Excerpted with permission from "The Dual Edged Role of the Business Model in Leveraging Corporate Technology Investments," in Taking Technical Risks: How Innovators, Executives, and Investors Manage High Tech Risks, article © The President and Fellows of Harvard College, 2001; book © MIT Press, 2001.
This excerpt is taken with permission from a contributed essay in Taking Technical Risks: How Innovators, Executives And Investors Manage High-Tech Risks, edited by Lewis M. Branscomb and Phillip E. Auerswald. Chesbrough and Rosenbloom discuss the necessity for successful firms to gauge potential value of new technologies by first holding them up against the company's business model.
We argue that successful firms tend to interpret the potential value of nascent technologies in the context of the dominant business model already established in the firm. The reward to be expected from any innovative venture must be assessed within the framework of a specific business model, which will specify how revenues will be generated, from whom, and what costs will be incurred in so doing. In other words, technology does not create value in a vacuum. The established model may or may not be appropriate to the opportunities inherent in the new technology. If not, its use will lead to inaccurate analysis and underinvestment. That is one source of the bias exhibited by successful firms facing novel technologies, and it is the one to which we devote the rest of our discussion.
The Business Model Concept
This term "Business Model" is widely used, but seldom well defined. In our usage, the functions of a Business Model are to:
- identify a market segment, that is, the users to whom the technology is useful and for what purpose;
- articulate the value proposition, that is, the value created for users by the offering based on the technology;
- define the structure of the value chain, that is, the network of activities within the firm required to create and distribute the products or services offered to customers;
- estimate the cost structure and profit potential of producing the offering, given the value proposition and value chain structure chosen;
- describe the position of the firm within the value network linking suppliers and customers, including identification of potential complementors and competitors;
- formulate the competitive strategy by which the innovating firm will gain and hold advantage over rivals.
Defining a business model to commercialize a new technology begins with articulating a value proposition inherent in the new technology. The model must also specify a group of customers or a market segment to whom the proposition will be appealing and from whom resources will flow. Value, of course, is an economic concept, not primarily measured in physical performance attributes, but rather what a buyer will pay for a product or service. A customer can value a technology according to its ability to reduce the cost of a solution to an existing problem, or its ability to create new possibilities. One challenging aspect of defining the business model for technology managers is that it requires linking the physical domain of inputs to an economic domain of outputs, sometimes in the face of great uncertainty.
Value derives from the structure of the situation, rather than from some inherent characteristic of the technology
Chesbrough & Rosenbloom
Value thus derives from the structure of the situation, rather than from some inherent characteristic of the technology itself: Increasingly, realizing value also involves third parties. The value network created around a given business shapes the role that suppliers and customers play in influencing the value captured from commercialization of an innovation. The parties in the value network can benefit from coordination if that increases the value of the network for all participants.
A market focus is needed to begin the process in order to know what technological attributes to target in the development, and how to resolve the many trade-offs that arise in the course of development, e.g. cost vs. performance, or weight vs. power. Technical uncertainty is a function of market focus and will vary with the dynamics of change in the marketplace.
Identification of a market is also required to define the "architecture of the revenues"—how a customer will pay, how much to charge, and how the value created will be apportioned among customers, firm, and suppliers. Options here cover a wide range including outright sale, renting, charging by the transaction, advertising and subscription models, licensing, or even giving away the product and selling after-sale support and services.
Having a sense of price and cost yields target profit margins for the opportunity. Target margins provide the justification for the real and financial assets required to realize the value proposition. The margins and assets together establish the threshold for financial scalability of the technology into available business. In order for the business to grow, it must offer investors the credible prospect of an attractive return on the assets required to create and expand the model.
The biases introduced by an established business model can cut two ways. First, as noted earlier, they can mask the potential for reward inherent in a valuable new technology to which the model is inappropriately applied. On the other hand, a model that has been notably successful in a series of new businesses can result in exaggerated expectations of the rewards from an innovation that has received insufficient scrutiny for that reason. The latter effect is similar to the force familiarly know as "technology push." In such cases, enthusiasm for a novel technology, especially when combined with hunger for revenue growth, can lead to investments in commercializing innovations without sufficient scrutiny of their true economic potential.