How to Design a Winning Business Model

To find and retaining a market position, a business strategy must either do things different from rivals or the same things in different ways.

Formulate the Winning Strategy
Choose and Capitalize on Business Strategy

T extbooks sometimes explain business strategy simply as a firm’s high-level plan for reaching specific business objectives. Strategic plans succeed when they lead to business growth, a strong competitive position, and strong financial performance. When the high-level strategy fails, however, the firm must either change its approach or prepare to go out of business.

Define Your Terms!

Define Business Strategy

Business strategy is the firm’s working plan for achieving its vision, prioritizing objectives, competing successfully, and optimizing financial performance with its business model.

The choice of objectives is the heart of the strategy, but a complete approach also describes concretely how the firm plans to meet these objectives. As a result, the strategy explains in practical terms how the firm differentiates itself from competitors, how it earns revenues, and where it earns margins.

Business strategy explains how the firm differentiates, generates revenues, earns margins.

Strategy in business—like strategy in chess—must have tangible objectives, a realistic plan for reaching them, and accurate knowledge of strengths and vulnerabilities. [Photo: Battle of the Somme, soldiers on break playing chess. Querrieu, France, October 1916]

Business strategy explains how the firm differentiates, generates revenues, earns margins.

Strategy in business—like strategy in chess—must have tangible objectives, a realistic plan for reaching them, and accurate knowledge of strengths and vulnerabilities. [Photo: Battle of the Somme, soldiers on break playing chess. Querrieu, France, October 1916]

Strategies Reflect the Firm’s Strengths, Vulnerabilities, Resources, and Opportunities. They also Reflect the Firm’s Competitors and Its Market.

Many different strategies and business models are possible, even for companies in the same industry selling similar products or services. Southwest Airlines (in the US) and Ryan Air (in Europe), for instance, have strategies based on providing low-cost transportation. The approach for Singapore Airlines focuses instead on brand image for luxury and quality service. In competitive industries, each firm formulates a strategy it believes it can exploit.

Formulating Strategy Is All About Meeting Objectives (Goals)

In business, the strategy begins with a focus on the highest level objective in private industry: Increasing owner value. For most companies that is the firm’s reason for being. In practical terms, however, firms achieve this objective only by earning profits. For most firms, therefore, the highest goal can be stated by referring to “profits.” The generic business strategy, therefore, aims first to earn, sustain, and grow profits.

An Abundance of Strategies

Strategy discussions are sometimes confusing because most firms have many strategies, not just a single “business strategy.” Analysts sometimes say marketing strategy when they mean the firm’s competitive strategy. And, a firm’s financial strategy is something different from its pricing strategy, or operational strategy. The firm’s many strategic plans interact, but they have different objectives and different action plans.

The Strategic Framework

The strategic framework is a hierarchy. At the top sits the firm’s overall (or generic) business strategy. Here, the aim is the highest-level business objective: earn, sustain, and grow profits. Some may immediately ask: Exactly how does the firm achieve it’s profit objectives?

Firms in competitive industries answer the “how” question by explaining how the firm competes. For these firms, therefore, the overall business strategy is rightly called a competitive strategy. A “competitive strategy” explains in general terms how the firm differentiates itself from the competition, defines its market, and creates customer demand.

However, detailed and concrete answers to the “how” question lie in lower level strategies, such as the marketing strategy, operational strategy, or financial strategy, The marketing strategy, for instance, might aim to “Achieve leading market share.” Or, “Establish leading brand awareness.” Financial strategy objectives might include: “Maintain sufficient working capital” or “Create a high-leverage capital structure.”

What Is a Business Model, Really?

Everyone agrees that executives must know how business models work if their organizations are to thrive, yet there continues to be little agreement on an operating definition. Management writer Joan Magretta defined a business model as “the story that explains how an enterprise works,” harking back to Peter Drucker, who described it as the answer to the questions: Who is your customer, what does the customer value, and how do you deliver value at an appropriate cost?

Other experts define a business model by specifying the main characteristics of a good one. For example, Harvard Business School’s Clay Christensen suggests that a business model should consist of four elements: a customer value proposition, a profit formula, key resources, and key processes. Such descriptions undoubtedly help executives evaluate business models, but they impose preconceptions about what they should look like and may constrain the development of radically different ones.

