Business Model Innovation Matters More Than Ever

The coronavirus pandemic has been a roller coaster for business managers. Some are cresting high, others are in freefall, and many more are simply trying to hang on until the nightmare ride comes to a stop. Amid the panic, there are valuable lessons for leaders who can take a deep breath and step back. Wharton management professor Raffi Amit and Christoph Zott, an entrepreneurship professor at the University of Navarra’s IESE Business School in Spain, have written a new book to guide businesses through the internal and external shocks caused by the pandemic and other disruptions. Business Model Innovation Strategy: Transformational Concepts and Tools for Entrepreneurial Leaders draws on 20 years of research and practice to help businesses embrace change by building a strategy that will make them more resilient and responsive to the marketplace. Amit and Zott joined Knowledge at Wharton to talk about the book. (Listen to the podcast at the top of this page.)

An edited transcript of the conversation follows.

Knowledge at Wharton: Before we dive into the book, could you give me a little background on your collaboration?

Raffi Amit: We’ve known each other since the mid-1990s, when we met at the University of British Columbia in Vancouver, Canada. Both Chris and I are strategy and entrepreneurship scholars with a very pragmatic orientation and very rich practical experiences. We observed in the mid- and late-1990s that there were all these e-businesses that were formed, and they are enormously valuable. We observed companies like eBay, for example, which was founded in 1995 and went public in 1998. It doesn’t have a product. The cost of goods sold is zero. Yet eBay is worth billions of dollars. Take Netflix, another example of a company that was founded in 1997 and went public in 2002. There’s really nothing new about its product. You could have rented CDs at Blockbuster, yet Netflix innovated in the way you rent a CD. Initially, it was mail order, and now it’s streaming. By innovating the way you rent a CD, it drove Blockbuster out of business.

This allowed Chris and me to realize that there is a new form of innovation that is distinct from product innovation, that is distinct from process innovation, and which does not require mountains of R&D expenses and years of research. This new form of innovation centered on the way companies do business. Namely, their business model. We published over two dozen papers together, and we decided to write a book about business model innovation.

Christoph Zott: The real answer is that because our last names fit so well together — Amit and Zott. We’re the team that looks at something and tries to find the answer from A to Z. If you go even beyond the internet and the focus on business models, what brought us together was our keen interest in entrepreneurship and everything that has to do with value creation. Raffi and I share a passion for that subject. We really want to understand how value is created, how people create something from nothing. This is this magical formula that is typically attributed to entrepreneurs. They’re able to turn ideas into something tangible. [They build] companies that provide employment to people. They create products that customers want to buy.

The relevant issue that we were observing, especially in the second part of the 1990s, was that there were a bunch of companies that were created very fast and made it to IPO really fast. Netscape, Yahoo, eBay. We asked ourselves, “What’s special about these businesses? Is there anything new here?” That led us to the realization that what these companies were doing and were really good at had nothing to do with our preconceived notions of products or services. But it was in how they did business, which we then called the business model.

“Everything that we have learned in business school for the past decades is still true. But the business model offers a new avenue for value creation.” –Christoph Zott

There was something fundamentally new going on, and it didn’t really have to do with the digitization of business. We saw that digitization was an enabler for firms to go about business in a new way, in a different way. This got us off on our work on business models and business model innovation. We wrote our first paper together in 2000, and it was published in the Strategic Management Journal. It’s still considered one of the seminal pieces on business models. It wasn’t that the business model was a brand-new idea for managers. But for academia, it was a new idea. We were interested in developing this idea and exploring it further because we thought it was a very, very rich idea. If you have companies that, within a matter of a few years, become worth billions of dollars, there must be something really to it. We’ve been at it now for a long time, and the book represents a summary of the insights that we and our colleagues have found and researched over the past 20 years.

Knowledge at Wharton: Let’s talk about what business model innovation is. In this book, you help define it by telling us what it is not. You wrote that, “Modifying an activity by making it faster, cheaper, or higher quality is not a business model innovation.” That statement seems to eliminate the traditional avenues of improvement that managers usually take. What should they be doing instead?

Zott: I’d like to address this question in two ways. Yes, we do say in our book what a business model is not. And we do this deliberately, because we think it helps people understand better what a business model is in the first place. In general, there is a lot of confusion about what a business model really is. If one person says A and another person thinks B, it’s very hard to think that they have a real conversation around this topic. So, we thought it would be very important first to define the concept clearly.

The second thing is that we don’t believe that other ways of creating value have become less important and that the business model eliminates these traditional avenues. In contrast, the business model adds to these traditional avenues of improvement for business managers. It complements them. Everything that we have learned in business school for the past decades is still true. But the business model offers a new avenue for value creation.

Knowledge at Wharton: Professor Amit, what is the framework for business model innovation?

Amit: Now we know what the business model is not — it’s not the product, it’s not the firm, it’s not all-encompassing, and it’s not the same thing as a business plan. The way we think about the business model is as a system of interdependent and interconnected activities that are designed to capture market needs, or perceived market needs, and create value for all the stakeholders. It’s a holistic concept that requires the manager to take a step back and apply system-wide or system-level thinking.

