Business Model Innovation

Innovation isn’t new of course, and there’s nothing fundamentally new about companies and individuals introducing new technologies that improve upon existing products and processes. The automobile, for example, was a revolutionary technological innovation when it was introduced but wasn’t truly disruptive of the transportation market because it was, initially, an expensive luxury item for the social elite. The truly disruptive innovation was a business model innovation -mass production – which introduced the Model-T Ford to the masses, and in the process transformed transportation from a horse-drawn to electro-mechanical market.

Innovation at the level of the business model then, is innovation that helps create new markets and value networks, eventually displacing existing markets and value networks. This transformation has traditionally taken many years to play out but that is changing, and changing fast.

What we are witnessing today is something of a Cambrian explosion of business model innovation that is changing not just how the game is played but the game itself. New technologies are eroding boundaries between industries and markets that were once considered distinct. In the process, new entrants are creating wealth on an unprecedented scale.

Let us consider three recent examples:

1. Uber.  In just five years Uber, the app-based transportation service, has emerged as one of the most valuable private companies in the world with a $40 billion market capitalization that well exceeds that of several publicly held transport companies (e.g., Delta Air Lines, American Airlines and United Continental), and several traditional car rental services (e.g., Hertz and Avis).

Uber has transformed the taxi market in more than 230 cities in 51 countries without owning a single car. Instead it has harnessed “big-data” with a smartphone app to create a marketplace that seamlessly connects independent drivers with passengers. In its home base in San Francisco traditional taxi rides have fallen by about two thirds in less than two years.

With a series of multi-billion dollar private financings behind it, Uber is looking to expand – not just to new geographies but also new markets as it experiments with transporting more than just people. In short, Uber is looking to disrupt urban logistics.

2. The Lending Club.  Founded in 2006, the Lending Club was conceived as a simple idea – using an online platform to match borrowers and lenders directly, cutting out the middleman banker, to offer cheaper loans to consumers that generate higher returns for lenders.

Renaud Laplanche, Lending Club’s CEO, had the foresight to exploit profound changes in the financials services market. The financial crisis of 2008 had eroded public trust in traditional banking institutions and the low interest rate regime had attracted professional investors looking for higher yield loans.

Eight years later the Lending Club is now the pre-eminent “per-to-peer” marketplace lender having processed over $6 billion of loans through its platform. A $1 billion IPO in December 2014 rewarded the Lending Club with a market capitalization of about $9 billion.

3. Xiaomi.  Just three years after it launched its first product, this Chinese smartphone maker has emerged as one of the most valuable private companies in the world with a market capitalization of $45 billion.

In 2014 Xiaomi overtook Samsung as the leading smartphone vendor (by volume) in China and became the world’s third largest vendor overall, after Apple.

Xiaomi is remarkable not just because of its enormous sales volume but also because of how it sells in those markets. By using social media campaigns and a flash-sales model built around successive product releases Xiaomi is often able to sell out of new products in minutes. Effectively it is supply rather than demand constrained.

Xiaomi’s growth strategy extends beyond expanding into new high-volume markets (e.g., India and Malaysia). It is intent on expanding its product portfolio too to include wearables (e.g., fitness tracking wristbands) online video content and TV set-top boxes.

As each of these examples illustrate, it’s innovation at the level of the business model which drives the most profound change and is creating vast new wealth.

And while its true that new entrants often pioneer this disruption, incumbents needn’t be hostages to their own history. Unfortunately, many incumbents pursue business model innovation as a defensive move to defend against new entrants or to protect a legacy business. In order to remain relevant and renew competitive advantage however, incumbents must embrace business model innovation as a route to growth.

While business model innovation may be more challenging than product or process innovation, it delivers superior returns. A recent survey conducted by BusinessWeek and the Boston Consulting Group concluded that business model innovation drove an annual return to shareholders that was four times greater than that achieved by product or process innovators.


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