Business and Business model – 3

The debate over the relevance and usefulness of the concept of business models has had a sidebar discussion on strategy and whether and how it differs from a business model. There is a vast literature on strategy but I am focusing here only on trying to evaluate the link and difference between strategy and business model. Without getting caught in hair-splitting, we must use the two to help think more clearly on what affects sustaining businesses. That is the goal and not an insular attention to the two keys.

According to Joan Magretta, in ‘Why Business Models Matter’, HBR May 2002, “To see the distinction between a strategy and a business model, you need only look at Wal-Mart”. A little later, she says: “From the very start, for instance, Walton chose to serve a different group of customers in a different set of markets. The ten largest discounters in 1962, all gone today, focused on large metropolitan areas and cities like New York. Wal-Mart’s “key strategy”, in Walton’s own words, “was to put good-sized stores into little one-horse towns which everybody else was ignoring.” He sought out isolated rural towns, like Rogers, with populations between 5,000 and 25,000. The nearest city was probably a four-hour drive away. He rightly bet that if his stores could match or beat the city prices, “people would shop at home.” And since Wal-Mart’s markets tended to be too small to support more than one large retailer, Walton was able to preempt competitors and discourage them from entering Wal-Mart’s territory.

Wal-Mart also took a different approach to merchandising and pricing than its competitors did—that is, it promised customers a different kind of value. While competitors relied heavily on private label goods, second-tier brands, and price promotions, Wal-Mart promised national brands at everyday low prices. To make this promise more than a marketing slogan, the company pursued efficiency and reduced costs through innovative practices in areas such as purchasing, logistics, and information management”.

Again a little later here is Magretta. “Unlike Sam Walton, Michael Dell was a true business-model pioneer. The model he created is, by now, well known: While other personal-computer makers sold through resellers, Dell sold directly to end customers. That not only cut out a costly link from the value chain, it also gave Dell the information it needed to manage inventory better than any other company in its industry. And because the pace of innovation in the industry was intense, Dell’s inventory advantage meant it could avoid the high cost of obsolescence that other computer makers had to bear”.

In “How to Design a Winning Business Model”, Ramon Casadesus-Masanell and Joan E. Ricart (HBR January–February 2011) argue in favour of business models as being the more important concept than strategy but their definition is perilously close to strategy which they acknowledge ((https://hbr.org/2011/01/how-to-design-a-winning-business-model). You may follow the link and see for yourself.

Meanwhile, I am thinking of business model itself as strategy. Indian IT firms cost as strategic plank. Let me qualify that by saying that most Indian IT services firms have positioned themselves as building a sustainable business based on (lower) cost. It is true though that many of them have explicitly recognized the risks to this approach and have made transitions to different axis. The cost-focused approach has forced them to look for ways to maintain the overall staffing cost by exploiting the education hierarchy in India with wages and salaries often linked to the background of the educational institutions by resorting to students from Tier II and Tier III cities.  They have reinforced the strategic plank further by using other third-party staffing firms that come with a lower wages than its own, very similar to the model followed by FMCG companies of using contract manufacturing rather than add to their work force.

McDonald’s entry and growth in India used the franchisee model as its pivotal plank to build a sustainable and flourishing business. Since location was everything and key locations would have consumed the bulk of (fixed) capital, it made economic sense to co-opt the real estate owner as a key stakeholder. It saved upfront cash infusion and provided the key location. Is this strategy and business model together?

Let us take another example to probe a little more. In the aftermath of World War II, when all the Western economies were rebuilding, the US came out with an innovation: deferred finance or instalment sales. The consumer durable industry grew fueled by easy purchasing options. With growing incomes grew demand for comforts and luxuries. Students of public finance will recall that the income elasticity of demand for comforts and luxuries is greater than one. Makers of consumer durables capitalized on this by making it easy for people to buy many things. In fact, it became such a force of habit that EMI is the most distinguishing characteristic of the US economy. Now is this strategy or business model?

Summing up

Let us sum up the discussion and see where we stand.

Newspapers never used the term business model to explain how they earned revenue. Nor for that matter did hospitals which actively practice price discrimination as the core pillar of their business. Or take animation films where a large chunk of the business goes beyond the film and extends to all kinds of merchandise to such an extent that when a story is being evaluated for an animation film one critical consideration is the potential for merchandising. That is the way the business makes money.

So, why do people persist in using the term business model? I am not asking this question because it stands discredited because of its umbilical ties with the internet. However, the question is worth asking – how come this question got asked with the birth of the internet? In my opinion, for one reason and one reason only: there was a free element which seemed to be the business but the money was to be made from something else although connected to the ‘business’ – traffic or information or data which was ostensibly of value to someone else.

This is not an academic exercise or hair-splitting. A concept must serve some purpose; else, it is just verbiage. Does the concept of business model help us in anyway? Does it help us think better about businesses? Or can we think equally well if not better despite abandoning the concept? After all, our only interest is in understanding what drives a business, is it sustainable, what risks does it run now and likely to run later, where is the threat coming from, to mention a few. If the existing arsenal of concepts, tools and techniques are sufficient, why look for another?

I can’t fathom. And I will go back to Drucker and check. You may have other thoughts.

Takeaways

The distinction made between strategy and business model seems strained, forced

Advocates of each claim privileged position for their choice

The criteria can only be whether it advances our understanding

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