Our studies suggest that one component of a business model must be the choices that executives make about how the organization should operate—choices such as compensation practices, procurement contracts, location of facilities, extent of vertical integration, sales and marketing initiatives, and so on. Managerial choices, of course, have consequences. For instance, pricing (a choice) affects sales volume, which, in turn, shapes the company’s scale economies and bargaining power (both consequences). These consequences influence the company’s logic of value creation and value capture, so they too must have a place in the definition. In its simplest conceptualization, therefore, a business model consists of a set of managerial choices and the consequences of those choices.

Companies make three types of choices when creating business models. Policy choices determine the actions an organization takes across all its operations (such as using nonunion workers, locating plants in rural areas, or encouraging employees to fly coach class). Asset choices pertain to the tangible resources a company deploys (manufacturing facilities or satellite communication systems, for instance). And governance choices refer to how a company arranges decision-making rights over the other two (should we own or lease machinery?). Seemingly innocuous differences in the governance of policies and assets influence their effectiveness a great deal.

Consequences can be either flexible or rigid. A flexible consequence is one that responds quickly when the underlying choice changes. For example, choosing to increase prices will immediately result in lower volumes. By contrast, a company’s culture of frugality—built over time through policies that oblige employees to fly economy class, share hotel rooms, and work out of Spartan offices—is unlikely to disappear immediately even when those choices change, making it a rigid consequence. These distinctions are important because they affect competitiveness. Unlike flexible consequences, rigid ones are difficult to imitate because companies need time to build them.

Take, for instance, Ryanair, which switched in the early 1990s from a traditional business model to a low-cost one. The Irish airline eliminated all frills, cut costs, and slashed prices to unheard-of levels. The choices the company made included offering low fares, flying out of only secondary airports, catering to only one class of passenger, charging for all additional services, serving no meals, making only short-haul flights, and utilizing a standardized fleet of Boeing 737s. It also chose to use a nonunionized workforce, offer high-powered incentives to employees, operate out of a lean headquarters, and so on. The consequences of those choices were high volumes, low variable and fixed costs, a reputation for reasonable fares, and an aggressive management team, to name a few. (See “Ryanair’s Business Model Then and Now.”) The result is a business model that enables Ryanair to offer a decent level of service at a low cost without radically lowering customers’ willingness to pay for its tickets.

Ryanair’s Business Model Then and Now

This depiction of Ryanair’s business model in the 1980s highlights the airline’s major choices at the time: offering excellent service and operating with a standardized fleet. The airline was forced to redesign its business model in the face of stiff competition.

Ryanair’s current business model rests on the key choices of offering customers low fares and providing nothing free. The rigid consequences include a reputation for fair fares and low fixed costs. Ryanair’s choices are aligned with its goals, generate cycles that reinforce the business model, and are robust given that it has been operating as a low-cost airline for 20 years.

Is it aligned with company goals?

The choices made while designing a business model should deliver consequences that enable an organization to achieve its goals. This may seem obvious until you consider a counterexample. In the 1970s, Xerox set up Xerox PARC, which spawned technological innovations such as laser printing, Ethernet, the graphical user interface, and very large scale integration for semiconductors. However, Xerox PARC was notoriously unable to spawn new businesses or capture value from its innovations for the parent due to a distressing lack of alignment with Xerox’s goals.

The choices that executives make while creating a business model should complement one another; there must be internal consistency. If, ceteris paribus, a low-cost airline were to decide to provide a level of comfort comparable to that offered by a full-fare carrier such as British Airways, the change would require reducing the number of seats on each plane and offering food and coffee. These choices would undermine the airline’s low-cost structure and wreck its profits. When there’s a lack of reinforcement, it’s possible to refine the business model by abandoning some choices and making new ones.

Business Strategy Examples

I’d like to wrap up this article with a collection of short examples extracted from the book, showing each of the strategies we have discussed above in action and applied to a real-life business:

Differentiation Strategy

The goal of a differentiation strategy is not to “compete” with rivals and take them out of business but quite the opposite: its goal is to avoid frontal competition by being unique, and a perception map as we saw earlier can help us do that.

For example, Dr Pepper Snapple Group (NYSE: DPS) owns more than 50 brands of flavored beverages including 7Up, Canada Dry, Snapple, Mott’s, Hawaiian Punch, Orange Crush and Sunkist, all of which occupy leadership positions in the very crowded and competitive refreshment drink shelves.

Different brands belonging to DR Pepper Snapple group. This is at the core of their differentiation strategy.

These products, however, are unique in what they offer and are positioned in their buyers’ minds as top brands in their respective categories, and DPS didn’t need to destroy Coke or Pepsi to achieve its position.

Strategic product re-positioning

If you find yourself in a dogfight over commoditized offers, you can still find a way out by focusing on narrower segments of customers or flipping to a low-price leadership strategy within that segment.

For decades since its introduction in the late 1800s Ivory, a soap bar manufactured by Procter & Gamble (P&G), enjoyed a privileged differentiation leadership position, being the brand that defined and resembled what “cleanness” meant in the soap category.

But when new deodorant soaps and “beauty bars” like Dial and Dove, which featured deodorant and skin care ingredients, became serious competitors in the mid 60s, P&G decided to reposition its iconic brand to become the low-price leader in the soap market, rather than engaging in head-to-head competition with the new entrants.

Ivory re-positioning strategy

The idea of repositioning is to zig when they zag. If low-price competition is tough, then slowly move onto a differentiated position or vice versa. If neither position works, narrow your target segment and move to a niche approach and restart the whole strategy process again.

Low-price leadership and strategy

In the case of Ivory, for example, the air bubbles that helped the soap float also helped reduce costs because the soap needed less materials, which in addition to basic wrapping, lack of deodorant and scent ingredients and low promotion, helped the product achieve costs advantages that other soap bars could not even dream of.

Market penetration strategy

Miller ad to increase appeal to male markets. A big shift in their market strategy.

Don’t forget that customer segments are just categorizations that YOU choose and there are many ways to go about it. So when a market is not growing, slicing it in a different way may help find new segments that could find the product valuable.

Market development strategy

When trying to target new markets, what you must look for is groups of people that could use the benefits of your solutions, but that for any number of reasons haven’t been targeted by your current market segmentation strategy.

Through Nespresso, Nestlé found a way to capture an entirely new market for its coffee: customers who preferred to make a great cup of fresh java at home, rather than having to get in their car or wait in line to buy one.

In this perfectly crafted business strategy, Nestlé created a great “vehicle” to deliver its coffee products making them a perfect match for each other, reminding us a bit of the success of Gillette’s famous razor and blade business model, where the company would make money from the blades, not the razor.

Strategic product improvements

This is the most common type of innovation and the one most people are familiar with. Things like “whiteness” in toothpaste, download speed in internet services, or storage capacity in computers are all good examples of linear product improvements, where every new product just offers more of it.

Basic structure of a corporate venture capital deal

Best Business Strategy Books

The content of this article has been extracted from Strategy for Executives™, a book that provides a fundamental, but practical, framework to understand and create a solid business’s strategy from scratch, applicable to the dynamic conditions that modern executives face in pretty much every market today.

There are many great business strategy books to choose from, including our all-time favorites The Innovator Solution by Clayton Christensen and Understanding Michael Porter by Joan Magretta, but why go through all these different frameworks and ideas, some of them outdated, when you can get a unified map to business strategy that incorporates all of them in a single framework?

Strategy for Executives, which is now free to download here, is based on extensive multi-year research, where we broke down the most popular strategy frameworks of the last 40 years, extracted their core ideas, and tied them all together into a single didactical and self-contained body of knowledge.

The research was led by Sun Wu, a seasoned Fortune 500 executive with more than 15 years of real-life experience, complemented by a thorough revision of more than 300 books and research papers, and over 500 hours of videos, interviews and formal training.

The result is a combination of fundamental concepts and a concise map to the strategy choices that modern executives have to make to thrive in today’s highly competitive markets.

Download Strategy for Executives book


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