As a product manager working for a product company I tend to mostly think of innovation as product related. But there are obviously other areas of innovation, one being business models. While product innovation is what solves customer problems and gives you that edge over competition, business model innovation ensures that your business is profitable and growing.
If you haven’t already done so, go read the Business Model Generation by Alex Osterwalder. It is one of those must-reads if you are a product manager. And frankly it is a must read for anyone involved in innovative business. The rest of this post refers to the Business Model Canvas as described in Business Model Generation, which is why we start with a quick recap.
Recap of the business model canvas
The objective of the business model canvas is to help you look at the big picture rather than get hung up on details. It covers everything from the value of your product, to how you sell and make money off of it.
The right side of the canvas covers values. Here you find customer segments, customer relationships, your channels to those customers, your value proposition and finally your revenue. This is where you define your market, describe your product-market-fit and how you get your product to market.
The left side of the canvas covers efficiency. This is where you find key partners, key activities, key resources and the cost of making your product successful. This is where you ensure that the value side is properly supported, with a scale, time-to-market and cost structure to make it profitable.
Ignoring low-cost value propositions for a second, the right side is where innovative business models primarily see the light of day. Hence the right side is where we will focus most of this post.
While frameworks, checklists and processes are great to really drill down into the details of your business model, I tend to prefer a good example before a framework. Examples tend to plant a seed that help you when creating or revising your own model. So here’s my collection of companies that have excelled at business model innovation.
Warby Parker cut out the middle man
Started as a pure online business in 2010, with only $2500 in seed capital, Warby Parker managed to cut out the middle man completely from their transactions. They design prescription glasses and sell them directly to their customers. Using the Internet they built a direct marketing and sales channel to their customers. They did this without investing in their own brick and mortar stores, which would have required huge investments.
Today this model is common and well understood, and it is easy to forget how fast the world has changed. Working with your customer channels for awareness but also for closing sales has a huge positive impact on your business model. Your channel can severely impact your reach, and thus revenue potential, as well as your cost structure.
Uber kicked off on-demand services
Taxi services where nothing new when Uber launched back in 2009. But Uber managed to innovate by changing the nature of taxi business around completely. For on-demand services convenience is key, and Uber made it dead simple to book a ride from your phone. An entire market has followed, to the extent where “Uber for X” has become such a common description of startups that people ridicule it.Uber innovated to the point where Uber-for-X became a joke in the startup world. Click To Tweet
Innovation based on on-demand business models are a combination of shifting revenue streams from one-time perpetual to pay-for-what-you-use, and a move to convenient self-service sales. Another company using this model is Handy for home services. For an extensive list of others check out the Uber for X collection on Product Hunt.
Airbnb is the poster child for the sharing economy
Crowded cities with expensive real estate, expensive parking and a limited need for your own car the sharing economy has exploded. Airbnb was launched in 2008 to solve an immediate problem. Two room mates could not afford their rent, while there was a shortage of hotel rooms in San Francisco. They started Airbnb and now have a service with over 1.5M rooms and homes to choose from. RelayRides and GetAround let you borrow a car from your neighbor when you need it, while with Lyft others will drive you around in their own car. With Parking Panda you can use parking spots of others on-demand. And TaskRabbit has stirred up head lines with their market place for hiring people to do tasks for you.
Peer-to-peer business models save money, are environmentally friendly and resource efficient. Many companies with this type of business model are considered hip, and tend to attract a young, conscious crowd living in urban areas. Peer-to-peer affect most aspects of your business model, from how revenue is generated to your customer relationships. Your customers are not only your customers, they are now also your partners, providing key resources needed to make your business successful.
Rent-a-life with Mud Jeans and Emblem Furniture
While leasing based models are not exactly new, they have expanded into areas of consumer goods that have not changed for a very long time. Leasing in the consumer goods space tend to be used for expensive articles, and has for a long time been a model widely used for example in the car industry. But with Rent the Runway, Girl Meets Dress, The Black Tux and Mud Jeans the model is taking over also in the expensive designer clothes market. Pay for a night with a designer dress and accessories, or lease your jeans for a year and get free repairs and swaps. Emblem Furniture lets you stage your home with rented designer furniture prior to selling it, giving you an expensive looking home for the week.
With a business model based on leasing, your company takes an upfront cost and thus financial risk. This is done with the promise to make more money long-term. The big advantage is that you expand your addressable market dramatically, compared to only selling to those with the financial means to pay up front. Channels and customer relations stay the same, but your revenue model obviously does not.Rent-a-life with Mud Jeans and Emblem Furniture! Innovative business models change CPG. Click To Tweet
Subscribe-to-a-life with Birchbox
If leasing goods is for short-term needs, such as that designer dress for a night, subscribing to goods is about outsourcing your shopping. Back in 2010 two young women started Birchbox, and pioneered a subscription service of beauty products for a monthly fee. With a personal beauty profile you don’t need to decide what products to get. Instead Birchbox match suitable products to your profile and send them with monthly shipments. With a million subscribers they have changed a complete market.
In 2011 two guys met and realized they were both frustrated with razor blade pricing. They started the Dollar Shave Club, where customers subscribe to monthly shipments of razor blades at a fair price. Stirring up a buzz, and getting huge investors onboard early on.
With a subscription model the revenue source is stable and long-term. Increasing the life-time value of a customer becomes important, and you need to focus on retention. With a long average customer life-time, the cost of customer acquisition is less important. Therefore high-touch channels can be used to close sales, and high-cost channels can be used to create awareness.
