Alternative approaches to business models
E2 Chapter 2
WHAT IS A BUSINESS MODEL?
Aspects of
traditional
business models
Capture residual
Define value Create value Deliver value
value
Business models are aimed at a wide variety of stakeholders
Financial
or non-
financial
Short
term and
Value Tangible
or
long term types intangible
Past,
present
and future
Value is therefore at the heart of business models and can be:
a) Financial or non-financial: and must be differentiated from price, cost, profit or cash
flow. These are related concepts but they are not the same as value but they are
important because they act as measures or stores of value.
b) Tangible and intangible: e.g. the move from an industrial economy to a knowledge-
and information-based economy increased the importance of intangible value to
firms.
c) Value affects the past present and the future. Past value is often used in reporting,
present value in operational management and future value in investment appraisal.
d) Short term and the long term: the short term is important because firms must
survive for them to have any long-term prospects. However, short-term value must
not undermine long-term value.
In summary:
The concept of the “business model” has been used over many decades for
three main reasons.
a) Legal and regulatory requirements in certain jurisdictions require some firms to
describe their business models when reporting to shareholders.
For example, UK Corporate Governance Code, which requires directors to “state that
the annual report and accounts ... provides the information necessary for
shareholders to assess the company’s position and performance, business model and
strategy”.
b) Business models can be the means by which the firms create long-term value and
success to identify and exploit business opportunities in the external environment.
c) By the use of these models and frameworks firms can respond to disruptions in their
operating environments, particularly from firms who have new or better business
models
Defining Value:
STAKEHOLDER MANAGEMENT
Critical to the decision and action to create value, it is vital that organisations
decide who they are creating value for, with whom and why they are so doing.
To do this a firm may apply a four step to this process:
Steps
Each stakeholder is ranked on the following attributes:
a) Power – ability to impose their will
b) Legitimacy – according to the norms and values of the firm and society
c) Urgency – the need for immediate action in the light of a stakeholder claim.
VALUE CREATION
• Value however is also about people. It is about how their needs are met. It is created
by people, with people and for people. Value goes beyond shareholder value to
creating shared value.
• For example, organisations such as Nestlé now produce shared value reports
annually indicating that value is co-created by different stakeholders and not just the
domain of shareholders
• Within the boundaries of cost control, there are five key elements that must connect
and align to create value at an appropriate cost. By way of comparison this can be
referred to as the operating model of the firm.
Key
elements
Partners Resources Processes Activities Outputs
Partners – these include suppliers, employees, contractors and other partners (high priority
stakeholders) who provide access to resources, markets and technologies. Firms must build
relationships, earn their trust and reward them appropriately for their contribution to value
creation.
Resources – firms use their relationships with their suppliers to source and secure the right
resources to make products or services that satisfy their customers. These are both tangible
and intangible inputs. For critical resources long-term availability is also a primary objective.
Processes – firms need to design, develop and deploy processes that provide the
infrastructure to convert resources (inputs) into goods and services (outputs).
Activities – firms and their partners engage in activities that use the processes to convert
resources into goods and services.
Outputs – firms’ outputs are in the form of products, services and experience, which aim to
meet the customer value proposition.
DELIVERING VALUE
Firms deliver value to customers and earn revenue from customers only when customers
receive and/or use the goods and services. It is therefore imperative that firms understand
their different customer segments and the channels by which to reach each of these
segments.
Value-based segmentation looks at groups of customers in terms of the revenue they
generate and the costs of establishing and maintaining relationships with them.
Measurable
easy to
Meaningful
understand
Segment
features
Mututally
substantial
exclusive
stable
Channels:
• Firms deliver value to customers through communication, distribution and sales
channels. In this context the advent and growth of technology has opened up many
channels for firms to connect with their customers, for example phones, tablets and
social media.
• In that respect therefore organisations must develop need a multi-channel
integrative customer model that delivers customer value and significant return on
investment.
CAPTURING RESIDUAL VALUE:
• Value is captured when revenue earned from delivering value exceeds the costs of
creating value.
• The difference between the two creates a surplus, the size of the surplus will depend
on market conditions but will also reflects the decisions made when defining value
and the success with which firms execute those decisions.
• Firms will share this surplus with stakeholders who contributed to and have been
part of the value creation process but have not yet received any value themselves.
Capturing Residual Value:
Value is captured when revenue earned from delivering value exceeds the costs of creating
value.
The difference between the two creates a surplus, the size of the surplus will depend on
market conditions but will also reflects the decisions made when defining value and the
success with which firms execute those decisions.
Firms will share this surplus with stakeholders who contributed to and have been part of
the value creation process but have not yet received any value themselves.
Efficiency of the process
Levels of activity
Cost model
Resources consumed during activities
Price paid for resources
Collection model
Issues to consider while
Revenue model
capturing value
Pricing model
Government - taxes
Shareholders - dividend
Sharing residual
value
Executives - incentives
Firm - retained earning
Cost model:
This is established when defining value. It is influenced by the value proposition to
customers and the partnerships that firms use to create and deliver value.
The total cost will be established by four key factors:
a) Efficiency of the processes.
b) Levels of activity.
c) Resources consumed during activities.
d) Price paid for resources.
Revenue model:
Revenue is earned when goods and services are delivered to customers and any prices
charged should accurately reflect the customer segments that the firm addresses, the
market conditions in which it trades and any regulatory control in place.
In addition, the firm will also need to establish a collection policy which dictates the speed
which revenue is converted to cash. Both pricing and collection policy (i.e. terms of trade)
are affected by these factors.
Sharing residual value:
This is based on the principle of creating shared value, which comprises shareholder value
and the value delivered to other stakeholders. The priority of these stakeholders will
depend on the environment on which they operate.
For example:
a) Government (taxes)
b) Shareholders (dividends)
c) Incentives for executives (performance-related pay)
d) The firm (retained income for reinvestments).
The sharing has to be sensitive to the interactions in the operating environment so that it
does not avoiding any harm to the harm the firm’s reputation, the creation and delivery of
further value and will be dependent on the strategy of the firm in terms of for example its
bonus schemes, dividend policy and investment opportunities.
