). Colors have
been chosen to support tracing the logic of development.
Figure 18: New Combinded Framework: Osterwalder’s Component Framework
Identified in Amit and Zott’s Framework
22 Extensions of original frameworks highlighetd in red
Structure
KeyPartners
CustomerSegments
Channels
CustomerRelaRonship
CostStructure
RevenueStreams
Content
ValueProposiRon
KeyAcRviRes
KeyResources
Governance
GovernanceInstruments
5. Business Model Due Diligence
55
Figure 1923: New Combined Framework: Amit and Zott’s Framework Identified
in Osterwalder’s Component Framework
Regardless of perspective, the combined framework now allows a theoreti-
cally grounded and practically applicable discussion about business models
and represents a useful framework for the evaluation process in business
model due diligence. This framework is meant to be open in character allow-
ing each user to customize it according to his purposes. Structure, content,
governance as organizing principle and first level structure unifying both
frameworks allows users to incorporate elements from both frameworks or
even “self-made” elements in a second level structure as displayed in figure
(20). Depending on which industry or which stage of venture maturity the new
framework is used for, this approach offers enough structure to serve as a
guideline and allows enough freedom to not be rigid or limiting.
23 Green: structure, blue: content, red: governance
5. Business Model Due Diligence
56
5.2 Evaluation Criteria
The combined framework now needs to be enriched with evaluation criteria.
These have been compiled in two steps. Firstly, a set of criteria has been put
together resulting from literature review. Secondly, these results have been
complemented by criteria attained from interviews with investment managers.
This has resulted in what is referred to as „short list“. Later on this short list is
extended by using the combined framework to come up with measurement
items on a more detailed level than the shortlist offers. This dual structure of
the evaluation instrument responds to time limitations encountered in the
screening phase and the necessity for extensive evaluation during the due
diligence phase.
Table 10: Sources of Evaluation Criteria, Short List
Criterion Source
Efficiency
Amit and Zott (2001) Complementarity
Lock-In
Novelty
Uniqueness
Hamel (2000) Fit
Profitability
Inimitability
Morris, Schindehutte, Richardson,
Allen (2006)
Robustness
Adaptability
Scalability
Investment Manager Interviews
Patentability
Plausibility
Completeness
5. Business Model Due Diligence
57
These criteria are expanded in a long list using the combined framework,
which can be laid on each evaluation criteria like a pattern. Structure-content-
governance serves as first level differentiation and the elements proposed by
both original frameworks serve as second level differentiation. The extended
Osterwalder components lend themselves especially well towards a com-
pleteness-check with the item “completeness”. All other items are differenti-
ated according to the extended Amit and Zott framework. It is assumed that
the Amit and Zott definitions are more general and all embracing. Therefore
the Osterwalder components are presumed as included and are omitted to
avoid redundancy (see table (...) merging terminology). However, the user
can customize the tool presented below as he pleases. This can be demon-
strated by the two criteria efficiency and completeness.
Figure 20: Framework Applied to Evaluation Criteria
5.3 Evaluation Instrument Operationalized
This evaluation approach has been operationalized translating it into an excel
tool that can be used by practitioners during business model due diligence.
Demonstrated with the example of one item – efficiency – the structure, con-
tent governance framework allows a structured evaluation of different as-
pects pertaining to this item. Specific measurable items are then formulated
Efficiency
Content
Goods
Processes
Resources
Struture
ParRcipaRngparRes
Natureoflinkages
ExchangeMechanisms
Sequenceofexchange
Governance
Controllmechanisms
Legalforms
IncenRveschemes
Completeness
Content
ValueProposiRon
KeyAcRviRes
KeyResources
Struture
Keypartners
Customersegments
Channels
CustomerRelaRonships
Coststructure
Revenuestream
Governance GovernanceInstruments
5. Business Model Due Diligence
58
on the second level of differentiation as described above, e.g. in the field of
content these would be detailed item in the field of goods, processes, re-
sources or value proposition, key activities and key resources if the Oster-
walder components are preferred by the user.
Figure 2124: Business Model Due Diligence Tool, Long List Ratings at Level 2
As demonstrated in the caption it is possible to manipulate the value given by
making a decision on how important this item is considered and how good
the information basis is, which is decided on. Some business plans might be
full of statements that are difficult to prove. Other may have assumptions that
are well supported with sufficient information coming from reliable sources.
Even others may even have first hand experiences from field tests or from a
business that has already set up operations.
The results computed in the orange fields are calculated as follows:
Result = ((value x weight) + (value x certainty)) : 2
Combined as arithmetic mean and rounded the results are aggregated on the
next level to finally arrive at an overall evaluation from 0-4.
24 Image section displaying 1 out of 14 criteria
5. Business Model Due Diligence
59
Figure 22: Business Model Due Diligence Tool, Caption
Using grouping-buttons, the tool allows you to „zoom out“ once you have fin-
ished inserting the values, weights and certainties considered relevant. Hav-
ing zoomed out all 14 items are seen in an overview on one page with an
overall evaluation telling you how well he business model performed it total.
This is the process recommended for a thorough evaluation during due dili-
gence. During the screening phase you simply stay on level 1 and evaluate
the 14 items directly without entering the detailed level 2.
Figure 2325: Business Model Due Diligence Tool, Short List Ratings at Level 1
25 Image section displaying 3 out of 14 items
6. Survey and Methodology
60
6. Survey and Methodology
6.1 Research Partner
This study has been conducted together with a „Praxis Partner“. This is to
ensure that the results would not only be a contribution to the scientific dis-
course in the field of business model innovation but also ensure relevance for
business practice. One investment manager was prepared to take the role of
a supervisor so that this study was accompanied both scientifically and relat-
ed to practice.
With HTGF a suitable partner was found to provide a conducive environment
for the study. With 22 highly experienced investment managers and numer-
ous portfolio companies a viable source of data is given through access to
business plans and interviews with investment managers. A large part of
HTGF’s portfolio companies operate in the field of e-business, which corre-
sponds to the focus this study has received having been largely informed by
literature from this field.
Key facts about HTGF in summary:
HTGF is Germany's leading early stage / seed VC fund. Where German VC
funds usually invest at a later stage, HTGF invests into companies not older
than 1 year. A total fund volume of EUR 272 million has been provided by the
German Federal Government and industrial investors such as Siemens,
Bosch and Daimler. Its track record of 200 portfolio companies within 5 years
since its founding is a remarkable feat for the VC industry.
6.2 Survey Results
The first part of the survey produced answers to the questions, how invest-
ment managers define the term business model and which criteria they use
when evaluating business models. Concerning the definitions of business
models the same situation is to be observed as in literature – there is a great
variety of different definitions. However there was some consensus on the
fact that the business model is all about how to make money.
The question targeting evaluation criteria produces four new criteria that were
not found in literature. These are:
- Scalability,
6. Survey and Methodology
61
- Patentability,
- Plausibility
- Completeness.
These items were then added to the list of items derived from literature and
presented in total to all interviewees in the second part of the survey asking
them to rate the items on a scale (0=irrelevant, 1=relevant, 2=very im-
portant). Short descriptions were provided explaining each of the items in the
following form:
1) Efficiency
Transactions are efficient when they are cheaper, faster and of better quality
and more simple than average.
2) Complementarities
Products and/or service are complementarily combined to bundles in a "job-
to-be-done" mentality and thereby meet needs and wants of customers ex-
tremely well.
3) Lock-In
Customers stay loyal because they love the product/service or because it's
cumbersome or painful to leave.
4) Novelty
Something in the business model is new, be it components, connections or
innovatively new combinations thereof.
5) Uniqueness
Something in the business model is unprecedented in the focal industry, be it
components, connections or combinations thereof. Strong USP.
6) Fit
High internal consistency because components of the business model fit to-
gether extremely well and reinforce each other.
7) Profitability
Over performing financial indicators.
6. Survey and Methodology
62
8) Inimitability
Inimitability due to any aspect that is not easily to replicate such as rare and
unique resources or exclusive partnerships. It can also include reputation,
experience/competence and corporate culture.
9) Robustness
Fends off threats well.
10) Adaptability
Plasticity allows adaption of business model if required due to change in en-
vironment
11) Scalability
Larger customer basis attainable by expanding into new customer segments
or new geographical regions.
12) Patentability
(only possible in the USA)
13) Plausibility
Assumptions in business plan are well supported with reliable data, field test
have been conducted or company already has experience from running op-
erations.
14) Completeness
To identify whether a business model is complete the extended 10-
component model is used.
The result concerning criteria rating are summarized in table (11):
6. Survey and Methodology
63
Table 1126: Criteria Rating by Investment Managers
Evaluation Criterion
IvM 1
IvM 2
IvM 3
IvM 4
IvM 5
IvM 6
IvM 7
IvM 8
IvM 9
IvM 10
IvM 11
IvM 12
Efficiency 1 1 2 2 1 1 2 2 2 1 2 1
Complementari-ties
1 0 1 1 1 1 1 1 0 1 1 1
Lock-In 2 2 0 2 1 1 2 2 1 2 2 2
Novelty 1 1 1 2 2 2 0 1 0 2 1 1
Uniqueness 2 2 2 1 2 2 0 2 2 2 1 1
Fit 1 0 2 1 1 2 2 1 2 1 1 1
Profitability 2 2 1 1 1 2 2 1 2 2 1 1
Inimitability 2 0 1 2 2 1 0 1 1 1 1 1
Robustness 1 1 1 1 1 1 2 1 1 2 1 1
Adaptability 1 2 1 1 2 0 2 1 2 1 2 2
Scalability 1 1 2 1 2 2 2 2 1 2 2 2
Patentability 1 1 1 0 2 2 0 0 0 1 0 1
Plausibility 1 2 1 0 1 1 2 1 1 2 2 2
Completeness 1 1 1 1 1 1 1 1 0 1 1 1
Moving towards understanding which of the criteria are the most relevant, the
arithmetic mean has been computed to finally allow a ranking of criteria
based on that.
Table 1227: Evaluation Aggregation
Evaluation Criterion
Value: 0
Value: 1
Value: 2
Arithmetic Mean
Efficiency 0 6 6 1.500 Complementarities 2 10 0 0.833 Lock-In 1 3 8 1.583 Novelty 2 6 4 1.167 Uniqueness 1 3 8 1.583 Fit 1 7 4 1.250 Profitability 0 6 6 1.500 Inimitability 2 3 7 1.417 Robustness 0 10 2 1.167 Adaptability 1 5 6 1.417 Scalability 0 4 8 1.667 Patentability 5 5 2 0.750 Plausibility 1 6 5 1.333 Completeness 1 11 0 0.917
26 IvM = investment manager, 0=irrelevant, 1=relevant, 2=very important 27 0=irrelevant, 1=relevant, 2=very important
6. Survey and Methodology
64
Table 1328: Criteria Ranking
Evaluation Criterion
Rank Category
Scalability 1 1 Lock-In 2 1 Uniqueness 2 1 Efficiency 3 1 Profitability 3 1 Inimitability 4 2 Adaptability 4 2 Plausibility 5 2 Fit 6 2 Novelty 7 2 Robustness 7 2 Completeness 8 2 Complementarities 9 2 Patentability 10 2
To test the hypothesis suggested initially two frameworks were presented in
a way that interviewees would be able to understand these quickly even if
they had never been confronted with them before which would be the case
for most of them if not even all of them. Since the framework of Amit and Zott
focuses on transactions and the linkages between elements of a business
model it lends itself to be used as a framework for dealing with „fit“. As op-
posed to the fact that the framework of Osterwalder is clearly a component
model and lends itself to be used in that sense. Both frameworks were pre-
sented in a visualized form (figure 16 and figure 17) and additional explanato-
ry information was given in prose. When asked which framework they would
prefer if they needed to choose one as a basis for an evaluation, 12 out of 14
interviewees chose Osterwalder’s framework.
This rejects the hypothesis and is a finding that is in line with the results from
rated criteria. Fit only ranked on position six. Clearly, fit is not perceived as
important in business practice as presumed in literature.
28 Category 1 = First priority „Top 5“, Category 2 = Second Priority
7. Conclusion
65
In summary, the survey has extended the list of criteria informed by literature
by four items resulting in a total list of 14 items. According to the investment
manager’s rating scalability, lock-in, uniqueness, efficiency and profitability
can be considered the „Top 5“ in that order of importance. It is unexpected to
find that two of Amit and Zott’s criteria rank relatively low, namely novelty
ranked 7 and complementarities ranked 9.
The hypothesis tested in this study was clearly rejected which was a surpris-
ing result. However the explanatory power of this result needs to be critically
reflected. Follow-up feedback clarified that both the frameworks presented
were not known among the interviewees. Especially the Amit and Zott ap-
proach appeared too complex to be understood dealing with it the first time
despite having received the approach in a visualized form with additional in-
formation in prose. It is arguable that another methodology such as a conjoint
analysis would produce different results. The attempt of testing this hypothe-
sis did therefore not prove to produce reliable results.
With 14 out of 22 investment managers participating in the survey, the results
concerning the evaluation instrument and its criteria however are solid. The
interviewees are well familiar with evaluating business models and were
therefore in a position to accurately contribute to the questions on criteria. As
small as the sample may be, this feedback comes from highly qualified inter-
viewees so that we can assume that the results concerning the criteria and
their ranking are viable.
7. Conclusion
In this Thesis, business model innovation has been established as an im-
portant topic for companies to be able to adapt, stay alive and outperform
competitors. It is identified as source for comparative advantage in an era
where an exclusive focus on conventional technological innovation is consid-
ered outdated. Businesses have proven to outperform market average due to
a successful business model without considerable technological innovation.
Business model evaluation is argued to be an important source of infor-
mation. This is particularly pertinent for early stage investment appraisals, as
this stage is characterized by information scarcity. This makes it vital to ex-
7. Conclusion
66
ploit every available source of information. No standardized and reliable pro-
cess had thus far been developed for business model evaluation. This need
has been addressed by developing a tool for business model due diligence
that is compatible with conventional processes inside the investment work-
flow. For this propose it was possible to identify two frameworks in literature
that complement each other in terms of theoretical anchoring and practical
usability and acceptance. With amendments made to each of them they were
merged into a combined framework leveraging the strengths of each one.
This framework was equipped with evaluation criteria informed by literature
and attained from expert interviews. Insights about criteria importance were
gained resulting in a Top-5 list encompassing scalability, lock-in, uniqueness,
efficiency and profitability.
While it was not possible to confirm the hypothesis of in question, the results
of the conducted research showed the evaluation instrument and developed
evaluation criteria to be viable and useful, grounded in the high level of quali-
fication of interviewees and widespread participation. It is now possible for
other VC funds to customize the developed evaluation tool according to their
specific needs and employ it in their venture appraisal process for business
model evaluation. This increases the volume and reliability of information
available for decision-making especially in early stage investments and
thereby decreases investment risk.
The value this study adds to the scientific discourse on business model inno-
vation is a suggestion towards business model evaluation. The evaluation
approaches found in literature have been identified, summarized and com-
pared. Two of these approaches have been merged thus making a contribu-
tion towards convergence rather than developing yet another new approach.
Evaluation criteria found in literature have been collected and supplemented
with criteria attained from expert interviews. Insight on relevance has been
gained by having these criteria ranked.
As implications for further research the environmental aspect of business
model is pointed to and the need for a methodology towards measuring fit.