When tires are not tires but “road grip” delivered by Bandvulc
For cost control reasons, there is an ongoing shift in business models for expensive industrial equipment from purchase and service agreements to pure service agreements. Rolls Royce were one of the pioneers, charging for engine runtime instead of purchase and maintenance in the airline industry. Xerox is another classical example, who don’t sell printers but instead sell a print service. You pay for what you print, not for the printer. Bandvulc sell “road grip” to transportation companies instead of lorry tires.Bandvulc sell road grip, not tires, with their innovative business model. Click To Tweet
Some industries make this shift out of necessity. During times of recession or industry turmoil huge investments tend to be delayed. For manufacturers struggling, a move to a pure service sell is an attractive option. Selling a service means less upfront costs for the customer, and hence an easier sell in times of financial struggle. If the product also happens to be high maintenance, the customer already has a comprehensive service agreement. Adding cost to this agreement to eliminate up front investments is often an easy sell.
Finally with this model manufacturers are also incentivized to build higher quality products. When a vendor both charge for their equipment and separately for maintenance, they have no short-term incentive to focus on quality. Quality problems generate revenue, so why bother? With a model where vendors make more profit the less maintenance they actually perform, product quality tend to improve as well.
App stores leverage the network effect
In June 2008 Apple expanded its music distribution platform iTunes to also include apps for their newly launched iPhone. This was a huge shift from previous models, where mobile device manufacturers typically developed their own apps. In cases where they actually supported third-party apps, it was not only cumbersome to download and install them, they were also not quality assured. For the device manufacturers those third-party apps also did not generate any revenue. Apples move changed all that. They gave their customers a better experience, and took a 30% cut of the revenue for all app sales on their iOS platform.
Already by the end of 2014 Apple had made $11 billion on 3rd party apps alone, for which their distribution costs are close to negligible. In August that same year Google followed in pursuit with their Android Market. In 2009 they started allowing paid applications, also taking a 30% cut. And while Google makes less revenue from their app store than Apple (about 50% in Q3 2015), they’ve still made billions of dollars with high margins.
The network effect has big implications on the business model, and is a bit of an exception when it comes to business model innovation. Much of the innovation actually happens on the left side of the canvas, related to efficiency. Third party developers become key partners needed to realize revenue, and activities will revolve around satisfying and helping those developers.
Pay-as-you-drink coffee with Keurig and Nespresso
Nespresso is yet another good example of successful business model innovation. They started off trying to sell and lease their coffee machines like many others, until they in 1988 pivoted and started charging for consumption, i.e. for the coffee. A proprietary coffee capsule system allowed them to almost give away their coffee machines, assuming they would make money selling those capsules. This lowered the bar for people to purchase their systems, but guaranteed an upside for Nespresso assuming they could build a customer base. Their business model traded an initial revenue loss for a future revenue upside.
Others have done similar journeys. Keurig is another coffee capsule system that also changed their business model in the late 90s. In 2014 they made only 15% of their revenue from selling hardware. Gillette is another famous example, charging a lot for their blades while selling their razors cheap or even giving them away. Amazon sell their Kindle hardware cheap and instead make money on the books “consumed” using that same hardware.
Business models based on the assumption that you have a closed and proprietary system can only last for so long. While they allow you to get expensive hardware on the market quickly they no longer apply once patents expire. Assuming you are successful there will be lower price alternatives showing up and taking some of that expected revenue. Nespressos 1700 patents started expiring back in 2012, and since then many others have started offering capsules compatible with their system. But the upside of this model is clear, and it is seen by many as the future for most hardware oriented startups.With pay-as-you-drink coffee Nespresso changed the hardware industry forever. Click To Tweet
Apple, Netflix and Amazon killed media distribution
The sales of music on physical medium dropped from one billion units in 2000, to 200 million in 2010. There were many reasons for this, but Apple with their iPod and iTunes was one big driver for change. Less dramatic, but still huge, is the drop in physical book sales. When eBooks really took off back in 2012, the physical book sales dropped 9% in one year. Amazon and their Kindle eBooks were important driving forces behind that drop in sales.
But the shift from physical distribution to downloads was only the beginning. In only a few years the media industry started moving away from this business model too. This was a model where the revenue side was based on the same structure as before. Instead streaming movies, music and book subscription services took over. Today Spotify has over 75 million active music subscribers, Netflix has 65 million streaming video subscribers and Amazon let all their 40 million prime subscribers read over 300 000 books for free.
Hardware heavy industries that move to a subscription model force manufacturers to take an upfront cost hit. In the media industry the main problem has been to convince content rights holders to trade upfront revenue for a potential future upside. Especially as a lot of innovation happened in startups who could not afford a cost structure with huge upfront fees. What helped a lot was of course that the music, movie and book industries were already severely challenged by the shift away from physical medium.
Subscription based media consumption changes the revenue side of the business model, but it also changes the relationship with customers. Relationships are no longer about constantly making new sales, but instead about retaining existing customers.
We’ve covered a large number of examples where business model changes, rather than product improvements, were the true innovation. In all honestly many of the above examples involved a fair amount of product innovation, but the common thread is that business model innovation was the driving force behind that product innovation. Business model innovation was what opened up a market, what created offerings previously unheard of and what created long-term growth for these businesses.
When back in the office I urge you to take a closer look at your existing business model, and use these examples as inspiration of how you can grow your business through business model innovation!