Business and Business model – 1

I was under the mistaken impression that the term ‘business model’ was a product of the internet world until a reflection on the businesses of newspapers and hospitals clarified that the operative concept of business model was used even earlier, even if the term itself wasn’t explicitly used. It also helped understand the difference between business and business model. In what follows, I am making an attempt to see what all can be thought through these to related concepts.

A correct definition or description often paves the way for clarity in thinking. Peter Drucker always asked anyone who consulted him – ‘What is your business?’ One famous example I have encountered as a Lecturer in Marketing four decades ago was of a company making bottles for the pharmaceutical industry. Drucker told them that they were in the business of packaging! Seemingly simple, it reoriented management thinking. Or what the business of cosmetics sells is ‘hope for beauty’. And so on. This is an extremely productive way of thinking about your business, because it also raises the connected question of what is the product – your business is cosmetics and your product is hope for beauty. Elegant and elemental!

It is not always easy though. Take newspapers for example. What is the product? The news or the news reader? Or rather how do we think about our business – from the perspective of the product (whatever that is) or the customer? Let us consider a business newspaper – is it a business newspaper or a newspaper for the businessman? Embracing the latter dramatically transformed The Economic Times towards the second half of 1990s; what it featured underwent significant changes. A change in the angle of vision can be decisive.

Be that as it may, the way a newspaper makes money furnishes a clue to the idea of a business model. The price per copy does not cover the cost of production; the money comes from advertising revenue. At least, it used to, until the advent of the internet pulled the rug from under the feet of many businesses. Not so much the internet per se but the fact that users did not have to pay. And this crucial change spawned other ‘business models’. For all its ‘innovation’, Google just copied the business model of the newspaper business, making its money through advertising, with a twist though. Typically, newspapers (or television) charged a certain fee irrespective of whether the advertisement was actually seen but Google’s model was based on ‘click per view’.
Or take a hospital. The axis on which the business of hospitals rests is price discrimination – different rates for different kinds of customers defined in reference to the room (or bed) they occupy – general ward or sharing or single room. Everything that a patient needs to get done is indexed to the room (tariff) – be it some diagnostic test, surgery, doctors’ visits or whatever. The business will collapse if it chose to charge the same tariff to all patients. In sum, price discrimination is the hospital’s business model. No one ever called it so; that’s how the business is run.

Or an example from the technology age – Dell PCs. While PC makers then were selling through resellers, Michael Dell chose to sell directly to customers with customers placing orders online. Dell’s innovation is a great example of making a virtue out of necessity – Michael Dell probably didn’t have the capital to set up a factory and perhaps would not have fancied the chances of raising the funds. Either factor made him think afresh on how to make and deliver personal computers to customers. The lower prices of Dell PCs were an outcome of the choice of business model, not a strategic plank.

The theory of business
Peter Drucker, the sage of management thinking, never used the term business model. In a justly famous article titled ‘The theory of business’ (Harvard Business Review, September-October 1994), Drucker describes what he calls a company’s theory of business. Let me quote this at length.

“Every organization, whether a business or not, has a theory of the business. Indeed, a valid theory that is clear, consistent, and focused is extraordinarily powerful. In 1809, for instance, German statesman and scholar Wilhelm von Humboldt founded the University of Berlin on a radically new theory of the university. And for more than 100 years, until the rise of Hitler, his theory defined the German university, especially in scholarship and scientific research. In 1870, Georg Siemens, the architect and first CEO of Deutsche Bank, the first universal bank, had an equally clear theory of the business: to use entrepreneurial finance to unify a still rural and splintered Germany through industrial development. Within 20 years of its founding, Deutsche Bank had become Europe’s premier financial institution, which it has remained to this day in spite of two world wars, inflation, and Hitler. And, in the 1870s, Mitsubishi was founded on a clear and completely new theory of the business, which within 10 years made it the leader in an emerging Japan and within another 20 years made it one of the first truly multinational businesses.

Similarly, the theory of the business explains both the success of companies like General Motors and IBM, which have dominated the U.S. economy for the latter half of the twentieth century, and the challenges they have faced”.

This ‘theory of business’ is based on certain assumptions about markets, identifying customers and competitors, about technology and its dynamics, about a company’s strengths and weaknesses. As he makes it clear, “These assumptions are about what a company gets paid for. They are what I call a company’s theory of the business”. As he goes on to discuss, problems arise when these assumptions need to be replaced but aren’t. Companies that remain prisoners of outdated and outmoded assumptions fall by the wayside and those that recognize the incompatibility of assumptions to the changed environment and reorganize their businesses continue to prosper.
Thus, whether you subscribe to a notion of business model or not, what is important is to think through and think afresh the organization’s business in a changed environment, the change being caused by new technology, entry of new players, changed regulation or whatever. What you cannot afford is to remain a prisoner to what has become obsolescent. Well, you can and move into the past tense.

Having sounded this warning, let us now examine the concept of business model and its relevance.

Takeaways

Businesses have not always used the term business model

Changes ushered in by the internet

Important to grasp the assumptions underlying any business

Continuous re-examination is the price of sustained success

You can read part 2, 3 and 4 of this article by clicking on the buttons below: