As a critical source of competitive advantage, innovation certainly deserves the attention it receives.  But innovation is also notoriously difficult to manage.  And while recognized innovators are widely admired for their achievements, every business leader knows that the pursuit of innovation is exceptionally challenging even as it is entirely necessary.

The roots of the problem lie in the fact that innovation takes place at the crossroads of two critical uncertainties:  uncertainty about the future, and uncertainty about what will be best for our organization.

Given these issues, executives face two key questions:

• First, What innovations should our organization be pursuing?
• And second, How should we create them?

We respond by noting that among the four types of innovation that any firm could pursue (more detail on this below), business model innovation should be highly attractive and pursued aggressively.  Why?  Because business model innovators are earning very attractive returns on capital, and finding new market opportunities that others have overlooked.

But business model innovation is also widely misunderstood, and consequently few organizations are reaping the significant benefits that can come from doing it well.

We’ve been thinking about this for some time, and working to understand why business model innovation may be important for every company.  We’re also working on a systematic program to organizations develop breakthrough business models of their own.

Four Types of Innovation

Organizations typically must allocate their innovation investments among four types of innovation:  incremental, breakthrough, new venture, and business model. (This is spelled out in considerable detail in Permanent Innovation.)

•  The purpose of incremental innovation is to maintain market share.  But it’s a maintenance strategy, and rarely confers much of an advantage.  It’s necessary, to be sure, but by no means is it sufficient to support growth.
•  The search for breakthroughs offers a shot at stardom, but as they are quite rare, pursuing breakthroughs is a properly recognized to be a high risk approach.
•  Successful new ventures can position a company for the very long term, but they are also high risk, capital intensive, and for good reasons they are rarely attempted.
•  In today’s business environment, this leaves the fourth option as the most attractive:  business model innovation can be not only the most cost-effective form of innovation, but for most firms it’s also the most promising route to success.

Recent research by IBM has shown that business model innovators are earning the most attractive returns on innovation investment, and also achieving the best rates of growth.

In fact, if you look at the most successful and admired companies of the last twenty years, you see that most of them have focused on developing innovative business models.  What company would not want to be included on this list of business model innovators:  Amazon.com, Apple, Costco, Fedex, Google, Ikea, Southwest Airlines, Starbucks, Wal-Mart, and Zara are 10 of the world’s most successful companies, and business model innovation has been the key to the success of each one.

Defining Business Model Innovation

But what exactly is a business model?

At its simplest, a business model simply describes how a company makes money.  It’s the products and services it offers, the way it delivers them, and through these elements it is the experiences that it creates for customers.

Business model innovators just find ways to create better experiences for their customers, and as a result of doing so the most successful among them earn profits that others did not recognize as even possible.

For example:

• Google discovered how to sell words at auction, a new business model that transformed the company into the world’s number one advertising agency, and soon thereafter into one of its most admired companies.
• Amazon.com developed a new business model for selling products online, has radically reshaped the book business, and is now working to extend its model into every market.
• Apple found a tremendously successful way to sell songs through iTunes, permanently reshaping the music industry.
• Fedex set up a system that delivers packages for ten to fifty times more than the Postal Service charges.
• Southwest Airlines sells airplane tickets for less than its competitors, but it has nevertheless been the most consistently profitable US airline for two decades.
• Wal-Mart, Costco, and Ikea, meanwhile, developed global manufacturing and supply chains that enable them to sell enormous quantities of products at prices once thought unattainably low, undercutting their competitors and redefining the very nature of retail.

To reiterate the point made above, the core of each success is that these companies found new ways to earn profits by providing their customers with new and better experiences.

Further, the experiences provided by their innovative business models have resulted in enduring relationships that transcended traditional boundaries between customers and companies, and as a result each transformed the industry in which it competes, permanently altering the competitive landscape while becoming a renowned leader.

If business model innovation is the goal, and for most companies the evidence strongly suggests that it should be, then we need a way to get there.

InnovationLabs is developing a set of analytical tools, exercises, and worksheets to help our clients develop a true master plan for business model innovation.  (Our complete set of innovation worksheets now numbers approximately 100 exercises.)

This process of 8 steps enables executives to understand the key drivers of business model innovation, and to apply them to develop business model innovations of their own.

1. The Business Model Universe
2. The External Drivers of Change
3. The Customer Experience Model
4. Core and Edge Markets Analysis
5. Market Leader Analysis
6. Competitor Analysis:  Jobs to Do
7. Who Innovates?
8. Putting it All Together: The Complete Business Model Innovation Master Plan

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In future posts I will be expanding upon the process and these 8 steps. If you have any thoughts or comments on the importance of business model innovation in your industry, or on the process steps mentioned here, I would love to hear from you.

This is also the topic of my current book project, The Innovation Master Plan:  How to Create a Winning Business Model. Please click on this link to go to the page where I am posting portions of the work-in-progress and inviting reader feedback.  Thank you!

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