There are really four dimensions in a business model. First, what are the activities that need to be carried out as part of this business model? Second, how are these activities sequenced or connected to each other?  Third, who carries out each of the activities? And fourth, why is this business model creating value for all stakeholders, and why does this business model enable the focal firm that innovates the business model to capture some of this value?

The basic idea is, as Chris pointed out, if you just change and make the product a little bit better — you add a feature, for example, or make it work faster — it doesn’t change the system of activities. So, when we talk about business model innovation, it refers to a business model that is new to the industry in which the firm competes. And business model innovation strategy, which is the title of the book, refers to the design of a new activity system, namely, the design of a new business model. It refers to the processes by which that new system of activities is created and the implementation of the system within the context of the firm. And very, very importantly, [it includes] the ongoing adaptation of that business model to a changing ecosystem or environment within which the firm competes.

Zott: I just wanted to repeat this very important observation — that a business model is not all-encompassing. If it were all-encompassing, how would it then be different from a firm or an organization? We’re talking about the business model of a company, of an organization. This is distinct. In terms of the business model, it’s the activity system that we would like to highlight as the crucial underlying conceptual backbone.

We could think of Apple, which is a very well-known example because Apple does both. Apple is brilliant with product innovation and design. They have innovated many gadgets that are household items today, which has made them one of the most valuable companies on the planet. The iPhone is one of the latest examples of that.

“When we talk about business model innovation, it refers to a business model that is new to the industry in which the firm competes.” –Raphael Amit

But they are also a very powerful business model innovator. With the introduction of their app store and iTunes and all of those innovations, what they have done is added a distribution platform to their hardware business, which makes their hardware business more valuable. They benefit from the sale of the gadgets, but they also benefit from the sale of the content that is played on these gadgets, so they benefit twice. There is a mutually reinforcing relationship here between their product innovation and their business model innovation.

Knowledge at Wharton: In the book, you stress the importance of adopting a business model mindset. That usually refers to startups and thinking like an entrepreneur, but it’s a little bit more than that for you. So, what is a business model mindset and why is it important?

Zott: You mentioned entrepreneurial mindset. That is one type of mindset that’s certainly very helpful. But when we talk about business model mindset, we refer to what Raffi has mentioned a little earlier as system-level thinking and holistic thinking. Entrepreneurs also need to think at the system level and holistically because they need to think about the entire business architecture. They need to think about all business functions.

It’s the same thing with the business model [mindset]. In the business model mindset, you need to be able to take a step back, and this sometimes is very difficult for managers because they’re focused. They work in organizations, within certain functions, so they’re good at one thing. They’re good at strategy, they’re good at marketing. They may work in sales, or they may work in finance. But they rarely have this opportunity to take a step back and rethink the entire construction, the entire architecture of the business for which they’re working. How does it all hang together? How are all these activities connected to each other? That is what we believe requires a specific mindset — this ability to see the forest and not just the trees. That’s the first requirement of a business model mindset. To be able to jump the level of analysis from a focus on activities or individual activities or products, to the system level.

Amit: Think about a car manufacturer executive’s reaction to the entry of Tesla into the automotive market. The first thing they are thinking about is, “Well, maybe what we should do is expand our product portfolio and have an electric car or a hybrid car,” because the focus is on the technology of the product.

But Elon Musk — who has a background at Wharton — already adopted a much broader perspective on his firm’s innovation strategy, taking Apple as an inspiration not only for promoting distinctive technology and slick product design, but also imitating and incorporating other key aspects of the Apple business model. For example, they have their own stores rather than having franchises distribute their car. They have total control of the entire process, from the design to manufacturing and the sales. General Motors doesn’t have that. Mercedes Benz doesn’t have that. Chrysler doesn’t have that. Ford doesn’t. They use third-party franchisees that do the sales, so they don’t have total control of the interaction with the end customer. But Tesla does. And that feedback allows Tesla to continuously innovate its offer and be ahead of the competition. It’s not focused just on the car. It’s a much more holistic perspective on doing business.

Knowledge at Wharton: That’s a really great example because we just found out that Elon Musk has topped the list of richest people in the world. Clearly, he’s doing something right. We can take some lessons from his business model mindset.

“You need to be able to take a step back, and this sometimes is very difficult for managers because they’re focused.” –Christoph Zott

Zott: The Tesla example is a brilliant one in order to highlight the two traps into which managers often fall. The first trap is the level of analysis trap, which is when managers continue to focus on what they thought was the important thing to focus on. Like, for example, the product. This is very clear in the car industry. If you look at traditional car firms, and you ask managers in those car firms what’s really important, many of them will continue to talk about the car and the engine and elements of the design of the car, and so on and so forth. They’re completely focused and concentrated on the car as a product. Whereas people like Elon Musk and others in the e-mobility industry know that the car as a product is one vision. The other vision would be the car as a software platform, or even as a service. And that would be a different type of level of analysis. To get from one to the other is extremely, extremely difficult. If you have worked all your life on products, and all of a sudden somebody comes along and says, “It’s not about the product anymore. It’s about how you do business,” that’s a difficult one to grasp.