Appendix
VI
Appendix
Business Model Definitions in Literature
Timmers (1998)
The business model is an architecture oft he product, service and information
flow, including a description oft he various business actors; a description oft
he sources of revenues
Amit, Zott (2001)
The business model depicts „the content, structure, and governance of
transactions designed so as to create value through the exploitation of busi-
ness opportunities“
Chesbrough, Rosenbloom (2002)
The business model is „the heuristic logic that connects technical potential
with the realization of economic value“
Magretta (2002)
Business models are „stories that explain how enterprises work. A good
business model answers Peter Drucker’s age-old questions: Who is the cus-
tomer? What does the customer value? It also answers the fundamental
questions every manager must ask: How do we make money in this busi-
ness? What is the underlying economic logic that explains how we can deliv-
er value to customers at an appropriate cost?“
Appendix
VII
Morris et al. (2005)
A business model is a „concise representation of how an interrelated set of
decision variables in the areas of venture strategy, architecture, and econom-
ics are addressed to create sustainable competitive advantage in defined
markets“. [...] It has six fundamental components: Value proposition, cus-
tomer, internal processes/competencies, external positioning, economic
model, and personal/investor factors.
Johnson et al. (2008)
Business models „consist of four interlocking elements, that, taken together,
create and deliver value“. These are: customer value proposition, profit for-
mula, key resources, and key processes.
Casadeus-Mansell, Ricart (2010)
„A business model is [...] a reflection of the firm realized strategy“
Teece (2010)
„A business model articulates the logic, the data and other evidence that
support a value proposition fort he customer, and a viable structure of reve-
nues and cost for the enterprise delivering that value“
Appendix
VIII
Component Business Models
Author(s) First Order Component(s) Second Order Concept(s)
Mahadevan, 2000
· Value stream for partners and buyers network (identifies the value proposition for the buyer, sellers, and market makers and portals in an Internet context) · Revenue stream (a plan for assuring revenue generation for the business) · Logistical stream (addresses various issues related to the design of the supply chain for the business)
Stewart, & Zhao, 2000
· Profit stream (includes the revenue stream and cost structure)
· Customer selection · Value capture · Differentiation and strategic control · Scope
Afuah & Tucci, 2001
· A system made of components, linkages between components, and dynamics · Customer value (the extent to which the firm’s offer is distinct or has a lower cost than its competitors’) · Revenue sources (Where do the dollars comes from? Who pays what value and when? What are the margins in each market and what drives them? What drives value in each source?)
· Scope · Price · Connected activities · Implementation · Capabilities · Sustainability
Alt & Zimmerman, 2001
· Mission · Structure · Processes · Revenues · Legal issues · Technology
Mission: · Goals; Vision; Value proposition Structure: · Actors and governance; Focus Processes: · Customer orientation; Coordination mechanism Revenues: · Source of revenues; Business logic
Applegate, 2001
· Concept (describes an opportunity) · Capabilities (define the resources needed to turn concept into reality) · Value (measures the return to investors and other stakeholders)
Concept: · Market opportunity; Product and service offered; Competitive dynamic; Strategy for capturing a dominant position; Strategic options for evolving the business Capabilities: · People and partners; Organization and culture; Operating model; Marketing sales
model; Management model; Business
development model; Infrastructure model
Value: · Benefits returned to stakeholders; Benefits returned to the firm; Market share and performance; Brand and reputation; Financial performance
Rappa, 2001 · Sustainability · Revenue stream · Cost structure · Value chain positioning
Appendix
IX
Osterwalder, 2004
· Value proposition · Customer segments · Partners’ network · Delivery channel · Revenue stream
· Relationship · Value configuration · Capability · Cost structure
Bonaccorsi et al., 2006
· Products and services delivery · Customers · Costs structure · Income
· Network (structural aspects) · Network externalities
Brousseau & Penard, 2006
· Costs · Revenue stream · Sustainable income generation · Goods and services production and exchanges
· Pricing strategies · Relationships (demand and supply) · Network externalities
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