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When Technology Meets the Business Model

Can elephants dance? Large companies are perceived to be less inclined to invest in new technologies than start-ups. But HBS professor Henry Chesbrough and Professor Emeritus Richard S. Rosenbloom say look to your business model—not the technology itself—to judge investment decisions.

Tech Investment the Wise Way

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:

  1. identify a market segment, that is, the users to whom the technology is useful and for what purpose;
  2. articulate the value proposition, that is, the value created for users by the offering based on the technology;
  3. 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;
  4. estimate the cost structure and profit potential of producing the offering, given the value proposition and value chain structure chosen;
  5. describe the position of the firm within the value network linking suppliers and customers, including identification of potential complementors and competitors;
  6. 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.

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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.

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Case Illustration

Excerpted with permission from "The Dual Edged Role of the Business Model in Leveraging Corporate Technology Investments."

Xerography surely ranks as one of the most significant new technologies of the mid-20th century, yet its commercial success came only after it had been rejected by several leading firms, including Kodak and IBM. Chester Carlson, a graduate in physics from Cal Tech who became a patent attorney during the Great Depression, made the core invention working in his kitchen in the late 1930s. After Carlson filed his first patent in 1937, numerous corporations expressed interest in the novel technology, but none was willing to invest in bringing it from concept to practical reality.

In 1944, he approached Battelle Memorial Institute, which soon entered into a partnership, investing in further development and acting as his agent. Commercialization was the work of Haloid Corporation, which approached Battelle in 1946 after learning of its work in xerography. Haloid, a small enterprise operating in Rochester, New York, in the shadow of mighty Eastman Kodak, served a niche market with high quality cameras and photographic papers for copying important documents. Its CEO, Joseph Wilson, driven to find a growth vehicle for his failing enterprise, "bet the company" in the 1950s on Carlson's invention.

Haloid sought vainly to find a strong marketing partner for the expensive new machine, but was rebuffed by Kodak and others. IBM rejected the 914 after a careful and highly professional market analysis by the respected consulting firm Arthur D. Little and Co. (ADL). ADL could not conceive a successful business model, in part because they could not identify a salient value proposition. They reported that:

[because] the Model 914 ... has considerable versatility, it has been extremely difficult to identify particular applications for which it is unusually well suited in comparison with other available equipment .... Perhaps the very lack of a specific purpose or purposes is the model 914's greatest single weakness. (Arthur D. Little, 1958)

Failing to recognize the radical character of xerographic technology, ADL analysts essentially assumed the 914 would be offered within the business model then extant in the office copy machine industry. Skeptical that customers would invest thousands of dollars to acquire a copier that would, after all, only be used to make a few hundred copies a month, they concluded: "Although it may be admirably suited for a few specialized copying applications, the Model 914 has no future in the office-copying-equipment market."

Having failed to find a partner, on September 26, 1959, Haloid brought the 914 to market by itself. It surmounted the obstacles of high cost by using an innovative business model. A customer needed to pay only $95 per month to lease the machine, and to pay four cents per copy beyond the first 2,000 copies each month. Haloid (soon to be renamed Xerox) would provide all required service and support, and the lease could be cancelled on just 15 days notice.

This was an attractive value proposition for customers. This business model imposed most of the risk on tiny Haloid Corporation: customers were only committed to the monthly lease payment, and did not pay anything more unless the quality and convenience of the 914 led them to make more than 2,000 copies per month. This let Haloid offer the 914 at a low entry price, to lure more customers. Only if the 914 were to lead to greatly increased volumes of copying would this business model pay off for Haloid.

Haloid's model essentially acknowledged that the ADL analysis was right, but was incomplete. Joe Wilson bet that ADL's conclusion could be reversed by a different business model. It proved to be a smart bet. Once installed, the appeal of the machine was intense; users averaged 2,000 copies per day (not per month), generating revenues far beyond even Joe Wilson's most optimistic expectations (Kennedy 1989). The business model established for the 914 copier powered compound growth at an astonishing 41% rate for a dozen years, turning $30 million Haloid Corporation into a global enterprise with $2.5 billion in revenues by 1972. This was an early demonstration of a proposition now more widely recognized: technologies that make little or no business sense in a traditional business model may yield great value when brought to market with a different model.