That ties into the second trap, which is the familiarity trap. You’re used to working within a particular activity system, within a particular company. You’re used to working within a car manufacturer that has things set up in a certain way, that has a production line, but then outsources many things to suppliers and works with dealerships. This is your familiar reference point. To cast that aside and say, “Wow, maybe we should do things very differently. Maybe we should not outsource so many things and should do them internally,” or vice versa — that’s not so easy, either. People are familiar with certain things, and have a hard time grasping the new and the need for a new way of doing things. The need for a new business model. They also are very much focused on a certain level of analysis, especially at the product level, and then have a hard time understanding why they should be talking about activities. “Why should activities matter? Isn’t it the product that’s important here?” We say both are important, but you need to make the move and the jump from one to the other. And that’s, I think, a mindset issue.

Knowledge at Wharton: The coronavirus pandemic has upended business in a very short period of time. But if we go back through history, there are a number of moments that have redefined business. We can think of World War II, the oil crisis in the 1970s, the development of the internet. Is this pandemic any different? Are there new lessons to be learned here?

Zott: I think that the COVID crisis is acting as an accelerator in many respects. Does it highlight very new issues? I’m not so sure. I think it brings to the forefront issues that were already there, but it makes them even more salient. It’s an accelerator in many ways, for example when we talk about education and digital ways of delivering education. In our universities, both at the Wharton School and at IESE Business School, we’ve seen a change that we would not have believed possible a year ago. I think of it more as an accelerator than as something that brings about fundamentally new desires and fundamentally new developments. Although we cannot exclude that.

Knowledge at Wharton: Dr. Amit, would you agree?

Amit: Let’s just put things a little bit in perspective. The COVID-19 pandemic triggered a severe, multifaceted global crisis — both a health crisis and an economic crisis. The shocks to the economy were both on the demand side as well as on the supply side. A catastrophic pandemic such as COVID-19 is very likely to alter the preferences, habits, and risk attitudes of consumers, in part because of the long stays at home and the social distancing measures that were applied. What seems very likely is that many companies — both large and small, both private and public, both for-profit and not-for-profit — will be prompted to reimagine themselves, to reinvent themselves, in order to survive and prosper in the future.

The way they engage with their customers might change dramatically. For the last almost year, we didn’t go to malls. We didn’t go shopping. We did everything online. If you are a mall owner, you will ask yourself, “Will consumers come back to malls? Will they need the mall? Will they need to go when they are so used to shopping online today?”

There are profound behavioral changes that might occur as a result of this pandemic. Companies need to look at themselves and say, “Should we find new ways to interact with our partners, with our customers?” Therefore, “Do we need to design a new business model?” There is no doubt that the pandemic has prompted companies to reimagine and redesign their business models. I think that we don’t really know how the new normal will evolve. That’s work in progress, right? There are so many things that are happening, both politically, socially, and otherwise, and there is a record level of uncertainty as a result. That, for sure, will affect how companies will decide to engage with their stakeholders.

“There is no doubt that the pandemic has prompted companies to reimagine and redesign their business models.” –Raphael Amit

I think that the breadth and depth of the changes that the pandemic has brought about, as well as the speed at which those things have occurred, will result in substantial business model innovation. Our book provides guidance to executives on how to go about doing this, because many are not that familiar with that process and with that type of thinking.

As we work with companies around the world, we see that they’re struggling. If you’re a mall, you’re trying to hold onto the retailers that lease space from you. But maybe they should think totally differently about the usage of the space, not just running after retailers and convincing them to continue to pay the rent. Maybe they should engage in different uses of the space. Maybe do some entertainment, maybe do some other things that would bring people back into malls, not just for shopping but for other activities that complement shopping.

Knowledge at Wharton: If readers take one thing away from your book, what do you want that lesson to be?

Amit: Pay attention to your business model strategy. It has become a strategic imperative and a key strategic choice that managers and entrepreneurs need to make. The business model requires an ongoing, innovative adaptation to the changing external environment. Make sure that your organization accepts change and has a business model innovation mindset to enable it to continue and prosper in the future.

Zott: I think the most important message to entrepreneurs and managers out there — and it’s a positive message — is that business model innovation has become a new form of innovation. It’s best conceived of as how to do business and how to do business in new ways. It’s centered on the firm’s activity system, and it represents a new form of value creation.

Think of it as a new type of innovation. You don’t have to be a rocket scientist. You don’t have to be an engineer. You don’t have to have a Ph.D. in anything in order to come up with a new business model idea. It’s very democratic, and it’s an equalizer. You can come up with new ideas, creative new ways of doing business, and build a fantastic new company around that. But as Raffi pointed out, in order to do this systematically and in a disciplined manner, you have to have a strategy for it, especially if you’re working for a large company. This is not just for start-up entrepreneurs, but it’s particularly important for established companies who need to reinvent themselves. And then COVID-19 presents us with a rationale for why it’s important to think about reinventing ourselves.